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LEGAL AND REGULATORY ASPECTS OF BANKING 2nd Edition

INDIAN INSTITUTE OF BANKING & FINANCE
MACMILLAN 'THE ARCADE', WORLD TRADE CENTRE, CUFFE PARADE
MUMBAI400005
Established on 30th April 1928
MISSION
• To develop professionally qualified and competent bankers and financial
professionals primarily through a process of education, training, examination,
consultancy/counselling and continuing professional development programs.
VISION
• To be the premier Institute for developing and nurturing competent
professionals in banking and finance field.
OBJECTIVES
• To facilitate study of theory and practice of banking and finance.
• To test and certify attainment of competence in the profession of banking and
finance.
• To collect, analyse and provide information needed by professionals in banking
and finance.
• To promote continuous professional development.
• To promote and undertake research relating to Operations, Products,
Instruments, Processes, etc., in banking and finance and to encourage innovation and
creativity among finance professionals so that they could face competition and succeed.
COMMITTED TO PROFESSIONAL EXCELLENCE Website: www.iibf.org.in
LEGAL & REGULATORY ASPECTS OF BANKING

(For JAIIB/Diploma in Banking & Finance Examination)
2nd Edition
Indian Institute of Banking & Finance
MACMILLAN
© INDIAN INSTITUTE OF BANKING & FINANCE, MUMBAI, 2005, 2008
(This book has been published by Indian Institute of Banking & Finance. Permission of
the Institute is essential for reproduction of any portion of this book. The views
expressed herein are not necessarily the views of the Institute.)
All rights reserved. No part of this publication may be reproduced or transmitted, in any
form or by any means, without permission. Any person who does any unauthorised act
in relation to this publication may be liable to criminal prosecution and civil claims for
damages.
J-'im t'tlitiim. 2005 Second edition, 2008 Reprinted, 2008 2009 (twice)
MACMILLAN PUBLISHERS INDIA LIMITED
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Madurai Chandigarh
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Companies and representatives throughout the world
ISBN 10:0230-63610-1 ISBN 13:978-0230-63610-1
Published by Rajiv Beri for Macmillan Publishers India Limited,
2/10 Ansari Road, Daryaganj, New Delhi 110 002
Printed by S.M. YOGAN at Macmillan India Press, Chennai 600 041.
LEGAL & REGULATORY ASPECTS OF BANKING
Originally prepared by K.D. Zacharias (Module A), C.P. Ravindranath (Module B), P.R.
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8/18/2019 JAIIB-MACMILLAN EBOOK-LEGAL AND REGULATORY ASPECTS OF BANKING.pdf
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- CAIIB DISCUSSION
Kulkarni (Module C), B. Gopalakrishnan (Module D) under the guidance of M.L.

Chandak, Advocate, High Court, Mumbai.
Revised and updated by K.D. Zacharias, Legal Adviser, RBI (Module A), G.M.
Ramamurthy, Legal Adviser, IDBI Ltd. (Modules B, C and D)
This book is meant for educational and learning purposes. The author(s) of the book
has/have taken all reasonable care to ensure that the contents of the book do not violate
any existing copyright or other intellectual property rights of any person in any manner
whatsoever. Jn the event the author(s) has/have been unable to track any source and if
any copyright has been inadvertently infringed, please notify the publisher in writing for
corrective action.
FOREWORD
The world of banking and finance is changing very fast and banks are leveraging
knowledge and technology in offering newer services to the customers. Banks and
technology are evolving so rapidly that bank staff must continually seek new skills that
enable them not only to r espond to change, but also to build competence in handling
various queries raised by customers. Therefore, there is a need for today's bank
employees to keep themselves updated with a new set of skills and knowledge.
The Institute, being the main provider of banking education, reviews the syllabus for its
associate examinations viz. JAIIB/CAIIB and various other examinations with the help
of Expert Groups from time to time to make the contents relevant and contemporary in
nature. The latest revision has been done by an expert group under the Chairmanship of
Prof. Y.K. Bhushan. This book and the other two books mentioned below are the
courseware for JAIIB which aims to impart up-to-date knowledge in the field of banking
and finance and equip the bankers to face the emerging challenges of today and
tomorrow.
As there is a growing demand for qualified manpower in the banking sector with accent
on banking knowledge and skills, together with technology-familiarity, customer-
orientation and hands-on application skills - which will substantially reduce the training
intervention at the bank level before/immediately after they are employed - the institute
has launched
candidates. the Diploma
Candidates in Banking
to the & Finance
course will in 2007
get extensive andfordetailed
graduation-plus
knowledgelevel
on
banking & finance and details of banking operations. The Diploma is offered in the
distance learning mode with a mix of educational support services like provision of
study kits, contact classes, etc. The key features of the Diploma is that it aims at
exposing students to real-life banking environment and that it is equivalent to JAIIB.
The JAIIB and the Diploma in Banking & Finance has three papers viz.
1. Principles & Practices of Banking
2. Accounting & Finance for Bankers
3. Legal & Regulatory Aspects of Banking
This book, the courseware for the third paper on Legal & Regulatory Aspects of
Banking, deals with legal and regulatory aspects that have a bearing on banking
operations, and are woven in to the units/chapters to make their relevance easily
understandable. Banking and business laws insofar as they relate to day-to-day banking
operations, have also been covered at appropriate places. Case laws are included,
wherever appropriate. There are various newly enacted laws like Anti-money
Laundering Act, Right to Information Act, Information Technology Act, etc., which
have significantly changed the way banking operations are done, and these laws are
explained in simple terms as needed to be understood by a practicing banker.
The Institute had constituted teams consisting of eminent bankers and academicians to
prepare the reading material for all the subjects as self-instructional study kits obviating
the need for the intervention of a teacher. This book represents the outcome of this
endeavour to bring out self-contained comprehensive courseware/book on the subject.
The Institute acknowledges with gratitude the valuable services rendered by the authors
- CAIIB DISCUSSION
in preparing the courseware in a short period of time.
VI
The team, who developed the book, has made all efforts to cover the entire syllabus
prescribed for the subject. However, the candidates could still refer to a few standard
textbooks to supplement this material which we are sure, will enhance the professional
competence of the candidates to still a higher degree. We have no doubt that the study
material will be found useful and will meet the needs of the candidates to prepare
adequately for the examinations. In addition, we are sure that these books will also be
useful to practitioners, academicians, and other interested readers.
We welcome suggestions for improvement of the book.
Mumbai 3-7-2008
R. Bhaskaran
Chief Executive Officer
RECOMMENDED READING
The Institute has prepared comprehensive courseware in the form of study kits to
facilitate preparation for the examination without intervention of the teacher. An attempt
has been made to cover fully the syllabus prescribed for each module/subject and the
presentation of topics may not always be in the same sequence as given in the syllabus.
Candidates are also expected to take note of all the latest developments relating to the
subject covered in the syllabus by referring to Financial Papers, Economic Journals,
Latest Books and Publications in the subjects concerned.
PAPER 3-
LEGAL&REGULATORY ASPECTS OF
BANKING
Objectives: The candidates would be able to acquire knowledge in:
• The legal & regulatory framework of the banking system and
• The various laws and enactments affecting day-to-day banking operations
MODULE, A.-REGULATIONS &COMPLIANCE

• The questions in this section will be with reference to legal issues and problems.
A. Provisions of RBI Act 1935, Banking Regulation Act 1949, Banking
Companies [Acquisition and Transfer of Undertakings Act 1970 & 1980].
B. Government and RBIs Powers:
-- Opening of New
Constitution Banksofand
of Board Branchand
Directors Licensing
their Rights
- Banks Shareholders and their Rights
- CRR/SLR Concepts
- Cash/Currency Management
• Winding Up - Amalgamation and Mergers

• Powers to Control Advances - Selective Credit Control - Monetary and Credit
Policy
• Audit and Inspection
- CAIIB DISCUSSION
• Supervision and Control-Board for Financial Supervision - Its Scope and Role
• Disclosure of Accounts and Balance Sheets
• Submission of Returns to RBI, etc.
• Corporate Governance
MODULE B - LEGAL ASPECTS OF BANKING OPERATIONS
• Case Laws on Responsibility of Paying/Collecting Banker
• Indemnities/Guarantees
- Scope and Application

- Obligations of a Banker
- Precautions and Rights
• Laws Relating to Bill Finance, LC and Deferred Payments

• Laws Relating to Securities
• Valuation of Securities - Modes of Charging Securities - Lien, Pledge,
Mortgage, Hypothecation,
etc.
• Registration of Firms/Companies
• Creation of Charge and Satisfaction of Charge
MODULE C - BANKING RELATED LAWS

• Law of Limitation
• Provisions of Bankers Book Evidence Act
• Special Features of Recovery of Debts Due to Banks and Financial Institutions
Act, 1993
• TDS and Service Tax
• Banking Cash Transaction Tax
• Asset Reconstruction Companies
• The Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest
Act,
• 2002The Consumer Protection Act, 1986
• Banking Ombudsman 2006
• LokAdalats
• Lender's Liability Act
MODULE D - COMMERCIAL LAWS WITH REFERENCE TO BANKING
OPERATIONS
• Indian Contract Act, 1872 (Indemnity, Guarantee, Bailment, Pledge and
Agency, etc.)
• The Sale of Goods Act, 1930 (Sale and Agreement to Sell, Definitions,
Conditions and Warranties,
Express and Implied, Right of Unpaid Seller, etc.)
• The Companies Act, 1956, Definition, Features of Company, Types of
Companies, Memorandum,
Articles of Association, Doctrines of Ultra Vires, Indoor Management and Constructive
Notice,
Membership of Company - Acquisition - Cessation, Rights and Duties of Members and
Register of
Members, Prospectus and Directors.
• Indian Partnership Act, 1932, Definition and Types of Partnership, Relation of
Partners to One
Another-Relation of Partners to Third Parties, Minor Admitted to the Benefits of
Partnership,
Dissolution of Firm, Effect of Non-Registration
- CAIIB DISCUSSION
• The Transfer of Property Act

• Foreign Exchange Management Act, 2000
• Prevention of Money Laundering Act, 2002
• Right to Information Act, 2005
• Information Technology Act, 2000
CONTENTS
Foreword v
MODULE A - REGULATIONS AND COMPLIANCE
1. Legal Framework of Regulation of Banks 3
2. Control Over Organisation of Banks 15
3. Regulation of Banking Business 31
4. Returns, Inspection, Winding Up 49
5. Public Sector Banks and Co-operative Banks 65
MODULE B - LEGAL ASPECTS OF BANKING OPERATIONS
6. Case Laws on Responsibility of Paying Bank 83
7. Case Laws on Responsibility of Collecting Bank 93
8. Indemnities 101
9. Bank Guarantees 107
10. Letters of Credit 119

11. Deferred Payment Guarantee 131
12. Laws Relating to Bill Finance 135
13. Various Types of Securities 143
14. Law Relating to Securities and Modes of Charging -1 •
155
15. Law Relating to Securities and Modes of Charging - II 163
16. Different Types of Borrowers 173
17. Types of Credit Facilities 181
18. Secured and Unsecured Loans, Registration of Firms, Incorporation of
Companies
19. 187 and Satisfaction of Charges
Registration 197
MODULE C - BANKING RELATED LAWS
SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS
AND ENFORCEMENT OF SECURITY INTEREST, 2002
(SARFAESI ACT)
20. Introduction to SARFAESI Act, 2002 205
21. Definitions at SARFAESI Act, 2002 209
22. Regulation of Securitisation and Reconstruction of Financial Assets of
Banks and Financial Institutions 219
xii
23. Enforcement of Security Interest

24. Central Registry
25. Offences and Penalties
26. Miscellaneous Provisions
THE BANKING OMBUDSMAN SCHEME, 2006
27. Purpose, Extent, Definitions, Establishment and Powers
28. Procedure for Redressal of Grievances
RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL INSTITUTIONS ACT,
1993 (DRTACT)
29. Preliminary
30. Establishment of Tribunal and Appellate Tribunal
- CAIIB DISCUSSION
31. Jurisdiction, Powers and Authority of Tribunals

32. Procedure of Tribunals
33. Recovery of Debts Determined by Tribunal and Miscellaneous Provisions
THE BANKERS' BOOKS EVIDENCE ACT, 1891
34. The Bankers' Books Evidence Act, 1891
THE LEGAL SERVICES AUTHORITIES ACT, 1987
35. LokAdalats
THE CONSUMER PROTECTION ACT, 1987
36. Preliminary, Extent and Definitions
37. Consumer Protection Councils
38. Consumer Disputes Redressal Agencies
THE LAW OF LIMITATION
39. Limitations of Suits, Appeals and Applications
TAX LAWS
40. Income Tax, Banking Cash, Transaction Tax, Fringe Benefit Tax and Service
Tax
231 241 245 249

255 259
267 271 275 279 285
293 299
303 311 315
327 331
MODULE D - COMMERCIAL LAWS WITH REFERENCE TO BANKING

OPERATIONS
41. Meaning and Essentials of a Contract

42. Contracts of Indemnity
43. Contracts of Guarantee
44.
45. Contract
Contract of
of Bailment
Pledge
46. Contract of Agency
47. Meaning and Essentials of a Contract of Sale
48. Conditions and Warranties
341 345 347 353 357 359 365 369
XIII
49. Unpaid Seller

50. Definition, Meaning and Nature of Partnership
51. Relations of Partners to One Another
52. Relations of Partners to Third Parties
53. Minor Admitted to the Benefits of Partnership
54. Dissolution of a Firm
55. Effect of Non-Registration
56. Definition and Features of a Company
57. Types of Companies
58. Memorandum of Association and Articles of Association
59. Doctrines of Ultra Vires/Constructive Notice/Indoor Management
60. Membership
61. Prospectus
62. Directors
- CAIIB DISCUSSION
63. Foreign Exchange Management Act, 1999

64. Transfer of Property Act, 1882
65. The Right to Information Act, 2005
66. Right to Information and Obligations of Public Authorities
67. The Prevention of Money Laundering Act, 2002
68. Information Technology Act, 2000
Bibliography
373 377 381 385 389 393 397 399 405 411 415 419 425 429 437 443 453 457 463 469
475
MODULE-A REGULATIONS AND COMPLIANCE

Unit 1. Legal Framework of Regulation of Banks
Unit 2. Control over Organisation of Banks
Unit 3. Regulation of Banking Business
Unit 4. Returns, Inspection, Winding Up
Unit 5. Public Sector Banks and Co-operative Banks
Unit 1 LEGAL FRAMEWORK OF REGULATION

OF BANKS
STRUCTURE
1.0 Objectives
1.1 Introduction
1.2 Business of Banking
1.3 Constitution of Banks
1.4 Reserve Bank of India Act, 1934
1.5 Banking Regulation Act, 1949
1.6 Reserve Bank as Central Bank and Regulator of Banks
1.7 Government as a Regulator of Banks
1.8 Control Over Co-operative Banks
1.9 Regulation by Other Authorities
1.10 Let Us Sum Up
1.11 Keywords
1.12 Check Your Progress
1.13 Answer to 'Check Your Progress'
1.14 Terminal Questions
1.0 OBJECTIVES
The objectives of this Unit are to understand:
• the definition and nature of the business of banking;
• the constitution of different types of banks;
• the regulatory scheme of the RBI Act and the BR Act;
• the role of the Reserve Bank and the Central Government as regulators; and
• the special position of public sector banks and co-operative banks.
- CAIIB DISCUSSION
1.1 INTRODUCTION
Banking in India is mainly governed by the Banking Regulation Act, 1949 and the
Reserve Bank of India Act, 1934. The Reserve Bank of India and the Government of
India exercise control over banks from the opening of banks to their winding up by
virtue of the powers conferred under these statutes.
All the regulatory provisions are not uniformly applicable to all banks. The applicability
of the provisions of these Acts to a bank depends on its constitution; that is, whether it is
a statutory corporation, a banking company or a co-operative society. In this unit, we
look at the definition of banking, the constitution of different types of banks and
applicability of regulatory laws, the general framework of the regulatory laws and the
role of regulators namely, the Reserve Bank of India and the government.
1 .2 B U S IN E S S O F B A N K I N G
i. Definition of Banking: Banking is defined in Section 5(b) of the Banking Regulation
Act as the acceptance of deposits of money from the public for the purpose of lending or
investment. Such deposits may be repayable on demand or otherwise and withdrawable
by cheque, draft, order or otherwise. Thus, a bank must perform two essential functions:
i) acceptance of public deposits, and ii) lending or investment of such deposits. The
deposits may be repayable on demand or for a period of time as agreed by the banker
and the customer. In terms of the definition, the banker can accept "deposits" of mone y
and not anything else. Further, accepting deposits from the "public" implies that a banker
accepts deposits from anyone who offers money for such purpose. However, a banker
can refuse to open account for undesirable persons and further, the opening of accounts
is subject to certain conditions like proper introduction and identification.
The "Know Your Customer" guidelines issued by the Reserve Bank require banks to
follow certain customer identification procedure for opening of accounts for protecting
the banks from frauds, etc., and also for monitoring transactions of a suspicious nature
for the purpose of reporting to appropriate authorities for taking anti-money laundering
measurers and combating financing of terrorism.
There is no exhaustive definition of "banking" in Common Law of England. However,
the usual characteristics of banking as identified by Lord Denning MR in United
Dominions Trust Ltd. vs Kirkwood ([1966] 1 All ER 968 at 975) are:
(a) the conduct of current accounts;
(b) the payment of cheques; and
(c) the collection of cheques for customers.
These characteristics are not equivalent to a definition, and these are also not the only
characteristics. (See, Paget's Law of Banking, 12th Edn., pp. 107 to 109)
ii. Deposits Withdrawable by Cheque: Under Section 49A of the Banking Regulation
Act, no organisation other than a bank is authorised to accept deposits withdrawable by
cheque. The Savings Bank
Scheme run by the government, a Primary credit society and any other person or firm
notified by the government are exempted from this prohibition.
iii. Acceptance of Deposits by Non-banking Entities: There are also non-banking
companies, firms and other unincorporated associations of persons and individuals who
accept deposits from the public. Acceptance of deposits by non-banking financial
companies is regulated by the Reserve Bank under the Non-Banking Financial
Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998 and other
directions issued by it under Chapter IIIB of the Reserve Bank of India Act. Other
companies are regulated by the Central Government under the Companies (Acceptance
of Deposit) Rules, 1975 issued under Section 58A of the Companies Act, 1956.
Individuals, firms and other unincorporated associations of persons whose business
- CAIIB DISCUSSION
includes the business of a financial institution or whose principal business is acceptance

of deposits, is prohibited under Section 45S of the RBI Act (as amended in 1997) from
accepting deposits from the public, except relatives. This prohibition does not apply to
acceptance of deposits by those who are mainly engaged in manufacturing or trading.
iv. Licence for Banking: In India, it is necessary to have a licence from the Reserve Bank
under Section 22 of the Banking Regulation Act for commencing or carrying on the
business of banking. Every banking company has to use the word "bank" as part of its
name (See, Section 7 of the Act) and no company other than a banking company can use
the words "bank", "banker", "banking" as part of its name. Further, no firm, individual or
group of individuals is permitted to use the words "bank", "banking" or "banking
company" as a part of the name or for the purpose of business. Subsidiaries of banks and
association of banks in certain cases as also Primary Credit Societies are exempted from
this r estriction.
v. Permitted Business: Although, traditionally, the main business of banks is acceptance
of deposits and lending, the banks have now spread their wings far and wide into many
allied and even unrelated activities. The forms of business permissible under Section
6(1) of the Banking Regulation Act, apart from banking business, are summarised
below:
(a) (i) Borrowing, raising or taking up of money;
(ii) Lending or advancing of money either upon security or without security;
(iii) Drawing, making, accepting, discounting, buying, selling, collecting and dealing in
bills of exchange, hundis, promissory notes, coupons, drafts, bills of lading, railway
receipts, warrants, debentures, certificates, scrips and other instruments and securities
whether transferable or negotiable or not;
(iv) Granting and issuing of letters of credit, travellers' cheques and circular notes;
(v) Buying, selling and dealing in bullion and specie;
(vi) Buying and selling of foreign exchange including foreign bank notes;
(vii) Acquiring, holding, issuing on commission, underwriting and dealing in stock,
funds, shares, debentures, debenture stock, bonds, obligations, securities and investments
of all kinds;
(viii) Purchasing
constituents and selling of bonds, scrips and other forms of securities on behalf of
or others;
(ix) Negotiating of loans and advances;
(x) Receiving of all kinds of bonds, scrips or valuables on deposit or for safe custody or
otherwise;
(xi) Providing of safe deposit vaults; and
(xii) Collecting and transmitting of money and securities.
(c) Contracting for public and private loans and negotiating and issuing the same.
(d) Insure, guarantee, underwrite, participate in managing and carrying out any
issue of state, municipal or other loans or of shares, stock, debentures or debenture stock
of companies and lend money for the purpose of any such issue.
(e) Carry on and transact every kind of guarantee and indemnity business.
(f) Manage, sell and realise any property which may come into its possession in
satisfaction of any of its claims.
(g) Acquire, hold and deal with any property or any right, title or interest in any
such property which may form the security for any loan or advance.
(h) Undertake and execute trusts.
(i) Undertake the administration of estates as executor, trustee or otherwise.
(j) Establish, support and aid associations, institutions, funds, trusts, etc., for the benefit
of its present or ex-employees; grant money for charitable purposes,
(k) Acquire, construct and maintain any building for its own purpose.
(L) Sell, improve, manage, develop, exchange, lease, mortgage, dispose of or turn into
account or otherwise deal with all or any part of the business of any person or company,
- CAIIB DISCUSSION
when such business is of a nature described in Section 6.

(m) Acquire and undertake the whole or any part of the business of any person or
company, when such business is of a nature described in Section 6.
(n) Do all such things which are incidental or conducive to the pr omotion or
advancement of the business of the company,
(o) Do any other business specified by the Central Government as the lawful business of
a banking company. The Central Government has accordingly specified leasing and
factoring as permissible business for banks.
vi. Prohibited Business: Section 8 of the Banking Regulation Act prohibits a banking
company from engaging directly or indirectly in trading activities and undertaking
trading risks. Buying or selling or bartering of goods directly or indirectly is prohibited.
However, this is without prejudice to the business permitted under Section 6(1) of the
Act. Accordingly, a bank can realise the securities given to it or held by it for a loan, if
need arises for the realisation of the amount lent. It can also buy or sell or barter for
others in connection with: (i) bills of exchange received for collection or negotiation, and
(ii) undertaking the administration of estates as executor, trustee, etc. Goods for the
purpose of this Section means every kind of moveable property, other than actionable
claims, stocks, shares, money, bullion and specie and all instruments referred to in
Clause (a) of sub-Section (1) of Section 6.
As regards immoveable properties, Section 9 prohibits a banking company from holding
such property, howsoever acquired, except as is required for its own use, for a period
exceeding seven years from the acquisition of the property. The Reserve Bank may
extend this period by another five years, if it is satisfied that such extension would be in
the interest of the depositors of the banking company. The banking company shall be
required to dispose of such property within the permitted period.
1.3 CONSTITUTION OF BANKS

i. Banks in India fall under one of the following categories:
(a) Body corporate constituted under a special statute;
(b) Company registered under the Companies Act, 1956 or a foreign company;
(c) Co-operative society registered under a central or state enactment on co-
operative societies.
ii. Public Sector Banks: The public sector banks including nationalised banks, State
Bank of India and its associates (subsidiaries) and the Regional Rural Banks fall in the
first category. By the Banking Companies (Acquisition and Transfer of Undertakings)
Act, 1970 and the Banking Companies (Acquisition and Transfer of Undertakings) Act,
1980 the Central Government nationalised (took over the business undertakings) of
certain banking companies and vested them in newly created statutory bodies
(corresponding new banks) constituted under Section 3 of the 1970/1980 Act. The State
Bank of India was constituted under the State Bank of India Act, 1955 and the six
associate/subsidiary banks were constituted under the State Bank (Subsidiary Banks)
Act, 1959 or other statutes (See Para 5.2.6). The regional rural banks are constituted
under the Regional Rural Banks Act, 1976. These banks are governed by the statutes
creating them as also some of the provisions of the Banking Regulation Act and the
Reserve Bank of India Act. The details are discussed in Unit 5.
iii. Banking Companies: A banking company, as defined in Section 5(c) of the Banking
Regulation Act is a company which transacts the business of banking. Such company
may be a company constituted under Section 3 of the Companies Act or a foreign
company within the meaning of Section 591 of that Act. All the private sector banks are
banking companies. These banks are governed by the Companies Act, 1956 in respect of
their constitution and by the Banking Regulation Act and the RBI Act with regard to
their business of banking.
- CAIIB DISCUSSION
iv. Co-operative Banks: A co-operative bank is a co-operative society registered or

deemed to have been registered under any Central Act for the time being in force
relating to the multi-state co-operative societies, or any other central or state law relating
to co-operative societies for the time being in force. If a co-operative bank is operating in
more than one state, the Central Act applies. In other cases, the state laws apply. The
Banking Laws (Application to Co-operative Societies) Act, 1965 extended certain
provisions of the Banking Regulation Act and the Reserve Bank of India Act to the co-
operative banking sector. After the Supreme Court held in Apex Co¬operative Bank's
case (AI R 2004 SC 141) that multi-state co-operative societies cannot be licensed as co-
operative banks, the Banking Regulation (Amendment) and Miscellaneous Provisions
Act, 2004 was enacted to permit licensing of multi-state co-operative banks. A "multi-
state co¬operative bank" under this Act means a multi-state co-operative society which
is a primary co-operative bank.
1.4 RESERVE BANK OF INDIA ACT, 1934

i. The Reserve Bank of India Act, 1934 was enacted to constitute the Reserve Bank of
India:
monetary(i) to regulate
stability in the issue
India, andof(iii)
bank tonotes, (ii)the
operate forcurrency
keepingand
reserves
creditfor securing
system of the
country to its advantage. The Act came into force on 6th March 1934. The Act has been
amended from time to time to meet the demands of changing times. The last amendment
to the Act was effected by the RBI (Amendment) Act, 2006.
ii. The Act deals with the constitution, powers and functions of the Reserve Bank. It does
not directly deal with regulation of the banking system except for Section 42, which
provides for cash reserves of scheduled banks to be kept with the Reserve Bank, with a
view to regulating the credit system and ensuring monetary stability. Further, Section 18
of the Act provides for direct discount of bills of exchange and promissory notes when a
special occasion arises, making it necessary or expedient for the purpose of regulating
credit in the interests of trade, industry and agriculture. The Act, in short, deals with:
(i) incorporation, capital, management and business of the bank:
(ii) the central banking functions like issue of bank notes, monetary control, acting as
banker to government and banks, lender of last resort;
(iii) collection and furnishing of credit information;
(iv) acceptance of deposits by non-banking financial institutions;
(v) general provisions regarding reserve fund, credit funds, publication of bank rate,
audit and accounts; and
(vi) penalties for violation of the provisions of the Act or the directions issued
thereunder.
1.5 BANK I NG REGULATI ON ACT, 1949

i. The Banking Regulation Act, 1949 was enacted to consolidate and amend the law
relating to banking and to provide for a suitable framework for regulating the banking
companies.
1965 the ActInitially, the Acttoprovided
was amended for regulation
cover co-operative of banking
banks companies
as well with certainonly, but in
modifications (See, Section 56). However, the Act, as provided in Section 3, does not
apply to primary agricultural credit societies and co-operative land mortgage banks. The
provisions of the Act are applicable to banking companies in addition to other laws
which are applicable to such companies, unless otherwise specifically provided in the
Act. Thus, Companies Act, 1956 which deals with the incorporation and working of
companies is applicable to banking companies except where special provisions are made
in the Banking Regulation Act in that regard.
ii. The Act regulates entry into banking business by licensing as provided in Section 22
- CAIIB DISCUSSION
thereof. The Act also puts restrictions on the shareholding, directorship, voting rights
and other aspects of banking companies. There are several provisions in the Act
regulating the business of banking such as restriction on loans and advances, rates of
interest to be charged, requirement as to cash reserve and maintenance of percentage of
assets, etc. There are provisions regarding audit and inspection and submission of
balance sheets and accounts. The Act provides for control over the management of
banking companies and also deals with the procedure for winding up of the business of
the banks and penalties for violation of its provisions. In short, the Act deals with:
(a) regulation business of banking companies;
(b) control over the management of banking companies;
(c) suspension and winding up of banking business; and
(d) penalties for violation of the provisions of the Act.
1.6 RESERVE BANK AS CENTRAL BANK AND REGULATOR OF BANKS
i. The Reserve Bank was constituted under Section 3 of the Reserve Bank of India Act,
1934 for taking over the management of currency from the Central Government and
carrying on the business of banking in accordance with the provisions of the Act.
Originally, under the RBI Act, the Bank had the responsibility of:
(a) regulating the issue of bank notes;
(b) keeping of reserves for ensuring monetary stability; and
(c) generally to operate the currency and credit system of the country to its
advantage.
ii. The Reserve Bank is a body corporate having perpetual succession and common seal
and shall sue and be sued in its name. The whole capital of the bank is held by the
Central Government. The Bank has its central office in Mumbai and offices in Mumbai,
Kolkata, Delhi and Chennai, and branches at most of the state capitals and some other
cities.
iii. The bank functions under the general superintendence and directions of the Central
Board of
Directors. The bank has to abide by the directions given by the Central Government in
public interest and

of a Governor afternot
consultation
more than with the Governor
four Deputy of thetobank.
Governors The board
be appointed byshall consist
Central
Government and other directors nominated by the Central Government. Apart from the
Central Board, the bank has also local boards situated at Mumbai, Kolkata, Delhi and
Chennai, which perform any duty delegated to them by the Central Board. The Governor
has the power of general superintendence and direction of the affairs of the bank and
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 in the discharge of the Bank's functions.
iv. The Reserve Bank is the sole authority for issue and management of currency in India
under Section 22 of the RBI Act. The bank may issue notes of different denominations
from Rs. 2 to Rs. 10,000 as the Central Government may decide on the
recommendations of the Central Board of the bank. Such notes shall be legal tender at
any place in India.
v. The bank is the banker to the Central Government under Section 20 of the Act, and
accordingly it is obligatory to undertake banking business for the Central Government.
In the case of state governments, their banking business is undertaken by the bank based
on agreements as provided in Section 21 A. Bank provides ways and means of advances
to the Central and state governments. These are temporary advances to meet immediate
needs when there is interval between expenditure and flow of r evenue.
vi. The role of the bank as regulator of banking sector is mainly by virtue of the
provisions of the Banking Regulation Act, 1949. In exercise of the powers under that Act
the bank regulates the entry into banking business by licensing, exercises control over
shareholding and voting rights of shareholders, exercises controls over the managerial
- CAIIB DISCUSSION
persons, and regulates the business of banks. The bank also inspects banks and exercises
supervisory powers, and may issue directions from time to time in public interest and in
the interest of the banking system with respect to interest rates, lending limits,
investments and various other matters.
vii. The major powers of the Reserve Bank in the different roles as regulator and
supervisor can be summed up as under:
(a) power to licence;
(b) power of appointment and removal of banking boards/personnel;
(c) power to regulate the business of banks;
(d) power to give directions;
(e) power to inspect and supervise banks;
(f) power regarding audit of banks;
(g) power to collect, collate and furnish credit information;
(h) power relating to moratorium, amalgamation and winding up; and (i) power to
impose penalties.
1.7 GOVERNMENT AS A REGULATOR OF BANKS
i. The Reserve Bank is the primary regulator of banks. But the Central Government has
also been conferred extensive powers under the RBI Act and BR Act either directly or
indirectly over the banks.
ii. The government holds the entire capital of the Reserve Bank and appoints the
Governor and the
mr.mhe.rs nf the Central Rmrd nnri Vns the power to remove them. The
government has also the
- - • j i
10
necessary in public interest after consultation with the Governor. Thus, the government
can exercise control over banks by influencing decision-making by the Reserve Bank
and has also got appellate authority in respect of several matters in which the Reserve
Bank has been conferred the power to decide at the first instance. Thus, under the
Banking
managerialRegulation
personnelAct appeal
under lies with
Sections 10Bthe
andCentral
36AA Government onSimilarly,
of the BR Act. removal ofthere are
also provisions for appeal in respect of cancellation of banking licence (under Section
22) and refusal of certificate regarding floating charge on assets (Section 14A).
iii. The government has the power to suspend the operations of the Banking Regulation
Act or to give exemption from any of the provisions of the Act on the
representation/recommendation of the Reserve Bank under Sections 4 and 53 of the Act,
respectively. The government has also the power to notify other forms of business which
a bank may undertake under Section 6(1 )(o) of the Act. Rule-making powers under
Sections 52 and 45Y are vested in the Central Government. There are also other
provisions under which the Central Government exercises powers as under:
(a) Approval for formation of subsidiary for certain business under Section 19;
(b) Notification with reference to accounts and balance sheet under Section 29;
(c) Issue of direction for inspection of banks under Section 35;
(d) Power to acquire undertakings of banks (Section 36AE);
(e) Appointment of court liquidator;
(f) Suspension of business and amalgamation of banks under Section 45.
The above provisions confer wide powers on the Central Government to regulate banks.
These are in addition to the powers conferred on the government as majority shareholder
or full owner of public sector banks under the statutes constituting them.
1.8 CONTROL OVER CO-OPERATIVE BANKS
i. A co-operative bank is a co-operative society engaged in the business of banking and
may be a primary Co-operative bank, a district central co-operative bank or a state co-
operative bank. Co¬operative banks operating in one state only are registered under the
- CAIIB DISCUSSION
State co-operative Societies Act concerned. The formation of such banks as well as their
management and control over personnel is regulated by the co-operative law of the state.
The Registrar of co-operative societies under the Co-operative Societies Act exercises a
wide range of powers on co-operative societies from registration to winding up.
ii. In the case of co-operative banks operating in more than one state, the Multi-State Co-
operative Societies Act, 2002 is applicable. In that case, the Registrar appointed by the
Central Government takes the place of the Registrar appointed by the State Government
in other cases.
iii. With the introduction of Section 56 in the Banking Regulation Act, 1949 with effect
from 1965, co¬operative banks have come under the regulatory purview of the Reserve
Bank. While the formation and management of co-operative societies operating in one
state only (including those conducting banking business) are under the control of the
State Government, licensing and regulation of banking business rests with the Reserve
Bank. Thus, there is dual control of State Governments and the Reserve Bank over these
banks.
IV. In the case of co-operative banks which are registered under the Deposit Insurance
and Credit Guarantee Corporation Act, the Reserve Bank has the power to order their
winding up. The circumstances in which Reserve Bank may require winding up are
mentioned in Section 13D of the Act.
11
1.9 REGULATION BY OTHER AUTHORITIES
i. Banks may be subject to the control of other regulatory agencies in the conduct of their
business. For instance, a banking company will be subject to the control of the
authorities under the Companies Act in respect of company matters. Similarly, a bank is
answerable to labour authorities in respect of the terms and conditions of service of its
workmen, opening and closing of its premises, engagement of contract labour, etc.
Banks are also liable to pay income tax like cash transaction tax, service tax, etc., and
other taxes and have to follow the rules and regulations in that regard.
ii. As provided in Section 6 of the Banking Regulation Act, banks may undertake certain
non-banking
may be subject business in additioncontrol
to the regulatory to the business of banking.
of other agencies. ForIninstance,
that regard also,
in the banks
case of
dealings in securities like shares and debentures, banks are subject to regulation by the
Securities Exchange Board of India under the Securities Contract (Regulation) Act, 1956
read with the Securities and Exchange Board of India Act, 1992. If the Bank desires to
raise capital through public issue, it has to comply with SEBI guidelines. In case of
Insurance Business - by IRDA and in case of Mutual Fund Business -RBI, SEBI.
The study herein is, however, largely confined to the r egulation of banks by the Reserve
Bank and the Central Government under the Reserve Bank of India Act and the Banking
Regulation Act.
1.10 LET US SUM UP
1. Banking means acceptance of deposits of money from the public for lending or
investment. Such
deposits may be repayable on demand or may be for a period of time as agreed to, by the
banker
and the customer, and may be repayable by cheque, draft or otherwise. Apart from
banking, banks
are authorised to carry on other business as specified in Section 6 of the Banking
Regulation Act.
Banks are, however, prohibited from undertaking any trading activities.
2. Banks are constituted as companies registered under the Companies Act, 1956,
statutory corporations
constituted under Special Statutes or Co-operative societies registered under the Central
or State
- CAIIB DISCUSSION
Co-operative Societies Acts. The extent of applicability of the regulatory provisions

under the
Banking Regulation Act and the Reserve Bank of India Act to a bank depends on the
constitution of
the bank.
3. Reserve Bank of India is the central bank of the country and the primary
regulator for the banking
sector. The government has direct and indirect control over banks. It can exercise
indirect control
through the Reserve Bank and also act directly in appeals arising from decisions of the
Reserve
Bank under the various provisions of the Banking Regulation Act. In public sector banks
like the
State Bank of India and its subsidiaries, nationalised banks and the regional rural banks,
50% or
more of their shares are held by the Central Government. Central Government has
substantial
control over the management of these banks. Only certain provisions of the BR Act are
applicable
to these banks as indicated in that Act. Co-operative banks operating in one state only
are registered
under the State Co-operative Societies Act and are subject to the control of the State
Government
as also the Reserve Bank. In the case of non-banking business of the banks, they are
subject to
control by other regulatory agencies.
1.11 KEYWORDS
Banking; Banking Company; Body Corporate; Co-operative Bank; Nationalised Bank;
Regional Rural Bank; Public Sector Bank.
12
1.12 CHECK YOUR PROGRESS
A. 1. State whether the following statements are True or False.
(i) A public sector bank is a body corporate created under a special statute.
(ii) A banking company is registered under the Banking Regulation Act.
(iii) Co-operative banks are registered under the Multi-State Co-operative Societies Act
or a
State Co-operative Societies Act.
(iv) Subsidiaries of the State Bank are companies registered under the Companies Act.
(v) Accepting deposits for safe custody would fall within the definition of "banking".
2. Fill in the gaps choosing the answers from the brackets.
(i) Reserve Bank was constituted under (BR Act, RBI Act, Companies Act)
(ii) A Regional Rural Bank is (a body corporate created under a special statute, a
co¬
operative society, a company)
(Reserve Bank, Registrar of Companies,
(iii) Banking companies are licensed by
Company Law Board)
(iv) Business which a banking company may undertake other than banking is as
stipulated by
(Reserve Bank, BR Act, RBI Act)
(v) BR Act was enacted for (regulating banking companies, creating Reserve
Bank,
- CAIIB DISCUSSION
regulating acceptance of deposits from public)

B. 1
State whether the following statements are True or False, (i) Central Government can
give direction to the Reserve Bank, (ii) All kinds of business of banks is regulated only
by the Reserve Bank, (iii) Central Government is the primary regulator of banks, (iv)
State governments have no control over co-operative banks. (v) On cancellation of
licence of any bank, an appeal lies with Central Government.
Fill in the gaps choosing the answers from the brackets.
(State Co¬
operative Societies Act, Multi-State Co-operative Societies Act, RBI Act)
Government can exempt a bank from the provisions of BR Act (on the
recommendation of RBI, whenever the government is satisfied, if requested by a bank)
exercises the central banking function in India. (State Bank, Central Bank of
(ii) (iii)
(i) Co-operative banks operating in different states are registered under
(Reserve Bank,
India, Reserve Bank)
(iv) Company matters of a banking company are regulated by
(Controller
Authorities under the Companies Act, SEBI) (v) Trading in shares and securities by
banks is subject to regulation by .
of Capital Issues, SEBI, Company Law Board)
1.13 ANSWERS TO 'CHECK YOUR PROGRESS'
A. 1. (i) True; (ii) False; (iii) True; (iv) False; (v) False.
2. (i) RBI Act (ii) a body corporate created under a special statute
(iii) Reserve Bank (iv) BRAct
(v) for regulating banking companies.
B. 1. (i) True; (ii) False; (iii) False; (iv) False; (v) True.
2. (i) Multi-State Co-operative Societies Act
(ii) On recommendation of RBI (iii) Reserve Bank
13
(iv) Authorities under the Companies Act (v) SEBI.

1.14 TERMINAL QUESTIONS
Fill in the gaps choosing the answers from the brackets. 1. One of the essential
characteristics of banking is _
(lending to traders; investment in
_. (body corporate
securities; acceptance of deposits from the public) 2. Banking companies operating in
India are constituted in the form of.
constituted under a special statute; company registered under the Companies Act, 1956
or a foreign company; society registered under the Societies Registration Act)
3. Companies Act applies to banking companies _. (notwithstanding the
provisions of the
Banking Regulation Act; insofar as its provisions are not inconsistent with the provisions
of the Banking Regulation Act; only in relation to registration and winding up)
4. Under the Reserve Bank of India Act, Reserve Bank regulates acceptance of
deposits by
(all companies; non-banking financial companies; non-banking non-financial
companies)
_. (to the extent as provided in the state laws
5. BR Act is applicable to co-operative banks
on co-operative societies; in a modified form as provided in Section 56 thereof; at par
- CAIIB DISCUSSION
with commercial banks)

6. "Corresponding new banks" means (new banks [nationalised banks] constituted
under
the Banking Companies [Acquisition and Transfer of Undertakings] Act, 1970 and the
Banking Companies [Acquisition and Transfer of Undertakings] Act, 1980; new
generation banking companies registered under the Companies Act; a new bank formed
by amalgamation of two banking companies)
7. Central Government may give directions to the Reserve Bank when considered
necessary in
public interest only after consulting (the Governor of Reserve Bank; the Central
Board of the Reserve Bank; the Finance Commission)
8. A co-operative society registered under the Multi-State Co-operative Societies
Act (is
prohibited from undertaking banking business; can be declared as a state co-operative
bank; can undertake banking business as a primary co-operative bank)
9. A multi-state co-operative bank means a multi-state co-operative society which is a

(primary co-operative bank; central co-operative bank; state co-operative bank) 10. For
the purposes of the BR Act, a "co-operative society" means a society registered or
deemed to
have been registered under (any Central Act for the time being in force relating to the
multi-state co-operative societies only; any state law relating to co-operative societies for
the time being in force only; any Central Act for the time being in force relating to the
multi-state co¬operative societies or any other central or state law relating to co-
operative societies for the time being in force)
UNIT
2
CONTROL OVER ORGANISATION OF BANKS
STRUCTURE
2.0 Objectives
2.1 Introduction
2.2 Licensing of Banking Companies
2.3 Branch Licensing
2.4 Paid-up Capital and Reserves
2.5 Shareholding in Banking Companies
2.6 Subsidiaries of Banking Companies
2.7 Board of Directors
2.8 Chairman of Banking Company
2.9 Appointment of Additional Directors
2.10 Restrictions on Employment
2.11 Control Over Management
2.12 Corporate Governance
2.13 Directors and Corporate Governance
2.14 Let Us Sum Up
2.15 Keywords
- CAIIB DISCUSSION
2.17 Answers to 'Check Your Progress'

16
2.0 OBJECTIVES
The objectives of this unit are to understand the laws that govern banking companies, in
respect of:
• Licensing and branch licensing
• Paid up capital and reserves
• Shareholding and rights of shareholders
• Formation of subsidiaries and holding of shares of other companies
• Constitution and regulation of board of directors
• Exercise of control by the Reserve Bank and the Government over the
appointment and removal of
chairmen, managerial and other personnel
• Corporate governance
2.1 INTRODUCTION
The Banking Regulation Act provides for regulation of the organisation of banking
companies. To start with, there are restrictions at the entry point, by way of licensing and
then the requirement of permission for opening or shifting of branches. There are further
regulations over the paid-up capital and reserves, shareholder's rights, constitution of the
board of directors, appointment of chairman and formation of subsidiaries. Apart from
the above, there are also controls over the managerial and other personnel, including the
power to remove unsuitable persons and to appoint suitable persons. In this unit, we
study various provisions of the Banking Regulation Act, providing for controls over the
organisation and management of banking companies.
2.2 LICENSING OF BANKING COMPANIES
i. License Requirement from RBI: To commence or carry on, the banking business in
India, a company requires a licence from the Reserve Bank under Section 22 of the
Banking Regulation Act, 1949. Commencing or carrying on a banking business without
awere
licence
thenisinprohibited. Whenrequired
existence were the Actto
came into
apply forforce, thewithin
licence bankingsixcompanies, which
months from the
commencement of the Act. But, such banking companies were permitted to continue
business, unless and until their applications for licence were rejected by the Reserve
Bank. The requirement of licence was meant to ensure the continuance of only those
banks, which were established and operating on sound lines and to prevent
indiscriminate formation of banking companies.
ii. Discretion of Reserve Bank: The granting of licence by the Reserve Bank may be
subject to such conditions as the RBI may think fit in each case. As held by the Gujarat
High Court in Shivabhai vs RBI, Ahmedabad (AIR 1986 Guj 19), Reserve Bank has the
discretion to grant or refuse the licence and when such decision based on relevant,
material and germane considerations, the decision cannot be assailed. Only if the
decision is based on extraneous considerations or is perverse, the court will intervene.
It is open to the RBI to consider the defects or improvements revealed in an inspection
held under Section 35 of the BR Act while disposing of an application for licence. (See,
Sajjan Bank Pvt. Ltd. vs RBI, AI R 1961 Mad 8). The refusal of licence to a company
would make it ineligible to undertake banking business, but it would still be open to the
company to carry on other business like money lending.
iii. Conditions to be Satisfied: Before granting a licence under Section 22, Reserve Bank
may have to be satisfied by an inspection of the books of the banking company or
otherwise in respect of the
fnllnwintr matters-
17
- CAIIB DISCUSSION
(a) Whether the company is or will be in a position to pay its present and future
depositors in full
as their claims accrue;
(b) Whether the affairs of the company are being conducted or likely to be
conducted in a manner
detrimental to the interests of its present and future depositors;
(c) Whether the general character of proposed management of the company will
not be prejudicial
to public interest or the interest of depositors;
(d) Whether the company has an adequate capital structure and earning prospects;
(e) Whether public interest will be served by grant of licence to the company;
(f) Whether considering the banking facilities available in the proposed area of
operation, the
potential scope for expansion of business by banks already in existence in that area and
other relevant factors, the grant of licence would be prejudicial to the operation and
consolidation
of banking system, consistent with monetary stability and economic growth;
(g) The fulfilment of any other condition which the Reserve Bank considers
relevant in public
interest or in the interest of depositors.
Although Section 11 of BR Act specifies the minimum capital and reserves requirements
of a banking company, the Reserve Bank can stipulate a higher requirement of capital
for licensing a banking company as under Section 22 the Reserve Bank has to be
satisfied that the company has an adequate capital structure and earning prospects.
iv. Foreign Banks: In the case of companies incorporated outside India applying for a
licence, apart from the conditions specified in the case of domestic companies, three
additional conditions have been stipulated for consideration by the Reserve Bank. These
are:
(a) Whether carrying on of banking business by the company in India will be in
public
(b) interest;
Whether the government or the law of the country, in which the company is
incorporated
discriminates in any way against banking companies registered in India;
(c) Whether the company complies with provisions of the BR Act, as applicable to
foreign
companies.
v. Local Area Banks: The Reserve Bank has recognised the concept of local area banks
and licensed a few(four) such banks. These are banking companies operating only in a
limited geographical area. The licence issued to these banks would restrict their
operations to the specified local area to ensure adequate banking services in that area.
vi. Cancellation of Licence: Sub-Section (4) of Section 22 of the Banking Regulation
Act authorises the Reserve Bank to cancel the licence granted to any banking company.
The cancellation of licence may be on any one or more of the following grounds:
(a) The company ceases to carry on banking business in India;
(b) The company at any time fails to comply with any of the conditions imposed
under the sub-
Section (1) of Section 22 of Banking Regulation Act;
(c) The company does not fulfil at any time, any of the conditions referred to in the
sub-Section(3)
or 3(A) of Section 22 of Banking Regulation Act.
Before cancellation of a licence for non-compliance with any of the conditions as above,
the company has to be given an opportunity for taking necessary steps for complying
with or fulfilling the conditions. However, in cases where the Reserve Bank is of the
- CAIIB DISCUSSION
opinion that delay will be prejudicial to the interests of depositors or the public, the
requirement of opportunity can be dispensed with. As observed by the Madras High
Court in Sajjan Bank Pyt. Ltd. vs RBI (AIR 1961 Mad. 8), the Reserve Bank has a wide
range of administrative discretion under the Act, which it is competent to exercise, and it
cannot be said that there is an excessive delegation of power. A banking company,
whose licence is cancelled, can appeal to the Central Government within a
; i _r
t/\ J r-.
18
2.3 BRANCH LICENSING
i. Apart from the requirement of licence for commencing or carrying on banking
business, banks have to obtain the prior permission of Reserve Bank for opening a new
place of business or changing location of the existing place of business. Under Section
23 of the Banking Regulation Act, 'Place of business' for this purpose includes any sub-
office, pay office, sub-pay office or any place at which deposits are received, cheques
cashed or moneys lent. However, changing the location of an existing place of business
within the same city, town or village would not need such permission. These restrictions
also apply to foreign branches of banking companies incorporated in India. Opening of a
temporary place of business up to one month for purpose of affording banking facilities
for any exhibition, mela, conference or like occasion is exempt. However, the temporary
branch has to be within the limits of the city; town or village where there is an existing
branch or in the environs thereof. The present guidelines from RBI provide that Banks
should submit their request for new branches, administrative offices, ATMs once in a
year for consideration of RBI as against the earlier practice of making individual
applications for each and every branch. When approved, the permission would be valid
for a period of one year before which the branches/ offices should be operationalised.
ii. For granting permission under Section 23, the Reserve Bank may require to be
satisfied of the following:
(a) Financial condition and history of the bank;
(b)
(c) General
Adequacy character of structure
of capital its management;
and earning prospects;
(d) Public interest.
This may be done by an inspection of the bank under Section 35 or otherwise.
While granting permission for opening or shifting a branch, the Reserve Bank may
impose any conditions which it thinks fit necessary. If any bank fails to comply with
such conditions, the permission may be revoked after giving an opportunity to the bank
to show cause.
iii. In the case of regional rural banks, the applications for permission have to be routed
through the National Bank (NABARD), and the national bank has to offer its comments
on merits to the Reserve Bank.
2.4 PAID-UP CAPITAL AND RESERVES
Section 11 of the Banking Regulation Act provides for certain minimum requirements as
to paid-up capital and reserves of banking companies. Any company wanting to
commence banking business has to comply with these requirements. The amounts
stipulated have reference to the places of business. 'Place of business' for this purpose
means any office, sub-office, sub-pay office and any place at which deposits are
received, cheques cashed or moneys lent. In the case of any dispute regarding
computation of paid-up capital and reserves of any banking company, the decision of the
Reserve Bank shall be final.
i. Foreign Banks: Under the sub-Section (2) of Section 11 of the BR Act, a foreign bank
(banking company incorporated outside India) operating in India, has to deposit and
keep deposited with the Reserve Bank, an amount of Rs.15 lacs and if it has a place of
business in Mumbai or Kolkata or both, Rs. 20 lacs. The amount has to be kept in cash,
- CAIIB DISCUSSION
unencumbered approved securities or partly in both. Apart from this, an amount of

twenty per cent of the profit for each year in respect of business transacted through the
branches in India as disclosed in the profit and loss account has to be deposited with the
Reserve Bank. The securities deposited can be replaced by other unencumbered
19
approved securities or cash deposited can be similarly replaced by securities. The
Central Government can exempt any foreign bank from this requirement on the
recommendation of the Reserve Bank for a specified period if the amounts deposited
already by it are considered adequate. On the cessation of business by any foreign bank
for any reason, these deposits shall form the assets of the company on which the
creditors in India shall have the first charge.
ii. Indian Banks: In case of banking companies incorporated in India, the requirements of
minimum paid-up capital and reserves under Section 11 (3) are as follows:
(a) If it has a place of business in more than one state, Rs. 5 lac and if such places
of business
include Mumbai, Kolkata or both, Rs. 10 lac.
(b) If the place of business is in only one state and does not include Mumbai or
Kolkata, Rupees 1
lac for its principal place of business, plus Rs. 10,000 for other places of business, in the
same
district in which the principal place of business is situated, plus an additional Rs. 20,000,
for
each place of business elsewhere; in total not exceeding Rs. 5 lacs. If the bank has only
one
place of business, the amount is limited to Rs. 50,000.
For banking companies commencing business after the commencement of the Act, paid-
up capital is stipulated as Rs 5 lac.
(c) If places of business are in one state only, but one or more of them is in
Mumbai or Kolkata,
Rs. 5 lac, plus

aggregate not Rs. 25,000 for each place of business outside these cities and the
exceeding Rs. 10 lac.
During 2005, RBI stipulated the minimum capital requirement for a new Private Bank at
Rs 300 crore as a part of Corporate Governance guidelines and as a policy of Foreign
Direct Investment.
iii. Paid-up Capital, Subscribed Capital and Authorised Capital: Apart from the above,
Section 12(1) of the Banking Regulation Act stipulates that the subscribed capital of a
banking company shall not be less than half of its authorised capital; and the paid-up
capital shall not be less than half of its subscribed capital. If capital is increased, this
requirement has to be complied within a period not exceeding two years as allowed by
the Reserve Bank.
Banking companies are permitted to have only ordinary or equity shares. However,
preference shares issued before 1 July 1944 are exempt. Further, the provisions of
Section 12(1) are not applicable to banks incorporated before 15 January 1937. Now
preference shares and other capital instruments are also allowed. Since 2005, Banks have
been permitted by RBI to raise capital even in the from of innovative debt instruments
which are perpetual and perpetual non-cumulative preference shares in addition to the
equity capital.
2.5 SHAREHOLDING IN BANKING COMPANIES
i. Voting rights of shareholders: There is no specified ceiling on a person's holding of
shares in a banking company under the Banking Regulation Act or any other law.
However, Section 12(2) of the Act puts certain restrictions on voting rights of
shareholders. Accordingly, no shareholder can exercise voting rights in respect of the
- CAIIB DISCUSSION
shares held by him/her in excess of ten per cent of the total voting rights of all the
shareholders of the banking company. This provision does not in any way affect the
transfer of shares or the registration of such transfers. It only puts a limit on voting
rights. However, Section 12(3) bars suits or other proceedings against registered
shareholders by any other person claiming title except by a transferee of shares, in
accordance with the law or on behalf of minors or lunatics for whom the registered
shareholder holds the shares. The provisions of the Companies Act also govern transfer
of shares of banking companies.
ii. Acknowledgement by Reserve Bank: Reserve Bank has instructed banking companies
that when
20
they receive more than the specified percentage of their shares for transfer to one party,
the bank's board must refer the matter to the Reserve Bank. The banks shall not transfer
the shares without receiving Reserve Bank's acknowledgement. This is with a view to
ensure that the controlling interest in a banking company does not change hands without
the knowledge and approval of the Reserve Bank.
iii. Reports on shareholding: A report regarding the particulars of shareholding of the
chairman, managing director or chief executive officer, by whatever name called, of
every banking company, requires submission to the Reserve Bank. Such report should
contain the full particulars and extent of value of shares held directly or indirectly and of
any change in the extent of holding or of any variation in the rights attaching thereto.
The Reserve Bank may also order for any other information relating to those shares.
iv. Commission, brokerage, discount: Section 13 of the Banking Regulation Act imposes
a ceiling on the commission, brokerage, discount or remuneration on the sale of shares of
banking companies. Accordingly, the payments on this account in any form should not
exceed two-and-a-half per cent of the paid-up value of the shares.
v. Dividend: There are also certain restrictions on the payment of dividend to the
shareholders of banking companies. Thus, under Section 15 of the Banking Regulation
Act, no dividend is payable until all capitalised expenses are completely written off.
Such expenses
commission, include preliminary
brokerage, expenses,
loss incurred and anyorganisation
other item, ofexpenses, share-selling
expenditure not represented
by tangible assets. However, dividends are payable without writing off depreciation, bad
debt etc., as under:
(a) Depreciation in value of approved securities, which is not capitalised or
accounted for as a
loss.
(b) Depreciation in investment of shares, bonds or debentures, other than the
approved securities
for which adequate provision has been made.
(c) Bad debts for which an adequate provision is provided.
RBI has given detailed eligibility criteria for declaration of dividend by banks and also
guidelines on the quantum of dividend that can be declared by banks. The eligibility
criteria require a minimum 9 % of CAR and Net NPAs not exceeding 1%. The quantum
of dividend that can be declared is based on the levels of net NPAs and in a graded level
(Maximum 40% pay out ratio) and can be paid out of only current year's profits.
2.6 SUBSIDIARIES OF BANKING COMPANIES
i. Formation of Subsidiaries: There are certain restrictions under Section 19 of the
Banking Regulation Act on the formation of subsidiaries by banking companies. This is
for purpose of preventing banks from carrying on trading activities by acquiring a
controlling interest in non-banking companies. Accordingly, subsidiaries are permissible
only for the following purposes:
(i) Undertaking any business which is permissible for banking companies under Section
6(1) clauses (a) to (o).
- CAIIB DISCUSSION
(ii) Carrying on the business of banking exclusively outside India. Prior permission of
the Reserve Bank is a must for this banking business.
(iii) Undertaking any other business which Reserve Bank with prior approval of the
Central Government permits. Reserve Bank may permit only such other business which
it considers conducive to the spread of banking in India or otherwise useful or necessary
in the public interest. The undertaking of any business by a subsidiary will not be
deemed to amount to the bank itself taking up that business directly or indirectly for th e
purpose of Section 8.
21
ii. Shareholding in other companies: Apart from the restriction on subsidiaries, there is
also a ceiling [Section 19(2)] on shareholding in companies other than subsidiaries.
Thus, the holding of shares by a banking company in any company as pledgee,
mortgagee or absolute owner shall not be exceeding thirty per cent of the paid-up share
capital of that company or the paid-up share capital and reserves of the banking
company. Further, holding of shares in any company in which the managing director or
manager of a banking company is interested in or concerned with in any manner, is
prohibited except in the case of subsidiaries.
2.7 BOARD OF DIRECTORS
i. Qualifications: Section lOAofthe Banking RegulationAct stipulates certain
qualifications fordirectors of banking companies. Accordingly at least fifty-one per cent
of the total number of directors shall be persons, who have special knowledge or
practical experience, with respect of accountancy, agriculture and rural economy,
banking, cooperation, economics, finance, law, small scale industry or any other matter,
the special knowledge or practical experience which is useful to the banking company, in
the opinion of the Reserve Bank. Further, at least two of the directors should have
special knowledge or practical experience in agriculture and rural economy or co-
operation or small scale industry.
ii. Substantial interest: The directors of a banking company shall not have a substantial
interest in or be connected with as employee, manager or managing agent in a company
or
BRfirm
Act.which carries
However, on trade, registered
companies commerceunder
or industry
Sectionas25perofSection 10A (2)(b)
the Companies Actofand
the
small scale industrial concerns are not included for the purpose. The proprietors of
trading, commercial or industrial concerns other than small scale industrial concerns are
also disqualified for directorship. 'Substantial interest' for this purpose is defined in
Section 2 of the Banking Regulation Act. Accordingly, holding of beneficial interest by
any individual or his spouse or minor child, whether singly or taken together in the
shares of a company exceeding Rs. 5 lacs or ten per cent of the paid-up capital of the
company amounts to substantial interest. In the case of firms, such holding of beneficial
interest exceeding ten per cent of the total capital of the firm amounts to substantial
interest.
iii. Period of office: The directors of a banking company shall not hold office for more
than eight years continuously. However, this provision is not applicable to the chairman
or a whole-time director. When the chairman or a whole-time director of a bank is
removed from office, he/she ceases to be a director of the bank and shall not be eligible
for further appointment as director of that banking company for a period of four years.
iv. Reconstitution of Board: When the board of a banking company is not constituted in
accordance with the requirements of Section 10A of the BR Act, the board has to be
reconstituted, to comply with the provisions. If any director has to be retired for such a
reconstitution, this may be done by lots, in the prescribed manner and such decision shall
be binding on every director of the board. If the Reserve Bank is of the opinion that the
board of any banking company does not fulfil the requirements, it may order such a bank
to reconstitute the board after giving reasonable opportunity of being heard. If, within
two months' time, the bank does not fulfil the order of the Reserve Bank, the Bank may
- CAIIB DISCUSSION
then remove any director (determined by lots drawn in the prescribed manner) and such
a person shall cease to hold office. The Reserve Bank may also appoint a new director in
the place of the person removed and he/she shall continue in office until the date up to
which his predecessor would have held office. However, any proceedings of a banking
company will not be invalid only because of any defect in the composition of the board.
22
2.8 CHAIRMAN OF BANKING COMPANY
i. Whole-time Chairman/Managing Director: Section 1 OB of the Banking Regulation
Act provides that every banking company should have a full-time or part-time chairman,
appointed from among its directors. The chairman, if appointed on a whole-time basis is
entrusted with the management of the entire affairs of the bank. The chairman on a part-
time basis has to be appointed with the prior approval of the Reserve Bank and such an
appointment shall be subject to any conditions that may be imposed by the Reserve Bank
while granting approval. In the absence of a chairman, the management of the whole of
the affairs of the banking company shall be entrusted to a managing director. The
exercise of powers by the whole-time chairman or managing director is subject to the
superintendence, control and directions of the board of directors. The whole-time
chairman and a managing director shall hold office for a period not exceeding five years
as the board may fix and is also eligible for reelection or reappointment. Although the
chairman is in full-time employment of the bank, he may be a director of a subsidiary of
the bank or of a company registered under Section 25 of the Companies Act. The
Reserve Bank may also permit the whole-time chairman or the managing director to
undertake part-time honorary work not likely to interfere with the duties of the chairman
or the managing director.
The whole-time chairman or the managing director of a banking company may continue
in office at the end of the term of the office until his/her successor assumes office,
subject to the approval of the Reserve Bank.
ii. Qualifications of Whole-time Chairman/Managing Director: The whole-time
chairman or the managing director of a banking company should have special knowledge
or practicalbank
subsidiary experience of the working
or a financial of or
institution a banking company
financial, or or
economic thebusiness
State Bank or a
administration. The whole-time chairman or the managing director will be disqualified
under the following circumstances:
(a) if he/she is director of a company other than a subsidiary of the banking
company or a charitable
company (registered under Section 25 of the Companies Act);
(b) if he/she is a partner of any firm which carries on trade, business or industry;
(c) if he/she has substantial interest in any other company or firm or is director,
manager, managing
agent, partner or proprietor of any trading, commercial or industrial concern; or
(d) if he/she is engaged in any other business or vocation.
iii. Removal of Wholetime Chairman/Managing Director: If the Reserve Bank is of the
opinion that the person elected to be the chairman of the board of directors and
appointed on a whole time basis or the managing director is not a fit and proper person
to hold such office, the Reserve Bank may require the banking company to remove such
a chairman or the managing director and appoint a suitable person. However, before
taking such an action, the Reserve Bank has to give such a person, as also the banking
company, a reasonable opportunity of being heard. If the banking company does not
comply with the order within two months, the Reserve Bank may remove the person
from the office and appoint a suitable person in his/her place. Such a chairman or
managing director would continue in office, for the residual period of office of the
person removed from office.
The banking company or the person affected by the Reserve Bank's order may appeal to
- CAIIB DISCUSSION
the Central Government within thirty days. The order of the Government where an
appeal is filed and the order of the Reserve Bank, where no appeal is filed shall be final
and not liable to be challenged before any civil court.
vi. Temporary vacancies: In cases where the wholetime chairman or the managing
director dies or
23
he/she resigns or is not capable of discharging his/her functions due to illness, temporary
arrangements can be made to carry out the duties of the chairman or the managing
director for a period not exceeding four months. However, this has to be done with the
approval of the Reserve Bank.
v. Power of Reserve Bank to appoint Chairman: In certain cases, the office of the whole-
time chairman or the managing director of a banking company may fall vacant and may
not be filled up by the bank immediately. This may adversely affect the interests of the
banking company. If the Reserve Bank is of the opinion that continuation of such
vacancy is likely to be against the interests of the banking company, it may appoint an
eligible person to fill such vacancy under Section 10BB of the Banking Regulation Act.
If the chairman or the managing director so appointed is not a director of the banking
company, he/she shall be deemed to be a director of the banking company. Such
appointment may be for a period not exceeding three years. There is also a provision for
reappointment after the initial period. The chairman or the managing director so
appointed may be removed from office only by the Reserve Bank and shall draw pay and
allowances from the banking company, as determined by the Reserve Bank.
vi. Qualification shares: The whole-time chairman or the managing director of a banking
company is exempted under Section IOC of the Banking Regulation Act from the
requirement of holding qualification shares. Similar exemption is also available to a
director of a banking company appointed by Reserve Bank under Section 10A of the
Act.
vii. Overriding provisions: The provisions of Section 10A, Section 10B and Section
10BB of the Banking Regulation Act regarding the appointment and removal of a
director, managing director or the chairman shall have overriding effect over all other
laws, contracts, etc. Any person affected by any action taken under these provisions is
not entitled to any compensation for any loss or for termination of office.
2.9 APPOINTMENT OF ADDITIONAL DIRECTORS
i. The Reserve Bank has the power to appoint additional directors on the boards of
banking companies under Section 36AB of the Banking Regulation Act. One or more
additional directors may be so appointed when the bank is of the opinion that it is
necessary to do so in the interest of:
(a) banking policy (b) public
(c) banking company (d) depositors of the banking company.
ii. The directors so appointed shall not require any qualification shares. They hold office
during the pleasure of the Reserve Bank. Subject to this, appointment may be for a
period not exceeding three years or further extended periods not exceeding three years at
a time as specified by the Reserve Bank. The additional directors are protected from any
liability or obligation for executing their functions in good faith. The provisions of
Section 36AB have overriding effect over other laws.
2.10 RESTRICTIONS ON EMPLOYMENT
i. The Banking Regulation Act (Section 10) prohibits employment of managing agents
and imposes restrictions on employment of certain type of persons, namely —
(a) a person who is or has been adjudicated insolvent or has suspended payment or has
compounded
- CAIIB DISCUSSION
with his/her creditors;
a nprtnn
\\\r 9 r*riminQl rrmrt r\f 'An
invnivina mortal
24
(c) a person whose remuneration or part thereof is by way of commission or share
in the profits
of the company;
(d) a person whose remuneration is excessive in the opinion of the Reserve Bank.
Before forming
an opinion regarding the remuneration, the Reserve Bank has to consider the financial
condition
and history of the banking company, its area of operation, resources, volume of business
and
the trend of its earning capacity, number of its branches, qualifications, age and
experience of
the person concerned, remuneration of other personnel in the bank or persons holding
similar
positions in other banks and the interest of depositors.
The above restrictions are applicable to workmen as well as management personnel, as
held by the Supreme Court in Central Bank of India vs Their Workmen (AIR 1960 SC
12). However, the restriction on remuneration does not affect payment of bonus
according to a settlement or award or in accordance with a scheme framed by the bank or
in accordance with the prevailing practice in banking business. Commission paid to
brokers, auctioneers, forwarding agents, etc., who are not regular members of the bank's
staff, is also
ii. Persons notare
who covered by these
directors of anyprovisions.
company other than a subsidiary of a banking
company or company registered under Section 25 of the Companies Act are also
prohibited from managing a banking company. However, this prohibition shall not apply
to a director for a temporary period of three months, or a further period not exceeding
nine months, if allowed by the Reserve Bank. Apart from this, persons engaged in any
other, business or vocation or whose term of office as a person managing the company is
for a period exceeding five years also fall in the prohibited category. However, the
period of office can be renewed or extended for further periods not exceeding five years
at a time.
2.11 CONTROLS OVER MANAGEMENT
i. Power to remove Management and other personnel: The Reserve Bank is empowered
under Section 36AA of the Banking Regulation Act to remove any chairman, director,
chief executive officer (by whatever name called), or other officer or employee of a
banking company. For this purpose, the bank has to be satisfied that it is necessary to do
so. The bank (RBI) has the discretionary power to remove management and other
personnel in the following circumstances:
(a) Public interest
(b) Preventing the affairs of the banking company being conducted in a manner
detrimental to the
interest of depositors
(c) Securing proper management of the banking company.
The Reserve Bank has to pass such an order recording the reasons in writing. Before
passing the order, the affected person has to be given a reasonable opportunity of making
- CAIIB DISCUSSION
a representation against the proposed order. Where an urgent action is required and delay
would be against the interests of the company or its depositors, the Reserve Bank is
empowered to direct by order, at the time of giving opportunity of making a
representation that the person concerned shall not act in his/her official capacity or
directly or indirectly take part in the management of the bank from the date of such
order, pending consideration of the representation. The person so removed shall not be
entitled to any compensation for loss of office notwithstanding anything contained in any
law, the memorandum, articles or any contract to the contrary as the provisions of
Section 36AA have overriding effect.
ii. Appeal: An appeal against the order of removal lies with the Central Government.
Such an appeal has to be filed within thirty days from the date of communication of the
order. The appellate decision of the Central Government, and subject thereto the order of
the Reserve Bank, shall be final and not liable to challenge in any Civil Court.
25
iii. Effect of the order of removal: On the Reserve Bank passing a removal order, the
person concerned ceases to hold office which he/she was holding till then. Further,
he/she is prohibited, from directly or indirectly taking part in the management of any
banking company for a period not exceeding five years as may be specified in the order.
Contravention of the order is punishable with a fine of Rs. 250 for each day during
which the contravention continues.
iv. Appointment of a suitable person: When any chairman, director, chief executive
officer, other officer or employee is removed by the Reserve Bank under Section 36AA
as above, the Reserve Bank may appoint a suitable person in his place. Such person shall
hold office at the pleasure of the Reserve Bank. Subject to this, the appointment may be
for a period not exceeding three years and is extendable for further periods not exceeding
three years at a time. Such appointee shall not incur any obligation or liability for action
taken in good faith in the execution of the duties of his office.
2.12 CORPORATE GOVERNANCE
i. The Concept: Corporate governance is a dynamic concept involving promotion of
corporate
employees, fairness, transparency
customers and other and accountability
stakeholders. It is ainconcept
the interest of shareholders,
of recent origin. However,
there is considerable divergence in the understanding and practice of corporate
governance across different jurisdictions. The concept has evolved since the first major
study by the Cadbury Committee in 1992. The DECO principles of corporate
governance published in 1999, the first international code of good corporate governance
approved by governments, was revised in 2004. Corporate governance can be seen as
'the way in which boards oversee the running of a company by its managers, and how
board members are in turn accountable to shareholders and the company' and it has
implications for company behaviour towards employees, shareholders, customers, banks
and other stakeholders. Further, good corporate governance plays a vital role in ensuring
the integrity and efficiency of financial markets and the lack of it can pave the way for
financial difficulties and sometimes even fraud.
ii. OECD Principles of Corporate Governance, 2004: The OECD principles of corporate
governance, 2004 stipulate what the corporate governance framework should ensure,
which is briefly as under:
(a) Ensuring the basis for an effective corporate governance framework: To
promote transparent
and efficient markets which are consistent with the rule of law. Also, to articulate clearly
the
division of responsibilities among the different supervisory, regulatory and enforcement
authorities.
(b) The rights of shareholders and key ownership functions: To protect and
facilitate the exercise
- CAIIB DISCUSSION
of shareholders' rights.
(c) The equitable treatment of shareholders: In the equitable treatment of
shareholders are included
the minority and foreign shareholders. Further, all shareholders should have the
opportunity to
obtain an effective redress for violation of their rights.
(d) The role of stakeholders in corporate governance: To recognise the rights of
stakeholders,
established by law or through mutual agreements and encourage active cooperation
between
the corporations and stakeholders in creating wealth, jobs, and the sustainability of
financially
sound enterprises.
(e) Disclosure and transparency: Timely and accurate disclosures made on all
material matters,
regarding the corporation, including the financial situation, performance, ownership, and
governance of the company.
(f) The responsibilities of the board: Strategic guidance of the company, effective
monitoring of
management by the board and the board's accountability to the company and the
shareholders
are the important aspects. These principles are applicable to all types of companies
including
banks.
26
iii. Corporate Governance and Banks: Banks hold a special position in corporate
governance as they accept and deploy large amounts of public funds in fiduciary
capacity and also leverage such funds through credit creation. The position of banks is
also important for the smooth functioning of the payment system. Accordingly, legal
prescriptions
supplementedfor byownership
regulatory and governance
prescriptions. of Basel
The banks Committee
laid down in onthe statutes are
Banking
Supervision has issued guidance (February 2006) for promoting the adoption of sound
practices of corporate governance by banking institutions. This guidance, entitled
Enhancing Corporate Governance for Banking Organisations, highlights the importance
of:
• the roles of boards of directors (with a focus on the role of independent
directors) and senior
management
• effective management of conflicts of interest
• the roles of internal and external auditors, as well as internal control
functionaries
• governing in a transparent manner, especially where a bank operates in
jurisdictions, or through
structures, that may impede transparency
• the role of supervisors in promoting and assessing sound corporate governance
practices.(See,
http://www.bis.org/press/pO6O213.htni).
Apart from the fiduciary role of banks, their cross-border operations add a special
dimension. This provides an added impetus for convergence in standards internationally.
In almost all countries, the policy framework with regard to corporate governance
involves a multiplicity of agencies. In India, the Department of Company Affairs,
Securities and Exchange Board of India (in respect of listed entities) are involved apart
from the Reserve Bank in respect of banks.
- CAIIB DISCUSSION
iv. Reserve Bank's approach: Following the formal policy announcement in regard to
corporate governance, in the mid term Review of the Monetary and Credit Policy, in
October, 2001, the Reserve bank constituted a Consultative Group in November, 2001
under the chairmanship of Dr. A.S. Ganguly with a view to strengthen the internal
supervisory role of the boards of banks. The report of the group was transmitted to all
the banks for their consideration in June, 2002 and simultaneously to the Government of
India for consideration. Earlier, an advisory group on corporate governance under the
chairmanship of Dr. R.H. Patil had submitted its report in March, 2001 which examined
the issues relating to corporate governance in banks in India, including the public sector
banks and made recommendations to bring the governance standards in India on par with
the best international standards. There were also some relevant observations by the
advisory group on banking supervision under the chairmanship of Shri M.S. Verma
which submitted its report in January, 2003. Keeping all these recommendations in view
and the cross-country experience, the Reserve Bank initiated several measures to
strengthen the corporate governance in the Indian banking sector, including the concept
of 'fit and proper' criteria for directors of banks which included the process of collecting
information, exercising due diligence and constitution of a nomination committee of the
board to scrutinise the declarations made by the bank directors. The RBI guidelines on
ownership and governance in the private sector banks released on February 28, 2005
(Paras 5 and 6) provide as under:
Shareholding
(i) The RBI guidelines on acknowledgement for acquisition or transfer of shares issued
on 3 February, 2004 will be applicable for any acquisition of shares of five per cent and
above of the paid-up capital of the private sector bank.
(ii) In the interest of diversified ownership of banks, the objective will be to ensure that
no single entity or group of related entities has shareholding or control, directly or
indirectly, in any bank in excess of ten per cent of the paid-up capital of the private
sector bank. Any higher level of
27
acquisition will2004
of 3 February, be with the prior
for grant approval of RBI and
of acknowledgement for in accordance
acquisition of with the guidelines
shares.
(iii) Where ownership is that of a corporate entity, the objective will be to ensure that no
single individual/entity has ownership and control in excess of ten per cent of that entity.
Where the ownership is that of a financial entity the objective will be to ensure that it is a
well-established regulated entity, widely held, publicly listed and enjoys good standing
in the financial community.
(iv) Banks (including foreign banks having a branch presence in India)/FIs should not
acquire any fresh stake in a bank's equity shares, if by such acquisition, the investing
bank's/FI's holding exceeds five per cent of the investee bank's equity capital as
indicated in RBI circular dated 6 July, 2004.
(v) As per the existing policy, large industrial houses will be allowed to acquire, by way
of strategic investment, shares not exceeding ten per cent of the paid-up capital of the
bank, subject to RBI's prior approval. Furthermore, such a limitation will also be
considered, if appropriate, in regard to important shareholders with other commercial
affiliations.
(vi) In case of a restructuring of the problem/weak banks or in the interest of
consolidation in the banking sector, RBI may permit a higher level of shareholding,
including by a bank.
2.13 DIRECTORS AND CORPORATE GOVERNANCE
(i) The board of directors should ensure that the responsibilities of directors are well
defined and the banks should arrange need based training for the directors in this regard.
While the respective entities should perform the roles envisaged for them, private sector
banks will be required to ensure that the directors on their boards representing specific
- CAIIB DISCUSSION
sectors, as provided under the B.R. Act, are indeed representatives of those sectors in a
demonstrable fashion, they fulfil the criteria under corporate governance norms provided
by the Ganguly Committee and they also fulfil the criteria applicable for determining 'fit
and proper' status of important shareholders (i.e., shareholding of five per cent and
above) as laid down in RBI circular dated 25 June, 2004.
(ii) As a matter of desirable practice, not more than one member of a family or a close
relative (as defined under Section 6 of the Companies Act, 1956) or an associate
(partner, employee, director, etc.) should be on the board of a bank.
(iii) Guidelines have been provided in respect of 'fit and proper' criteria for directors of
banks by the RBI circular dated 25 June, 2004 in accordance with the recommendations
of the Ganguly Committee on corporate governance. For this purpose a declaration and
undertaking is required from the proposed/existing directors.
(iv) Being a director, the CEO should satisfy the requirements of the 'fit and proper'
criteria applicable for directors. In addition, RBI may apply any additional requirements
for the chairman and CEO. The banks will be required to provide all information that
may be required while making an application to RBI for approval of appointment of
chairman/CEO.
With regard to public sector banks, the principles of corporate governance have been
statutorily recognised as per Banking Companies (Acquisition and Transfer of
Undertakings) Financial Institutions Laws (Amendment) Act, 2006. The Act as amended
provides for shareholder directors to be a person having 'fit and proper' status and the
Reserve Bank has to notify the 'Fit and Proper' criteria [Section 9(2)].
28
2.14 LET US SUM UP

A company wanting to commence banking business requires prior licence from the
Reserve Bank. The Reserve Bank has the discretion to reject licence or approve the
licence on such conditions as it thinks fit. Before granting licence, Reserve Bank has to
be satisfied by inspection or otherwise of the suitability of the company for licence. A
licence once given

heard. Further, may alsonew
for opening be cancelled
branches after givingbranches
or shifting the bankoutside
an opportunity to beor
a city, town
village, permission of the Reserve Bank is required. Banking companies have to have
minimum capital and reserves as specified in the Banking Regulation Act. The
shareholders of a banking company are entitled to dividends only after all the capitalised
expenses are written off. The commission or brokerage payable on selling shares is
restricted to two and half per cent of the paid-up value of the shares. The board of
directors of a bank has to be constituted with persons having special knowledge or
experience in accountancy, banking, economics, law, etc., as stipulated. The directors
should not have substantial interest in other companies or firms. The maximum period of
office is limited to eight years continuously. The Reserve Bank is empowered to
reconstitute the board, if the board is not properly constituted. Every banking company
should have a full-time chairman (or a full-time managing director, if there is no full-
time chairman) with the specified qualifications. The Reserve Bank has powers to
remove the chairman and appoint a suitable person in his place in certain cases. The
Reserve Bank also has powers to remove the directors or managerial personnel or other
employees of banking companies. The principles of corporate governance including the
'fit and proper' criteria for directors apply to banking companies as well as public sector
banks.
2.15 KEYWORDS
Additional Director; Authorised Capital; Overriding Provisions; Paid-up Capital; Place
of Business; Substantial Interest; Subscribed Capital; Subsidiary.
- CAIIB DISCUSSION
(i) A company has to obtain a from the Reserve Bank to commence banking
business
in terms of Section 22 of the BR Act. (registration; licence; commencement certificate)
(ii) Shifting of a bank's branch in the same does not require Reserve Bank's permission
arising out
under Section 23. (district; state, city, town or village) (iii) Foreign banks are required
under Section 11 of the BR Act to deposit
of their business in India with the Reserve Bank, (twenty per cent of profit for each year;
thirty
per cent of profit for each year; twenty per cent of the deposits collected each year)
(iv) Banks may float subsidiaries for carrying on the business specified in . (their
Memorandum of Association; Section 6(1 )(a) to (o) of the BR Act; their Articles of
Association)
(v) A shareholder of a banking company can exercise voting rights up to of the
total
voting rights of all shareholders, (one per cent; ten per cent; hundred per cent)
(vi) Banking companies are not permitted to give dividend until all are written off.
(bad debts, expenses, capitalised expenses)
2.
Say whether True or False, (i) A temporary branch for less than thirty days in a town
where a bank has an existing branch
does not require permission from Reserve Bank. (ii) A company whose banking licence
is rejected can undertake business as a moneylender or
undertake other business, (iii) The decision of Reserve Bank to revoke licence is final
and no appeal lies from it.
29
(iv) Banking companies are permitted to give brokerage up to two-and-half per cent of
the paid-up
value of shares.
(v)
(vi)No person can
A banking hold the
company shares
cannot of banks
hold sharesbeyond ceiling
in any other specifiedother
company under theaBR Act.
than
subsidiary.
3. Fill in the gaps choosing the answer from the brackets.
(i) A director of a banking company should not have in any other company, (beneficial
interest, any interest, substantial interest)
(ii) At least of the directors should have the qualifications prescribed under Section
10A(2) of the BR Act. (50 per cent, 75 per cent, 51 per cent) (iii) When the board of a
banking company is ordered to be reconstituted under Section 10A of the
BR Act, directors will be removed for the purpose of reconstitution. (by rotation,
by lots, by majority decision)
(iv) Before removing the chairman of a bank from office, Reserve Bank has to . (give
compensation for loss of office, give opportunity of being heard, give an option to
continue as
director) (v) The provisions of Section 36AA of the BR Act regarding removal of
managerial personnel have
over other laws, (no effect, overriding effect, persuasive effect)
(vi) Reserve Bank is authorised to appoint under Section 36AB of the BR Act.
(directors,
additional directors, managing director)
(vii) The (Central Government; RBI; SEBI) has stipulated the 'fit and proper' criteria
for directors of banking companies.
4. Say whether True or False.
(i) The maximum period of office that may be held continuously by an ordinary director
- CAIIB DISCUSSION
in a
banking company is eight years, (ii) The decisions of the board of directors, during the
period when the board's constitution is
defective shall be void.
(iii) The post of chairman of a banking company may be on part -time basis, (iv) The
chairman of a banking company can hold office only for a maximum period of eight
years, (v) From the order removing chairman of a banking company, appeal lies to the
Central Government
within thirty days of the order. (vi) Reserve Bank has the power to remove any officer or
other staff of a banking company under
Section 36M of the BR Act.' (vii) The concept of 'fit and proper' criteria for directors is
not applicable to public sector banks.
2.17 ANSWERS TO CHECK YOUR PROGRESS'
1. (i) licence; (ii) same city, town or village; (iii) 20 per cent of profit for each
year; (iv) Section
6(l)(a) to (o) of BR Act; (v) 10 per cent; (vi) capitalised expenses.
2. (i) True; (ii) True; (iii) False; (iv) True; (v) False; (vi) False.
3. (i) substantial interest; (ii) 51 per cent; (iii) by lots; (iv) give opportunity of
being heard; (v) over¬
riding effect; (vi) additional directors; (vii) RBI
4. (i) True; (ii) False; (iii) True; (iv) False; (v) True; (vi) True; (vii) False
Fill in the gaps choosing answers from the brackets.
30
. (such conditions as the Central Government may specify; such conditions as
the
Reserve Bank may think fit to impose; confirmation by the Central Government).
2. Reserve Bank is not empowered to cancel the licence granted to a banking
company on the
ground
changesthat . (theoffice
its registered company
fromceases to carry
one state on any
to another of its
state; business;
the company the
is company
not in a
position to pay its depositors in full as their claims accrue).
3. A bank requires permission of the Reserve Bank for opening a new branch or
shifting an existing
branch . (to any new location from where it is situated; otherwise than within the
same city, town or village; otherwise than in the same building).
4. In addition to the requirements as to minimum capital and reserves under
Section 11 of the BR
Act, Reserve Bank . (cannot look into the capital structure of a banking company;
has to satisfy itself under Section 22(3) of the BR Act as to adequacy of capital structure
and earning prospects; has to consult the Central Government as to the adequacy of the
capital structure of a banking company before licensing).
5. In the case of a banking company, a shareholder cannot exercise voting rights
on poll .
(in excess of ten per cent of the total voting rights of all the shareholders of the
company; in excess of two per cent of the total voting rights of all the shareholders of the
company; in excess of ten per cent of the total voting rights of all the shareholders except
with prior permission of the Reserve Bank).
Choose the correct statements from the following.
6. (i) There are no restrictions in the BR Act on payment of dividend by banking
companies,
(ii) Before payment of dividend by a banking company, all its capitalised expenses,
unless
- CAIIB DISCUSSION
specifically exempted under the BR Act, have to be completely written off. (iii) Banking
companies are not permitted to pay dividend above ten per cent of net profits.
7. (i) There are no specific qualifications required for the directors of a banking
company.
(ii) At least fifty-one per cent of the directors of a banking company should consist of
persons
with professional or other experience as provided in the BR Act. (iii) At least fifty-one
per cent of the directors of a banking company should be chartered accounts
or experts in finance.
8. (i) There is no provision for maintenance of reserves by a banking company
under the BR Act.
(ii) Every banking company has to maintain a reserve fund and transfer before declaring
dividend,
not less than twenty per cent of the profit to the reserve fund, (iii) The maintenance of a
reserve fund is optional for a bank.
9. (i) The chairman of a banking company has to be always on whole-time basis
and should be
entrusted with the management of the whole of the affairs of the banking company, (ii)
The chairman of a banking company can be on part-time basis and a managing director
can
be appointed on whole-time basis who shall be entrusted with the whole of the affairs of
the
banking company, (iii) The chairman of a banking company can be on part-time basis
and the whole of the affairs
of the banking company shall be entrusted to a committee of the board of directors. 10.
(i) A banking company can form subsidiaries for undertaking any business approved by
its
board of directors, (ii) A banking company can form subsidiaries for undertaking any
business mentioned in Section
6(1) (a) to (o) of the BR Act, which is permissible for a banking company to undertake,
(iii) A banking company does not r equire the permission of the Reserve Bank to form a
subsidiary
for doing banking business exclusively outside India.
UNIT
3
REGULATION OF BANKING BUSINESS
STRUCTURE
3.0 Objectives
3.1 Introduction
3.2 Power to Issue Directions
3.3 Acceptance of Deposits
3.4 Nomination
3.5 Loans and Advances
3.6 Regulation of Interest Rate
3.7 Regulation of Payment Systems
3.8 Internet Banking Guidelines
3.9 Regulation of Money Market Instruments
3.10 Banking Ombudsman
3.11 Reserve Funds
3.12 Maintenance of Cash Reserve
- CAIIB DISCUSSION
3.13 Maintenance of Liquid Assets

3.14 Assets in India
3.15 Let Us Sum Up
3.16 Keywords
32
3.0 OBJECTIVES
The objectives of this unit are to understand the law, in particular the provisions of the
Banking Regulation Act, relating to:
• issue of directions by Reserve Bank to banks
• regulation of acceptance of deposits by banks
• regulation of loans and advances
• regulation of interest rates of banks on deposits and borrowing
• maintenance of reserve fund
• maintenance of cash reserve by scheduled banks and other banks
• maintenance of liquid assets
• maintenance of assets in India
3.1 INTRODUCTION
The Banking Regulation Act provides for regulation of the business activities of banking
companies. Accordingly, the Act empowers the Reserve Bank to issue directions for
regulating terms and conditions of making of loans and advances and other matters
including acceptance of deposits. The Banking Regulation Act also imposes certain
restrictions on loans and advances to the directors of banking companies, and companies
and firms in which they are interested. The Act contains provisions for creation of a
reserve fund and transfer of a percentage of profits to that fund. There are also provisions
for maintenance of cash reserve, liquid assets and assets in India. In this unit, we look a t
the relevant provisions of law in this regard.
3.2 POWER
i. The Banking TO ISSUE
Regulation: DIRECTIONS
Act authorises the Reserve Bank to issue directions to banks
under Sections 21 and 35Aof the Act. While Section 21 gives the power to regulate
advances by banking companies, Section 35A gives wide powers generally to regulate
banking companies. The Reserve Bank has been issuing directions from time to time
under Section 21 (read with Section 35A) regulating rates of interest and other terms and
conditions of acceptance of deposits and making of loans and advances. Regulation of
deposits and loans and advances are discussed below (See, Paras 3.4 and 3.5,
respectively).
ii. Nature of Directions: The directions issued by the Reserve Bank in exercise of powers
under Sections 21 and 35A of the BR Act, being statutory directions, are binding on the
banks. The circulars of the Reserve Bank giving instructions to banks where it has
statutory powers to give such instructions are also binding on the banks, even if they do
not specifically refer to any statutory provisions. However, as held by the Supreme Court
in State Bank of India vs. CIT (AIR 1986 SC 757), non-statutory circulars of the Reserve
Bank cannot affect legal rights. The Reserve Bank's powers to issue directions are over
the banks. Hence, the directions are addressed to banks only and not to customers or the
public. The effect of violation of Reserve Bank's directions/ instructions which are
binding on banks, has been considered by the Supreme Court in BOI Finance Ltd. vs.
The Custodian (AIR 1997 SC 1952) in the context of some banks entering into certain
repo transactions against the circulars of the Reserve Bank prohibiting such transactions.
The court found that the action of the banks violated the Reserve Bank's instructions and
held that the violations would not invalidate the contracts with third parties but would
render the banks liable to prosecution. The effect of directions will be prospective and
- CAIIB DISCUSSION
not retrospective in the absence of any statutory provisions providing for retrospective
operation of directions.
33
iii. Bonafides: The powers of the Reserve Bank to issue directions have to be exercised
with bonafide intentions, as held by the Gujarat High Court in RBI vs Harisidh Co-op.
Bank Ltd. (AIR 1988 Guj 107). In that case the Court considered the power of the
Reserve Bank to issue directions for superseding the board of a co-operative bank for
securing its proper management and upheld the action taken by the Reserve Bank on the
finding that it was without mala fide.
iv. Caution and Advice: Apart from giving directions, the Reserve Bank may also
caution or give advice to banking companies. Section 36 of the Banking Regulation Act
provides that the Reserve Bank may caution or prohibit banking companies generally or
any banking company in particular against any transaction or class of transactions.
Further, the Reserve Bank may generally give advice to any banking company.
3.3 ACCEPTANCE OF DEPOSITS
i. As discussed in unit I, the essence of banking business is the acceptance of deposits
from the public withdrawable by cheque. [See also the judgement of Madras High Court
in Sajjan Bank Pvt. Ltd. vs RBI (AIR 1961 Mad 8)]. The definition of "banking" in
Section 5(b) of the Banking Regulation Act acknowledges this position.
ii. Types of Deposits: Banks accept different types of deposits, both time and demand
deposits, from the public. While time deposits, like fixed deposits or recurring deposits
are repayable after an agreed period, demand deposits, like deposits in current account
and savings bank accounts, are repayable on demand, subject to the terms and conditions
of the deposits. The period of the deposit and rate of interest applicable to the deposit are
matters to be agreed between the depositor and the bank under the terms of the deposit,
subject to any directions given by the Reserve Bank in this regard.
iii. Regulation of acceptance of deposits: The Banking Regulation Act does not contain
any specific provisions for regulation of acceptance of deposits of banks. However,
Section 35 A which authorises the Reserve Bank to give directions is wide enough to
cover acceptance
the public interestof
ordeposits. Accordingly,
in the interest acceptance
of banking policy orofindeposits may of
the interests be depositors
regulated in
by
issuing directions. The Reserve Bank issues directions from time to time r egulating the
rates of interest applicable to deposits. The directions may either fix the rates or specify
the minimum and/or maximum rate of interest on savings deposits and time deposits for
various periods as also for special categories of deposits like senior citizen, NRI
deposits. If only minimum and/or maximum rates are specified or no rates are specified,
the banks are free to decide their rates accordingly. The directions issued by the Reserve
Bank may also stipulate conditions regarding minimum or maximum periods for which
deposits may be accepted, reduction of interest payable on premature withdrawal and
payment of interest on renewal of overdue deposits.
However, currently RBI prescribes the minimum and maximum period for which
deposits can be accepted and prescribes interest rates only in respect of Savings Deposits
and NRI deposits leaving others for the individual banks.
iv. Returns on unclaimed deposits: Banks have to file a return every year on their
unclaimed deposits under Section 26 of the Banking Regulation Act. The return has to
be filed within thirty days of the end of each calendar year in the form and manner
prescribed and should cover all deposits not operated for ten years. In the case of fixed
deposits the period of ten years starts from the expiry of the period of the deposit.
34
3.4 NOMINATION
i. Repayment of Deposits: Section 45ZA of the Banking Regulation Act provides that a
depositor or depositors of a banking company (including co-operative banks) may
- CAIIB DISCUSSION
nominate one person in the prescribed manner as nominee to whom the deposit may be
returned in the event of death of the sole depositor or depositors. Unless the nomination
is varied or cancelled, the nominee is entitled to all the rights of the depositor/s in the
event of death of the depositor/s. In the case of minor nominees, there is also a provision
to appoint a person to receive the deposit on behalf of the minor. Payment by a bank in
accordance with these provisions gives a valid discharge to the bank, but this does not
affect the right or claim a person may have against the nominee in respect of the amount
received by him. Rule 2 of the Banking Companies (Nomination) Rules, 1985 provides
for the procedure and forms for making nomination in respect of deposits with
commercial banks. In the case of Co-operative banks, similar provisions are incorporated
in the Co-operative Banks (Nomination) Rules, 1985.
ii. Articles in Safe Custody and Safety Lockers: There are also provisions in the Banking
Regulation Act for nomination in respect of articles kept in safe custody with banks and
safety lockers. Sections 45ZC and 45ZE provide that any person who leaves any article
in safe custody and in safety lockers respectively with a banking company, may
nominate one person as nominee to receive the article in the event of death of that
person. The nomination has to be in the prescribed manner and on return of articles kept
in safe custody or removal of contents of locker by nominees as provided, the bank gets
a valid discharge. Rules 3 and 4 of the Banking Companies (Nomination) Rules, 1985,
and also the Rules 3 and 4 of the Co-operative Banks (Nomination) Rules, 1985 deal
with the form and procedure applicable to articles in safe custody and safety lockers
respectively in the case of banking companies and co-operative banks.
3.5 LOANS AND ADVANCES
i. The definition of 'banking' in Section 5(b) of the Banking Regulation Act indicates that
acceptance of deposits may be for lending or investment. Thus, lending or making of
loans and advances is a core business of a banking company. Lending may be for short
term or long term, on secured or unsecured basis and for different purposes.
ii. Regulation of Loans and Advances
(a) The Reserve Bank is empowered under Section 21 of the Banking Regulation
Act to issue
directions to control advances by banking companies. Such directions may be issued to

banking
companies generally or to any particular banking company. The Reserve Bank may
determine
the policy in relation to advances and issue directions when it is satisfied that it is
necessary to
give directions:
(i) In public interest (ii) In the interests of depositors
(iii) In the interests of banking policy.
(b) The directions given by the Reserve Bank are binding on banking companies,
and may be on
one or more of the following matters:
(i) Purpose for which advances may or may not be made.
(ii) Margins, to be maintained in respect of secured advances.
(iii) Maximum amount of advances or other financial accommodation which may be
made to any company, firm, association of persons or individual. The policy on these
matters may be specified having regard to the paid-up capital, reserves and deposits of
the banking company and other relevant considerations.
35
(iv) Maximum amount up to which guarantees may be given by a banking company on
behalf of any company, firm, association of persons or individual. In this case, also the
paid-up capital, reserves, deposits and other relevant considerations have to be taken into
account for determining the maximum amount.
- CAIIB DISCUSSION
(v) Rate of interest and other terms and conditions on which advances and other financial
accommodation may be made or guarantees may be given.
The Reserve Bank issues directions from time to time regulating the lending operations
of banking companies in exercise of these powers vested under Section 21. Apart from
this, the general powers to give directions under Section 35A are also available for
regulation of loans and advances.
iii. Selective Credit Control
(a) Purpose: Banks have been traditionally financing trade and commerce and
against items they
deal in even before the country started industrializing. To ensure that prices of essential
commodities like food grains, pulses, edible oils, sugar, jaggery and cotton and textiles
are not
increased by certain sections of the business community with a motive of profit
maximisation
by hoarding with the help of bank finance, these restrictions have been put in place.
These
cover the quantum of credit that can be extended and also the rate at which it can be
extended.
With self-sufficiency achieved by our country over the years in almost all of the above,
RBI
had taken them out of the purview of selective credit control and currently restrictions
are
there only in case of levy sugar.
(b) Methods and tools: Selective credit control seeks to influence the demand for
credit by
(i) making borrowing more costly for certain purposes which are considered relatively
inessen¬tial, or
(ii) by imposing stringent conditions on lending for such purposes, or (iii) by giving
concessions for certain desired types of activities.
The tools employed for exercising selective credit control are:
(i)
(ii)minimum margins
ceilings on for of
the levels lending
credit;against
and selected commodities; •
(iii) charging of minimum rate of interest on advances against specified commodities.
The quantum and cost of credit are regulated by operating these tools of control.
iv. Price control: In India, selective credit control has been generally used for preventing
speculative hoarding of essential commodities and basic r aw materials using bank credit.
This is with a view to check the undue rise of prices of such sensitive commodities.
v. Restrictions on loans and advances: Section 20 of the Banking Regulation Act
imposes certain restrictions on loans and advances. Accordingly, no banking company
shall grant loans or advances on the security of its own shares. Further, a banking
company, is prohibited from entering into any commitment for granting any loans or
advances to or on behalf of any of its directors. The prohibition also applies to loans and
advances to:
(a) firms in which any director is interested as a partner, manager, employee or
guarantor, and
(b) any company (other than a company registered under Section 25 of the
Companies Act) in
which a director of the banking company holds substantial interest as defined in Section
5(ne)
of the Act or of which he is director, manager, managing agent, employee or guarantor.
If the director of a banking company is a partner or guarantor of any individual, loans
and advances to such individual are also barred. 'Director' includes a member of any
board for managing or
- CAIIB DISCUSSION
36
advising the bank regarding management of all or any of its affairs. It is open to the
Reserve Bank to specify any transaction as not being a loan or advance for this purpose
by a general or special order. In so doing the bank has to consider the nature of the
transaction, period, manner and circumstances in which the amount is likely to be
realised, the interest of depositors and other relevant considerations. If there is any doubt
or dispute as to whether a transaction is a loan or advance, the decision of the Reserve
Bank in the matter shall be final.
vi. Restrictions on power to remit debt: For remitting any debt to its directors, a banking
company requires prior permission of the Reserve Bank under Section 20A of the
Banking Regulation Act. Permission is also required for remission of loans to:
(a) any firm or company in which a director is interested as director, partner,
managing agent, or
(b) any individual for whom a director is partner or guarantor. Any remission made
in contravention
of Section 20 is void and will have no effect.
3.6 REGULATION OF INTEREST RATE
The Reserve Bank is authorised to regulate interest rates under Section 21 (read with
Section 35A) of the Banking Regulation Act. This includes rates of interest for loans and
advances as well as deposits. While giving directions on interest rates, there should not
be any discrimination against any class of depositors or loanees or banks. Any
differential treatment should be justifiable in law as not being against the principles of
equality. In Harjit Singh vs Union of India (AIR 1994 SC 1433), the Supreme Court held
in the context of reduction of rate of interest on bank loans to riot victims that the
concession should be extended to loanees from financial institutions also, as there was
no basis for discrimination between loanees from banks and loanees from financial
institutions.
i. Interest on deposits: The rates of interest on deposits were not regulated by the Reserve
Bank until 1964. Hence, it was open to the banks to decide their deposit rates freely.
Thereafter the Reserve Bank has been issuing directions from time to time regulating
rates of on
interest interest applicable
current account to
wasdifferent typesAsofthe
prohibited. deposits. Accordingly,
directions are issuedpayment
by virtueofof the
powers vested in the Reserve Bank under Section 35A of the Banking Regulation Act,
before issuing the directions the Bank has to be satisfied that the directions are necessary
in public interest or in the interest of depositors or of banking policy. Reserve Bank may
permit higher rate of interest in favour of certain categories of depositors like
former/existing employees or depositors of certain classes of banks like co-operative
banks. Of late, the movement has been in the direction of liberalisation of interest rates,
thereby giving increased freedom to banks to decide the rates themselves.
ii. Interest rate on loans and advances: Interest rate on loans and advances is subject to
regulation specifically under Section 21(2)(e) of the Banking Regulation Act apart from
the general provisions of Section 35A. The Reserve Bank has been issuing directions
from time to time under Section 21 (read with Section 35A) of the Act regulating
different aspects of lending including lending rates. Accordingly, different rates are
permissible for different sectors like small-scale industries, agriculture, large-scale
industries, etc., and of late, much freedom has been given to banks to decide the rates
themselves. Further, the rate of interest may vary on the basis of the period of the loan.
The Reserve Bank tightens the regulations or gives relaxations thereby permitting banks
to decide the rates on their own, depending on the position of money supply in the public
interest or in the interest of depositors or of banking policy. Currently the directions of
RBI regarding interest rates of advances cover only finance to exporters and small loans
with limits up to Rs 2 lac and DRI loans.
37
- CAIIB DISCUSSION
iii. Usurious loans Act, 1918: The Usurious Loans Act, 1918 prohibits lending at
exorbitant rates. The law has been made to protect the weaker borrowers from the
powerful moneylenders. Similarly, debt relief legislation in different states attempts to
protect the agriculturists and other weaker sections from unscrupulous lenders, by
remitting debts or giving other concessions. Although the lending rates of banks are
regulated by the Reserve Bank, borrowers often used to resort to these laws for remitting
loans or reducing rates of interest in respect of loans taken by them from banks. This was
coming in the way of the monetary policy decided by the central bank. Accordingly,
Section 21A was inserted in the Banking Regulation Act to make the rates of interest
charged by banking companies beyond the scrutiny of courts.
iv. Protection to interest rate: Section 21A of the Banking Regulation Act provides that a
transaction between a banking company and its debtor cannot be reopened by any court
on the ground that the rate of interest charged is excessive. This provision is given an
overriding effect over the provisions of the Usurious Loans Act, 1918 or any other law
relating to indebtedness in force in any state.
Section 21A was held to be valid and not ultra vires the Constitution by the Supreme
Court. In Corporation Bank vs D. S. Gowda [(1994) 5 SCC 213], the Supreme Court
held that banks can compound interest on annual rates and not half yearly rates in view
of the express directives of the Reserve Bank. The court further held that where the
Reserve Bank fixes both minimum and maximum rates of interest, courts would not
interfere in the matter of interest rate, if the rate charged by the bank is not in violation
of the Reserve Bank directive. However, the court did not express any opinion on the
question whether Section 21A would debar the courts from interfering if the circulars or
directives of the Reserve Bank do not fix the maximum and leave it to the discretion of
the banks to fix the rate above the minimum.
3.7 REGULATION OF PAYMENT SYSTEMS
The Reserve Bank of India Act, until recently, did not contain any provision for
regulation of payment systems. Section 58 empowers the Bank to make regulations for
giving effect to the provisions of the Act and Clause (g) of the sub-Section (2) thereof,
provides for making provisions for regulation of clearing houses for the banks including
post office
clearing saving
house banks.
rules (The clearing
and regulations houses
framed by are
the now functioning
mutual consent ofunder the uniform
members and no
statutory rules or regulations have been framed.) However, the regulation of payment
systems has become important in the context of electronic payment systems becoming
popular and the probability of complications in the absence of a suitable regulatory
framework with statutory backing. In the absence of specific powers under the Act, the
Bank has not been able to frame any regulations relating to payment systems. Hence, the
Information Technology Act, 2000 has amended the Reserve Bank of India Act,
inserting the Clause (pp) in Section 58 (2) empowering the Reserve Bank to frame
regulations for payment systems of banks and financial institutions. Financial institution
for this purpose will have the same meaning as provided in the Clause (c) of Section 45
of the Reserve Bank of India Act. Accordingly, the Central Board of the Reserve Bank
has framed the Reserve Bank of India (Board for Regulation and Supervision of
Payment and Settlement Systems) Regulations, 2005. Further, RBI is in the process of
finalising the guidelines under the Payment and Settlement Systems Act, 2007.
i. Board for regulation and supervision of Payment and Settlement Systems: The Reserve
Bank, in terms of the RBI (Board for Regulation and Supervision of Payment and
Settlement Systems) Regulations, 2005, has constituted a Board for Regulation and
Supervision of Payment and Settlement Systems (BPSS) as a committee of its Central
board. The Board has the Governor of the Bank as its chairman and its functions include
prescribing policies relating to the regulation and supervision of all types of payment and
settlement systems, setting standards for existing and future systems,
38
- CAIIB DISCUSSION
authorising the payment and settlement systems, determining criteria for membership to
these systems including continuation, termination and rejection of membership.
3.8 INTERNET BANKING GUIDELINES
The Reserve Bank has issued guidelines in respect of internet banking. These guidelines
cover:
(i) technology and security issues; (ii) legal issues;
(iii) regulatory and supervisory issues.
These guidelines apply, in addition to Internet banking, to other forms of electronic
banking to the extent relevant. All banks offering internet banking have to make a
review of their systems in the light of these guidelines and report to the Reserve Bank
the types of services offered, extent of their compliance with the recommendations,
deviations, if any and their proposal indicating a timeframe for compliance.
3.9 REGULATION OF MONEY MARKET INSTRUMENTS
The Reserve Bank of India (Amendment) Act, 2006 (Section 45W) empowers the Bank,
in public interest or to regulate the financial system of the country to its advantage, to
determine the policy relating to interest rates or interest rate products and give directions
in that behalf to all agencies or any of them, dealing in securities, money market
instruments, foreign exchange, derivatives, or other instruments of like nature as the
Bank may specify from time to time. Further, the Bank may, for the purpose of enabling
it to regulate these agencies call for any information, statement or other particulars from
them, or cause an inspection of such agencies to be made. However, the directions issued
by the Bank in this behalf shall not relate to the procedure for execution or settlement of
the trades in respect of the transactions on the recognised Stock Exchanges. Every
director or member or other body for the time being vested with the management of the
affairs of the agencies falling under Section 45 W has to comply with the directions
given by the Reserve Bank and submit the information or statement or particulars as
required.
3.10 BANKING OMBUDSMAN
Ombudsman is generally an authority (official) appointed to receive and investigate on
the public grievances against the Government or any other authority or institution or
organisation
alternative toand
the redress such
adversary grievances
system as a non-adversarial
for resolution adjudicator,
of disputes. The or that
position is an of an
independent and non-partisan officer who deals with specific complaints from the public
against administrative injustice and maladministration. The banking ombudsman is an
authority originally established under the Banking Ombudsman Scheme, 1995 by the
Reserve Bank of India in exercise of the powers vested in it under Section 35A of the
Banking Regulation Act. The scheme aimed at resolution and settlement of complaints
of the banking public against the commercial banks (excluding RRBs) and the scheduled
primary co-operative banks without resorting to courts. It was modified by the Banking
Ombudsman Scheme, 2002 and later by the Banking Ombudsman Scheme, 2006 to
enlarge the extent and scope of the authority and functions of banking ombudsman for
'redressal of grievances against deficiency in banking services, concerning loans and
advances and other specified matters'. All commercial banks, regional rural banks and
scheduled primary co-operative banks are required to comply with the modified scheme.
1. Object of the scheme: The object of the scheme is to enable resolution of
complaints relating to
specified services rendered by the banks and to facilitate the satisfaction or settlement of
such
complaints.
2. Grounds of complaint: The grounds on which complaints may be made to the
banking ombudsman
are:
39
- CAIIB DISCUSSION
3.
(i) Deficiency in banking or other services in respect of:

(a) non-payment or inordinate delay in the payment or collection of cheques,
drafts, bills, etc.;
(b) non-acceptance, without sufficient cause, of small denomination notes tendered
for any
purpose, and for charging of commission in respect thereof;
(c) non-acceptance, without sufficient cause, of coins tendered and for charging of
commission
in respect thereof;
(d) non-payment or delay in payment of inward remittances;
(e) failure to issue or delay in issue of drafts, pay orders or bankers' cheques;
(f) non-adherence to prescribed working hours;
(g) failure to honour guarantee or letter of credit commitments;
(h) failure to provide or delay in providing a banking facility (other than loans and
advances)
promised in writing by a bank or its direct selling agents;
(i) delays, non-credit of proceeds to parties' accounts, non-payment of deposit or non-
observance of the Reserve Bank directives, if any, applicable to rate of interest on
deposits
in any savings, current or other account maintained with a bank; (j) delays in receipt of
export proceeds, handling of export bills, collection of bills, etc., for
exporters provided the said complaints pertain to the bank's operations in India; (k)
complaints from Non Resident Indians having accounts in India in relation to their
remittances
from abroad, deposits and other bank-related matters; (1) refusal to open deposit
accounts without any valid reason; (m) levying of charges without adequate prior notice
to the customer; (n) non-adherence by the bank or its subsidiaries to the instructions of
Reserve
Debit cardBank on ATM/
operations or credit card operations; (o) non-disbursement or delay in
disbursement of pension (to the extent the grievance can be
attributed to the action on the part of the bank concerned, but not with regard to its
employees); (p) r efusal to accept or delay in accepting payment towards taxes, as
required by Reserve
Bank/Government; (q) refusal to issue or delay in issuing, or failure to service or delay
in servicing or redemption
of Government securities;
(r) forced closure of deposit accounts without due notice or without sufficient reason; (s)
refusal to close or delay in closing the accounts; (t) non-adherence to the fair practices
code as adopted by the bank; (u) any other matter relating to the violation of the
directives issued by the Reserve Bank in
relation to banking services.
(ii) Deficiency in banking service in respect of loans and advances pertaining to:
(a) non-observance of Reserve Bank Directives on interest rates;
(b) delays in sanction, disbursement or non-observance of prescribed time schedule
for disposal
of loan applications but not declining credit;
(c) non-acceptance of application for loans without furnishing valid reasons to the
applicant;
(d) non-observance of any other direction or instruction of the Reserve Bank as
may be
specified by the Reserve Bank for this purpose from time to time;
- CAIIB DISCUSSION
(iii) Such other matters as may be specified by the Reserve Bank from time to time in
this behalf.
Jurisdiction and Procedure: The location and the territorial jurisdiction of the
ombudsman are as specified by the Reserve Bank. A complaint may be made in writing
by a person himself or through an authorised representative. No complaint to the banking
ombudsman shall lie unless,
40
(a) the complainant had, before making a complaint to the banking ombudsman,
made a written
representation to the concerned bank and the bank had rejected the complaint or the
complainant
had not received any reply within a period of one month after the bank received his
representation
or the complainant is not satisfied with the reply given to him by the bank;
(b) the complaint is made not later than one year after the complainant has received
the reply of the
bank to his representation or, where no reply is received, not later than one year and one
month
after the date of the representation to the bank;
(c) the complaint is not in respect of the same subject matter which was settled or
dealt with on
merits by any previous banking ombudsman proceedings whether or not received from
the
same complainant or along with one or more complainants or one or more of the parties
concerned with the subject matter;
(d) the complaint does not pertain to the same subject matter for which any
proceedings before
any
ordercourt, tribunal or arbitrator or any other forum is pending or a decree or award or
has been passed by any such court, tribunal, arbitrator or forum;
(e) the complaint is not frivolous or vexatious in nature;
(f) the complaint is made before the expiry of the period of limitation prescribed
under the Indian
Limitation Act, 1963 for such claims.
The Supreme Court has in a recent case, M/s Durga Hotel Complex vs. Reserve Bank of
India and Ors. [Appeal (civil) 1389 of 2007], observed that a banking ombudsman,
though might have initially jurisdiction to entertain a complaint on the basis that it has a
legal foundation, in terms of the scheme, he may be divested of that jurisdiction, or the
foundation in law might be lost, on either of the parties, approaching the Court, the
arbitrator or the debts recovery tribunal in respect of the same subject matter. This is on
the basis that the complaint must continue to have a foundation in law at the time the
ombudsman takes up the claim for his consideration and renders his decision or award
and that foundation would be lost when the complaint is taken to a Court, Arbitrator,
Tribunal or any other competent forum. The ombudsman being an authority or tribunal
of limited jurisdiction conferred by the scheme, the exercise of jurisdiction or power by
the ombudsman would depend on his having jurisdiction, not only to entertain a claim
but also to end it. Accordingly, once he/she is deprived of his jurisdiction or gets
deprived of his jurisdiction over the subject matter, he/she could no more proceed with a
complaint which was earlier filed and therefore, a complaint goes out of his/her purview
when the subject matter of it is taken to a court, arbitrator, tribunal or forum. Moreover,
the relief that can be granted by the ombudsman may not conflict with a more
- CAIIB DISCUSSION
comprehensive adjudication by a court, arbitrator, tribunal or forum with wider powers.

In short, when the ombudsman is about to pronounce his award, he finds that the subject
matter of the dispute has been taken to the debts recovery tribunal or a civil court or an
arbitrator or to any other competent forum, the ombudsman will have to decline
jurisdiction to pass any order or award on the complaint to bring about a resolution of the
complaint by way of a non adversarial adjudication.
The ombudsman may call for information from the bank concerned and make endeavour
to promote a settlement with the bank. The ombudsman is free to follow the procedure
considered appropriate. Where a complaint is not settled by agreement within a period of
one month from the date,of receipt of the complaint or such further period as the banking
ombudsman may consider necessary, he may pass an award after affording the parties
reasonable opportunity to present their case. He shall be guided by the evidence placed
before him by the parties, the principles of banking law and practice, directions,
instructions and guidelines issued by the Reserve Bank from time to time and such other
factors which in his/her opinion are necessary in the interest of justice. An award shall
not be binding on a bank against which it is passed unless the complainant furnishes a
letter of
41
acceptance of the award in full and final settlement of his claim within a period of fifteen
days from the date of receipt of copy of the award. If the complainant fails to furnish
his/her letter of acceptance within this time or within extended time of fifteen days, the
award will lapse. However, on a written request for extension of time, the banking
ombudsman may grant extension of time up to a further period of fifteen days for such
compliance. Within one month from the date of receipt by the bank of the acceptance in
writing of the award by the complainant (or within such time not exceeding a period of
fifteen days that may be granted by the banking ombudsman), the bank has to comply
with the award. However, if the bank or the complainant is aggrieved by the award, it/ he
can make an appeal to the appellate authority (Deputy Governor, Reserve Bank) under
the scheme.
4.
banking Banking Ombudsman
ombudsman vis¬ and Reserve Bank Directions: The legal position of
a-vis the Reserve Bank has been considered by the Supreme Court in Canara Bank vs
P.R.N.
Upadhyaya (AIR 1998 SC 3000). The court observed that since an ombudsman is
appointed by
virtue of the scheme framed under S 35A of the Banking Regulation Act, 1949, he/she is
obliged to
comply with the directions/circulars and notifications issued by the Reserve Bank under
Section
35A or 21 of the Act. He/She is also required to issue directions to banks based on the
Reserve
Bank directions/circulars and ensure their compliance. The ombudsman cannot ignore
these circulars
and directions while dealing with the complaints filed by customers of banks. The
impugned award
having been made, ignoring various circulars/directions issued by the Reserve Bank, the
same was
held to be not sustainable. The court, therefore, set aside the impugned award and
remitted the
complaint to the ombudsman for its fresh disposal in the light of the circulars/directions
issued by
the Reserve Bank with regard to charging of rate of interest from the landlord loanees,
whose
- CAIIB DISCUSSION
buildings were taken on lease/rent by the concerned bank and calculating the interest rate
at quarterly
rests.
5. Banking Ombudsman and Debt Recovery Tribunals: As regards the position of
banking ombudsman
vis-a-vis the debt recovery tribunal, the Allahabad High Court in M/s Hindustan Ferro
and Industries
Ltd. vs Debt Recovery Tribunal (AIR 2001 All 155) observed that while the object of the
scheme
is to enable resolution of complaints relating to provision of banking services and the
satisfaction
or settlement of such complaints, the purpose of the Act is to provide for the
establishment of
tribunals for expeditious adjudication and recovery of debts due to banks and financial
institutions
and for matters connected therewith or incidental thereto. The procedure prevailing prior
to the
enactment of the Act for recovery of debts due to the banks and financial institutions has
blocked
a significant portion of their funds in unproductive assets, the value of which
deteriorated with the
passage of time. It was for this compelling reason and to obviate the difficulties in
recovering debts
due to the banks and financial Institutions that the Act was enacted. The scheme has
nothing to do
with the proceedings of recovery of debts due to the banks and financial institutions. The
scheme
formulated by the Reserve Bank under the Banking Regulation Act, 1949 cannot
override the
provisions of the Act.
3.11 RESERVE
i. Creation FUNDS
of Reserve Fund: Every banking company incorporated in India has to create
a reserve fund under Section 17(1) of the BR Act out of the profits as shown in the
profits and loss account prepared under Section 29 of the Act. Every year, a sum
equivalent to not less than twenty per cent of such profits has to be transferred to the
reserve fund. Such transfer of profits to reserve fund has to be made before any dividend
is declared.
ii. Exemption from Contribution: If any banking company has an adequate paid-up
capital and reserves
42
in relation to its deposit liabilities, the Reserve Bank may recommend to the Government
of India for exemption from the requirement of transfer of profits to reserve fund.
Thereupon, the Government may pass an order in writing, exempting the banking
company from Section 17(1) for such period as may be specified in the order. No such
order shall be made unless the amount already in the reserve fund together with the
amount in the share premium account is not less than the paid-up capital of the banking
company.
iii. Appropriation from Reserve Fund/Share Premium Account: Appropriation of any
amount from the reserve fund or the share premium account has to be reported to the
Reserve Bank within twenty-one days of such appropriation. The banking company has
also to explain the circumstances in which such appropriation was made. It is open to the
Reserve Bank in any particular case to extend the period for submitting the report or to
condone the delay in making the report.
- CAIIB DISCUSSION
iv. Foreign Banks: The provisions of Section 17(1) of the Banking Regulation Act for
creating a reserve fund do not apply to foreign banks operating in India. In their case,
instead of creating a reserve fund under Section 17(1), Section 11(2) of the Act requires
them to deposit and keep deposited with the Reserve Bank an amount calculated at
twenty per cent of the profit for each year in respect of all the business transacted
through their branches in India. The amount may be deposited in cash or unencumbered
approved securities or partly in cash and partly in unencumbered approved securities.
Section 11 (2A) also provides for exemption by Central Government on the
recommendation of the Reserve Bank, where the deposits already made are considered
adequate in relation to the deposit liabilities of the banking company.
3.12 MAINTENANCE OF CASH RESERVE
Every banking company which is a scheduled bank has a duty to maintain certain cash
reserve with the Reserve Bank under Section 42 of the Reserve Bank of India Act. In the
case of non-scheduled banks, Section 18 of the Banking Regulation Act provides for the
maintenance of cash reserve.
i. Scheduled Banks: A scheduled bank is a bank included in the second schedule of the
Reserve Bank of India Act. Under Section 42(6) of the Act, the Reserve Bank may
include any bank in the second schedule if it satisfies the following requirements -
(a) it has a paid-up capital and reserves of an aggregate value of not less than Rs. 5
lac;
(b) it satisfies the Reserve Bank that its affairs are not conducted in a manner
detrimental to the
interests of depositors;
(c) it is:
(i) a state co-operative bank, or
(ii) a company as defined in Section 3 of the Companies Act, or
(iii) an institution notified by the Central Government in this behalf, or
(iv) a corporation or a company incorporated outside India under the foreign laws.
Thus, a banking company which has the requisite capital and reserves of Rs. 5 lac and
the affairs of which are not conducted in a manner detrimental to the interests of
depositors
exclude any is bank
eligible
fromto the
be included in the second
second schedule, if theschedule.
aggregateThe Reserve
value Bank, may
of its paid-up capital
falls below Rs. 5 lac, or its affairs are found to be conducted in a manner detrimental to
the interests of depositors on an inspection under Section 35 of the Banking Regulation
Act, or if it goes into liquidation, or otherwise ceases to carry on banking business.
ii. Quantum of Cash Reserve: The cash reserve required to be maintained by a scheduled
bank with the Reserve Bank under Section 42(1) of the Reserve Bank of India Act (as
amended in 2006) is an
43
average daily balance, being 'such per cent of the total of the demand and time liabilities
in India of that bank as shown in the return referred to in the sub-Section (2), as the
Reserve Bank may from time to time, having regard to the needs of securing the
monetary stability in the country, notify in the Gazette of India'. Thus, under the
amended statute, the Reserve Bank can, in order to secure monetary stability in the
country, determine the CRR for scheduled banks without any ceiling or floor rate (as
against a statutory minimum of three per cent earlier). 'Average daily balance' for this
purpose means the average of the balances held at the close of business of each day for a
fortnight. The liabilities, for this purpose do not include paid-up capital and reserves and
any credit balance in the profit and loss account.
Further, the amounts borrowed from the Reserve Bank, IDBI, Exim Bank, IIBI, National
Housing Bank and National Bank for Agriculture and Rural Development, are also
excluded. Apart from this, in case of a scheduled bank, other than a state co-operative
bank, the aggregate of liabilities of the scheduled bank to the State Bank, subsidiary
- CAIIB DISCUSSION
banks, Nationalised banks, banking companies, co¬operative banks and any financial
institutions notified by the Government in this behalf, shall be reduced by the aggregate
of liabilities of these banks and institutions to that scheduled bank. Further, the Reserve
Bank is empowered under the sub-Section (1C) of Section 42 to specify, from time to
time whether any transaction shall be regarded as liability in India of a scheduled bank.
iii. Interest: Until the amendment to the RBI Act in 2006, the Reserve Bank was
authorised under the Act [Section 42(1 B)] to pay interest to a scheduled bank when it
maintained reserves above the statutory minimum as required under the Reserve Bank's
notification under the erstwhile proviso to the sub-Section (1) or under the sub-Section
(1A) of Section 42. As the sub-Section (IB) providing for interest has been omitted now,
the Reserve Bank cannot pay interest on any portion of the CRR balances of banks.
iv. Returns: Every scheduled bank has to submit a return to the Reserve Bank showing
its demand and time liabilities and borrowings from banks in India, classifying them into
demand and time liabilities and giving other details required under Section 42(2) of the
Reserve Bank of India Act. The return has to be as at the close of business on each
alternate Friday and has to be sent not later than seven days after the date to which it
relates. In some cases, it may be impracticable to furnish fortnightly returns by reason of
the geographical position of the banks and its branches. If so, the Reserve Bank may
permit presentation of a provisional return fortnightly, to be followed by a final return
within twenty days after the date to which it relates. Alternatively, such a bank may be
permitted to file a monthly return within twenty days after the end of the month. In
addition to the above, where the last Friday of the month is not an alternate Friday for
the purpose of return, a special return as at the close of business on that day has to be
submitted within seven days. Where the relevant Friday is a holiday under the
Negotiable Instruments Act, the return has to be prepared as at the close of the preceding
working day.
v. Penalties: When the balance maintained by any scheduled bank falls below the
stipulated minimum, such a bank shall be liable to pay a penal interest to the Reserve
Bank. During the first fortnight, when such shortage occurs, the penal interest shall be
three per
penal cent above
interest the banktorate
shall increase fiveand
perifcent
the above
shortage
thecontinues
bank rate.inWhere
the next
thefortnight, the
shortfall still
persists in the third fortnight, every director, manager or secretary of the bank who is a
wilful party thereto shall be punishable with a fine. In that case, the Reserve Bank may
also prohibit the bank from accepting fresh deposits. Contravention of the order of
prohibition is also punishable with a fine. Failure to file the return as required, also
attracts a penalty under Section 45(4) of the Act. Where Reserve Bank is satisfied that a
bank had sufficient reason for committing the default, either in maintaining reserves or
in filing return, the penalty may be
44
waived. When penalty is imposed for a default, the amount has to be paid within
fourteen days of the notice demanding payment. On failure to pay accordingly, Reserve
Bank may obtain a direction from the Principal Civil Court for levying the penalty and
obtain a certificate for the amount which may be enforced like a decree of a civil court.
vi. Cash Reserves of Non-Scheduled Banks: In the case of banking companies, which
are not scheduled banks under Section 18 of the Banking Regulation Act, the cash
reserve need not be maintained with the Reserve Bank. It may be with the bank itself, or
in a current account with the Reserve Bank or by way of net balance in current accounts
or in one or more of these ways. The balance maintained should not be less than three
per cent of the demand and time liabilities as on the last Friday of the second preceding
fortnight. The bank has also to submit a return to the Reserve Bank before the twentieth
day of every month showing the amount so held on alternate Fridays during the month,
along with particulars of its demand and time liabilities in India on such Fridays. If the
- CAIIB DISCUSSION
Fridays concerned fall on holidays under the Negotiable Instruments Act, the returns
have to be filed as on the preceding working day.
3.13 MAINTENANCE OF LIQUID ASSETS
Every banking company has a duty to maintain a certain percentage of their assets in
India under Section 24 of the Banking Regulation Act in the form and manner specified
by the Reserve Bank by notification in the official gazette. Recently, the Banking
Regulation (Amendment) Ordinance, 2007 amended the provisions of Section 24,
omitting the sub-Sections (1) and (2) of Section 24 which provided for a statutory
minimum requirement of 25 per cent. Under the sub-Section (2A), as modified by the
Ordinance, a scheduled bank, in addition to the average daily balance which it is, or may
be required to maintain under Section 42 of the Reserve Bank of India Act, 1934 shall
maintain in India, assets, the value of which shall not be less than such percentage not
exceeding 40 per cent of the total of its demand and time liabilities in India as on the last
Friday of the second preceding fortnight. Banking companies other than scheduled banks
have also to maintain such assets in addition to the cash reserve, which they are required
to maintain under Section 18 of the BR Act.
i. Returns: For ensuring compliance with the above provisions, a monthly return has to
be submitted to the Reserve Bank by every banking company. The return has to be
submitted not later than twenty days from the end of the month to which it relates, in the
prescribed form and manner and giving particulars of assets and demand and time
liabilities at the close of business of each alternate Friday. If such a Friday is a public
holiday, the return has to be prepared as at the close of the preceding working day.
Without prejudice to the above, the Reserve Bank is also empowered to require a
banking company to furnish a return showing particulars of the assets and demand and
time liabilities as at the close of each day of a month.
ii. Penalty for Default: If the balance on any alternate Friday (or the preceding working
day, when such Friday is a holiday) falls below the minimum requirement, the banking
company is liable to pay to the Reserve Bank penal interest at the rate of three per cent
above bank rate on the shortfall for the day. If the default recurs on the succeeding
alternate Friday, the penal interest is raised to five per cent above the bank rate on the
shortfall.
manager andIf the default of
secretary occurs on the next
the banking succeeding
company Friday, with
is punishable then every
a fine.director,
The Reserve
Bank is also empowered to impose a similar penal interest for shortfall in the assets on
any day and if shortfall continues on the succeeding working day, the higher penal
interest is payable as above. If the Reserve Bank is satisfied on the application of a
banking company that it had sufficient cause not to comply with the provisions as to
maintenance of assets, penal interest may be waived.
45
3.14 ASSETS IN INDIA
i. Quarterly position of assets: Every banking company has to maintain in India certain
amount of assets as required under Section 25 of the Banking Regulation Act.
Accordingly, at the close of business on the last Friday of every quarter, such assets shall
not be less than seventy five per cent of the demand and time liabilities of the banking
company in India. If the last Friday is a holiday under the Negotiable Instruments Act,
the assets are based upon as at the close of business on the preceding working day.
'Quarter' for this purpose means the period of three months ending on the last day of
March, June, September and December. This provision is meant to ensure that the
resources mobilised by banks operating in India, especially the foreign banks, are largely
invested within the country. The assets may be in cash, gold or unencumbered approved
securities. 'Assets in India' also include export bills drawn in and import bills drawn on
and payable in India and expressed in currencies approved by the Reserve Bank for this
purpose. Such bills and securities approved by the Reserve Bank in this behalf are
treated as assets in India even if these assets were held outside India. The paid-up
- CAIIB DISCUSSION
capital, reserves and any credit balance in the profit and loss account of a banking
company shall not be treated as 'liabilities in India' for this purpose.
ii. Returns: A return regarding the assets maintained in India under Section 25(1) of the
Banking Regulation Act has to be submitted to the Reserve Bank within one month from
the end of every quarter. Such return has to be filed in the form and manner prescribed
by the rules made under the Act.
3.15 LET US SUM UP
i. The Banking Regulation Act empowers the Reserve Bank to issue directions to
banking companies in public interest, in the interest of banking policy and in the interest
of depositors. Section 21 provides for the issue of dir ections to regulate loans and
advances by banking companies. This may be done by regulating the purposes of
lending, margins in respect of secured loans, rate of interest and terms and conditions of
lending. Section 35A gives wide general powers to issue directions. The Reserve Bank
issues directions from time to time under Section 21 (read with Section 35 A) regulating
acceptance of deposits and lending. Under Section 21A of the Act, the rate of int erest on
loans and advances contracted between a bank and its customer is not liable to be
reopened by a court of law. Section 20 of the Act imposes restrictions on loans and
advances to directors, and companies and firms in which directors are interested as
director, partner, etc.
ii. A banking company which is a scheduled bank has to maintain a certain percentage of
the time and demand liabilities as cash reserve with the Reserve Bank under Section 42
of the Reserve Bank of India Act, as notified by the Reserve Bank from time to time.
Failure to do so renders the banking company liable to penalty. For non-scheduled
banking companies, Section 18 of the BR Act provides for cash reserve. Banking
companies have also to maintain a certain percentage of their demand and time liabilities
in liquid assets as stipulated under Section 24 of the BR Act. These assets may be
maintained to the extent and in the form and manner as notified by the Reserve Bank.
Apart from this, banking companies are required to maintain such assets in India at not
less than seventy five per cent of demand and time liabilities as at the close of business
of the last Friday of every quarter. Banking companies also have to transfer to the
reserve
account.fund twenty per cent of their annual profits as disclosed in the profit and loss
3.16 KEYWORDS
Bank Rate; Demand Liabilities; Scheduled Bank; Selective Credit Control; Time
Liabilities; Usurious Loans.
46

(i) Reserve Bank may issue directions to banking companies under Section 21 of BR Act
on
. (audit, loans and advances, capital structure)
(ii) may regulate acceptance of deposits including rate of interest on deposits by
(iii) (iv)
(v)
(vi)
2. Say
(i)
(ii) (iii)
(iv) (v) (vi)
3. Fill
(i)
(ii) (iii)
- CAIIB DISCUSSION
(iv) (v) (vi)

4. Say
(i)
(ii)
banking companies under Section 35A of the BR Act. (Government, Reserve Bank,
Board of Directors)
The banking ombudsman can settle a dispute between. (a bank and its customer/
s, two or more customers, a bank and the Government)
Directions can be issued to banking companies on loans and advances . (in strict
confidence, in public interest, in the interest of borrowers)
The purpose of is to make credit available to essential sectors of the economy
according to national priorities, (selective credit control, maintenance of cash reserve,
reserve fund)
Act prohibits lending at exorbitant rates and empowers reopening of such
contracts.
(BR Act, RBI Act, Usurious Loans Act)
whether the following statements are true or false.
Reserve Bank can issue directions on loans and advances under Section 21 of the
Banking
Regulation Act.
Regulation of credit to different sectors of the economy is known as selective credit
control.
Banks are free to lend to their directors.
Banks have to file a r eturn to Reserve Bank regarding unclaimed deposits under Section
26 of
the BR Act.
Directions may be issued under RBI Act to banks in respect of loans and advances in the
interest of depositors.
The directions issued by Reserve Bank under Section 35 A of the BR Act may be either
generally
to banks
in the or choosing
gaps to a particular bank. from the brackets.
the answers
The amount transferable to the reserve fund by the banks incorporated in India is
of the profit for each year. (25 per cent, 20 per cent, 10 per cent)
Every banking company has to maintain certain amount of assets under Section 25 of the
Banking Regulation Act as at the (last Friday of every fortnight, last Friday of
every month, last Friday of every quarter)
The penalty which is payable by a banking company which is a scheduled bank for
failure to
maintain the cash reserve in any week for the first time is (3 per cent, 3 per cent
over the bank rate, 5 per cent over the bank rate)
have to maintain cash reserve under Section 18 of the BR Act. (Cooperative
banks, Banking companies which are not scheduled banks, Nationalised banks)
The liquid assets to be maintained under Section 24(2A) of BR Act are
of the
balances maintained under Section 42 of the RBI Act. (inclusive, not inclusive, partly
inclusive)
The payment of penalty under Section 24 of BR Act can be enforced by making an
application
before (the Government, civil court, high court)
whether the following statements are true or false.
Only scheduled banks have a duty to maintain cash reserve under Section 42 of the
Reserve
Bank of India Act.
- CAIIB DISCUSSION
Every banking company has to maintain the liquid assets as required under Section 24 of
the
Banking Regulation Act.
47
(hi) The share capital and reserves of a banking company form part of its demand and
time liabilities
for the purpose of Section 42 of the RBI Act. (iv) The cash reserve required under
Section 42(1) of the RBI Act will be a minimum of three per
cent of the demand and time liabilities, (v) Interest is payable to scheduled banks on the
cash reserve maintained as required under Section
42(1) of the RBI Act. (vi) No banking company incorporated in India is required to
maintain reserve fund under Section
17(1) of the BR Act.
(ii) Reserve Bank (iv) in Public Interest (vi) Usurious Loans Act
1.
2. 3.
4.
(i) Loans and Advances (iii) a bank and its customer/s (v) Selective Credit Control
(i) True; (ii) True; (iii) False; (iv) True; (v) False; (vi) True
(i) 20 per cent
(ii) last Friday of every quarter (iii) 3 per cent over bank rate
(iv) banking companies which are not scheduled banks (v) not inclusive (vi) civil court
(i) True; (ii) True; (iii) False; (iv) False; (v) False; (vi) False
Fill
1. in theThegaps choosingofanswers
directions from Bank
the Reserve the brackets.
issued to the banking companies under
Section 35A of the
Banking Regulation Act are . (binding on them only; not binding on them and are
in
the nature of guidelines; binding on the banks and the public)
2. A contract if entered into by a banking company with any party in
contravention of a direction
issued by the Reserve Bank . (shall be invalid; shall render the banking company
liable to prosecution for violation of directions; shall render the bank and any other party
to the contract liable to prosecution for violation of directions)
3. Liquid assets are required to be maintained in India under Section 24 of the BR
Act, may be held
in the form of . (cash only; cash and gold only; cash, gold or unencumbered approved
securities)
4. For the purpose of maintenance of liquid assets under Section 24 of the BR Act,
unencumbered
approved securities shall be valued at . (face value; current market price; average
of
market price for previous six months)
5. The penal interest chargeable on a banking company under Section 24(4) of the
BR Act for not
maintaining liquid assets as specified under Section 24(2A) of the Act . (may be
waived by the Reserve Bank if it is satisfied that the bank had sufficient cause for the
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- JAIIB CAIIB STUDY MATERIALS
- CAIIB DISCUSSION
failure; has to be charged in all cases and the Reserve Bank has no option but to waive
penal interest; can be reduced by the Reserve Bank, but, not completely waived).
Choose the correct statements from the following:
6. (i) There are no restrictions on a banking company against grant of loans or
advances on the
security of its own shares.
48
(ii) (iii)
7. (i)
(ii)
(iii)
8. (i)
00
(iii)
9. (i) (ii)
(iii)
10. (i)
(ii)
(iii)
A banking company can lend to any firm in which its director is a partner. A banking
company is prohibited from entering into any commitment for granting loans or
advances to or on behalf of any individual in respect of whom any of its directors is a
partner or guarantor.
The power of the Reserve Bank to control advances extends to specifying the purposes
for
which advances may or may not be made.
A direction,
generally andregarding advances
not to any bankingmay be issued
company by Reserve Bank to banking companies
in particular.
A direction regarding advance can be issued by the Reserve Bank only in the interest of
banking policy and on no other grounds.
The depositor of a banking company can make a nomination in the form prescribed
under
the Banking Companies (Nomination) Rules, 1985.
There is no form prescribed for nomination by depositors under Banking Companies
(Nomination) Rules, 1985.
The nominee is entitled to receive the proceeds of the deposit on maturity of the deposit
during the lifetime of the depositor or later.
Banking ombudsman is appointed by the Government under the Banking Regulation
Act. Banking ombudsman is appointed by the Reserve Bank under the Banking
Ombudsman Scheme, 2006 framed in the nature of directions under the Banking
Regulation Act, 1949. Banking ombudsman is appointed by the Reserve Bank under the
Reserve Bank of India Act.
For maintenance of cash reserve under Section 42 of the RBI Act, 'demand and time
liabilities'
do not include paid-up capital of the banking company.
Loan taken from the Reserve Bank and Exim Bank are included in 'demand and time
liabilities'
under Section 42 of the RBI Act.
Any loan taken by a regional rural bank from its sponsor, forms part of its demand and
time
- CAIIB DISCUSSION
liabilities for the purpose of cash reserve under Section 42 of the RBI Act.
UNIT
4
RETURNS, INSPECTION, WINDING UP
STRUCTURE
4.0 Objectives
4.1 Introduction
4.2 Annual Accounts and Balance Sheet
4.3 Audit and Auditors
4.4 Submission of Returns
4.5 Preservation of Records and Return of Paid Instruments
4.6 Inspection and Scrutiny
4.7 Board for Financial Supervision
4.8 Acquisition of Undertakings

4.9 Amalgamation of Banks
4.10 Winding up of Banks
4.11 Penalties for Offences
4.12 Let Us Sum Up
4.13 Keywords

50
4.0 OBJECTIVES
The objectives
respect of of this unit are to understand the laws applicable to banking companies in
• preparation of accounts and balance sheet
• audit of accounts
• filing of returns
• inspection and scrutiny
• acquisition of assets by the Central Government
• amalgamation with other banks
• winding up
• penalties for default or contravention
4.1 INTRODUCTION
Banking companies have to prepare their balance sheet and accounts annually as
provided in the Banking Regulation Act. The accounts have to be audited by duly
qualified auditors as stipulated in the Act. The audited balance sheet and accounts have
to be submitted as returns to the Reserve Bank and copies thereof have to be submitted
to the Registrar of Companies. Banking companies have to file many other returns to the
Reserve Bank. The Banking Regulation Act also provides for inspection and scrutiny of
the books and accounts of banking companies. The board for financial supervision has
been set up for this purpose. The Central Government is authorised to acquire the assets
of banking companies and order the amalgamation of any banking company with another
banking company. The Reserve Bank has the power to apply to the High Court for the
winding up of banking companies. Non-compliance with the provisions of the Reserve
Bank of India Act, the Banking Regulation Act and the orders, rules, regulations, or
directions issued under them is punishable under these acts. In this chapter, we examine
- CAIIB DISCUSSION
the law relating to the above matters.

4.2 ANNUAL ACCOUNTS AND BALANCE SHEET
i. All Banks whose shares are listed with Stock Exchanges are required to publish their
unaudited quarterly results as per proforma prescribed by the SEBI. Every banking
company has to prepare its balance sheet and profit and loss account as stipulated in
Section 29 of the Banking Regulation Act. The balance sheet and profit and loss account,
has to be prepared at the end of each calendar year or on expiry of the twelve months
period, ending with any other date which the Central Government may notify in the
official gazette in this behalf, as on the last working day of the year or the period, as the
case may be. For this purpose, banking companies incorporated in India, have to cover
their entire business and in the case of foreign banks operating in India, the business
transacted through all their branches in India. While preparing the accounts, the banking
company has to comply with the directions and instructions issued by the Reserve Bank
in respect of income recognition, asset classification, provisioning, etc., from time to
time.
ii. The balance sheet and profit and loss account of a banking company incorporated in
India has to be signed by the manager or principal officer of the company and at least
three directors if there are more than three directors and by all directors if there are not
more than three directors. In the case of foreign banks, the manager or the agent of its
principal office in India can sign.
iii. The balance sheet and profit and loss account have to be prepared in the forms set out
in the III Schedule to the BR Act or as near thereto as circumstances permit. The
Companies Act requires every company to prepare its balance sheet and profit and loss
account in the forms set out in the part I of schedule VI to that Act. However, the
respective provisions of the Banking Regulation Act have overriding effect in respect of
banking companies. Hence, the provisions of the Companies
51
Act that are inconsistent with the provisions of the Banking Regulation Act are not
applicable to banking companies. However, those pr ovisions of the Companies Act that
are consistent with the Banking Regulation Act are applicable. The forms specified in
the third schedule of the Banking Regulation Act may be modified by the Central
Government from time to time by notification in the official gazette.
iv. In the case of banking companies, the profit and loss account, which has to be placed
before the annual general meeting should relate to the period ending with the last
working day of the year immediately preceding the year in which the annual general
meeting is held. The provisions of Section 210 of the Companies Act, in this behalf have
been specifically made inapplicable to banking companies by Section 2y^3A) of the
Banking Regulation Aci.
v.
Publication of Accounts and Balance Sheet: The accounts and balance sheet prepared
under Section 29 of the Banking Regulation Act along with the auditors' report have to
be published, as provided in Section 31 thereof read with Rule 15 of the Banking
Regulation (Companies) Rules, 1949. Accordingly, the publication has to be made in a
newspaper, which is in circulation at the place where the banking company has its
principal office, within a period of six months from the end of the period to which the
account and balance sheet relate. For this purpose, 'newspaper' means any newspaper or
journal published at least once a week but does not include a journal other than a
banking, commercial, financial or economic journal. As per current guidelines, Banks
whose shares are listed in the capital market are required to publish their unaudited
- CAIIB DISCUSSION
quarterly results as per proforma prescribed by SEBI.

VI
Submission to Reserve Bank: Every banking company has to submit thr ee copies of its
balance sheet and profit and loss account to the Reserve Bank within three months from
the end of the period to which they relate. This period may be extended by the Reserve
Bank by a further period not exceeding three months.
vu
Furnishing of Accounts and Balance Sheet to Registrar: Section 220 of the Companies
Act provides for submission by companies of copies of accounts and balance sheet along
with the auditor's report to the Registrar of Companies. However, in the case of banking
companies, Section 32 of the Banking Regulation Act provides for furnishing to the
registrar three copies of the accounts, balance sheet and auditor's report submitted to the
Reserve Bank under Section 31 of the Act, which would be dealt with in all respects, as
if these were submitted under Section 220 of the Companies Act. When any company
submits additional information relating to balance sheet and profit and loss account to
the Reserve Bank under Section 27(2) of the Banking Regulation Act, the company has
to send a copy thereof to the Registrar as well.
viii. Display of Balance Sheet and Accounts: Foreign banks (banking companies
incorporated outside India) operating in India have to display in a conspicuous place, in
their principal office a copy of the last audited balance sheet and profit and loss account.
This has to be done not later than the first Monday in August of any year in which it
carries on business. The accounts and balance sheet have to be kept displayed until
replaced by a copy of the subsequent balance sheet and profit and loss account.
Similarly, foreign banks have also to display copies of their complete audited balance
sheet and profit and loss account relating to their banking business as soon as these are
available and keep displayed till the subsequent accounts are available.
4.3 AUDIT AND AUDITORS
The balance sheet and profit and loss account of a banking company have to be audited,
as stipulated under Section 30 of the Banking Regulation Act. Accordingly, a person
duly qualified under any law for the time being to be an auditor of companies is eligible
to be the auditor of a banking company.

52
i. Powers and Functions of Auditors: The powers, functions and duties of the auditors
and the liabilities and penalties to which they are subjected to under Section 227 of the
Companies Act are applicable to auditors of banking companies. In addition to the
above, the auditor of a banking company has to give certain additional information in his
audit report. In the case of banks incorporated in India, the additional matters are as
under:
(a) Whether or not information and explanation, required by him were found to be
satisfactory;
(b) Whether or not the transactions of the company, as noticed by him were within
the powers of
the company;
(c) Whether or not returns from branches were adequate for the audit;
(d) Whether or not profit and loss account shows a true picture of the profit and
loss for the
period covered;
(e) Any other matter, which the auditor considers necessary to bring to the notice
of the shareholders
of the company.
In dealing with bank accounts, the responsibility of the auditor is not confined to
safeguarding the interests of the proprietors. The auditor will be reasonably blamed, if
after signing the usual auditor's report on an apparently sound balance sheet, the bank is
- CAIIB DISCUSSION
afterwards found insolvent (See the judgment of the Kerala High Court in Institute of
Chartered Accountants vs. Srinivasa, AIR 1960 Kerala. 309 at 311 and the judgment of
Madras High Court in Registrar of Companies vs. RM. Hegde, AIR 1954 Madras 1080
at 1084).
ii. Special Audit: Reserve Bank is empowered under Section 30( IB) of the Banking
Regulation Act to order a special audit of the accounts of any banking company. Such an
order may be passed when the Reserve Bank is of the opinion that special audit is
necessary in the public interest or in the interest of the banking company or its
depositors. An order, on special audit may relate to any transaction or class of
transactions or such period or periods as the Reserve Bank may specify in the order. The
bank may by the same order or by a different order appoint a duly qualified auditor for
this purpose or may direct the auditor of the banking company himself to conduct such a
special audit. The Reserve Bank's directions are binding on the auditor of the banking
company and the auditor has to make a report of such an audit to the Reserve Bank and
also give a copy thereof to the banking company. The expenses in relation to the special
audit have to be borne by the banking company.
4.4 SUBMISSION OF RETURNS
Every banking company has to furnish several returns to the Reserve Bank under various
provisions of the Banking Regulation Act and under the Reserve Bank of India Act. The
details of these returns are discussed below.
i. Return on Liquid Assets: Every banking company has to submit a return of its liquid
assets under Section 24(3) of the Banking Regulation Act. The return has to be
submitted within twenty days from the end of the month to which it relates. The return
has to be in the form prescribed under Rule 13A of the Banking Regulation (Companies)
Rules, 1949. The return should contain particulars of assets and the demand and time
liabilities, as at the close of business of each alternate Friday or when such a Friday is a
holiday, as at the close of business of the preceding working day. The Reserve Bank is
also empowered to require a banking company to furnish returns showing particulars of
assets and demand and time liabilities as at the close of each day of the month.
ii. Monthly Returns: Every month, a banking company has to submit to the Reserve
Bank a return
as at the close under Section 27 of the BR Act, showing its assets and liabilities in India
of business
53
on the last Friday of the previous month. Such a return has to be submitted before the
close of the month succeeding to which it relates. The return has to be in the form
prescribed under Rule 14A of the Banking Regulation (Companies) Rules, 1949. Apart
from this, the Reserve Bank may also call for statements and information relating to the
business or affairs of a banking company at any time. The bank may direct the banking
company to submit such statement or information within such time as it may direct. The
Bank may also call for information every half year regarding investments of a banking
company or the classification of its advances in respect of industry, commerce or
agriculture.
iii. Accounts and Balance Sheet: The annual accounts and balance sheet have to be
submitted to the Reserve Bank within three months from the end of the period to which
they relate. The Reserve Bank may extend the time by a further period of three months.
iv. Return of Assets in India: A banking company has to submit to Reserve Bank under
Section 25(1) of the Banking Regulation Act, a quarterly return regarding its assets in
India. The return has to be submitted within one month of the end of the quarter. The
return has to be filed in the form specified in the Rule 14A of the Banking Regulation
(Companies) Rules.
v. Return of Unclaimed Deposits: Under Section 26 of the BR Act, a banking company
has to file within thirty days of the close of each calendar year a return on unclaimed
deposits (not operated for ten years). This has to be submitted as specified in the Rule
- CAIIB DISCUSSION
14B of the Banking Regulation (Companies) Rules.

vi. Return of Cash Reserve of Non-Scheduled Banks: Every banking company, not being
a scheduled bank, has to furnish a return to the Reserve Bank under Section 18(1) of the
BR Act relating to cash reserve. The r eturn has to be submitted before the twentieth day
of every month showing the amounts held on the alternate Fridays during a month along
with the particulars of demand and time liabilities in the form stipulated in the Rule 13A
of the BR (Companies) Rules.
vii. Return by Scheduled Banks: Under Section 42 of the RBI Act, scheduled banks have
to submit returns to the Reserve Bank of their demand and time liabilities as specified in
the sub-Section (2) thereof.
4.5 PRESERVATION OF RECORDS AND RETURN OF PAID INSTRUMENTS
i. Preservation of Records: The Central Government is empowered under Section 45 Y
of the Banking Regulation Act to make rules specifying the periods of preservation of
books, accounts and other documents by banks and the periods of preservation of
different instruments paid by banks. Accordingly, the Government has notified the
Banking Companies (Preservation of Records) Rules, 1985 and the Cooperative Banks
(Period of Preservation of Records) Rules, 1985. These rules specify the period of
preservation of different types of ledgers and registers, and records other than ledgers
and registers. The rules further provide that, notwithstanding this, the Reserve Bank
may, having regard to the factors specified in Section 35A(1) of the BR Act, direct any
bank by an order in writing for preserving any books, accounts or registers for a longer
period than the period specified under the rules.
ii. Return of Paid Instruments: Under Section 45Z of the Banking Regulation Act, a bank
is authorised to return paid instruments to their customers even before the end of the
period of preservation specified under the Act. However, in that case, the bank shall not
return the instrument without making and keeping in its possession a true copy of all
relevant parts of the instruments by a mechanical or another process ensuring accuracy
of the copy. Banks are not entitled to charge the customers (including Government
departments and corporations) for giving such copies of instruments.
54
4.6 INSPECTION AND SCRUTINY
i. Inspection: The Reserve Bank is empowered under Section 35 of the Banking
Regulation Act to conduct an inspection of any banking company. The bank may
conduct such an inspection at any time. The Central Government may also direct the
Reserve Bank to conduct inspection of any bank and in that case, the Reserve Bank is
bound to comply with such a direction. After inspection of the books and accounts of the
banking company, a copy of the inspection report has to be given to the banking
company. The directors and officers of a banking company are bound to produce for
inspection all books, accounts and other documents in their custody. The inspecting team
may also require the bank to furnish any statements or information relating to the affairs
of the banking company within the time specified by them. The inspecting officer is
authorised to examine any director or officer of a banking company on oath.
ii. Powers of the Government: A copy of the report of inspection has to be sent to the
Central Government in all cases where inspections have been conducted as directed by
the Central Government. In other cases, it is optional for the Reserve Bank to send
copies of inspection to the Government. On consideration of the report, if the Central
Government is of the opinion that the affairs of a banking company are being conducted
to the detriment of the interests of the depositors, the Government may -
(a) Prohibit the banking company from receiving fresh deposits.
(b) Direct the Reserve Bank to apply for winding up of the banking company under
Section 38 of
the BR Act.
However, before taking such action, the Government has to give an opportunity to the
- CAIIB DISCUSSION
banking company to make a representation in respect of the report. The Central

Government is authorised to defer the passing of such an order or to cancel or modify
such an order subject to any terms and conditions imposed by it. It is also open to the
Central Government to publish an inspection report or a portion thereof after giving the
banking company a reasonable notice.
iii. Scrutiny: Apart from making regular inspections, Reserve Bank is also empowered to
conduct a scrutiny of the affairs and the books and accounts of any banking company
under the sub-Section (1 A) of Section 35 of the Banking Regulation Act. One or more
officers of the Reserve Bank may conduct such a scrutiny. A copy of the report has to be
furnished to the banking company, if it makes a request for the same or if adverse action
is contemplated against the banking company, based on the scrutiny. Otherwise, unlike
in the case of inspection, it is not mandatory to give a copy of the report to the banking
company. The powers of the Reserve Bank to call for books, accounts and documents or
statements and information as for examination of any director or officer of the banking
company on oath extend to scrutiny as well.
4.7 BOARD FOR FINANCIAL SUPERVISION
i. Constitution of the Board: The Board for Financial Supervision (Board) is a committee
established under Regulation 4 of the Reserve Bank of India (Board for Financial
Supervision) Regulations, 1994. These regulations were framed by the Reserve Bank
under Section 58 of the Reserve Bank of India Act, 1934 with the previous sanction
cfthe Central Government. The Board has jurisdiction over the banking companies,
Nationalised banks, State Bank and its subsidiaries.
ii. Composition of the Board: The Board consists of the following members:
(a) Governor of the Reserve Bank of India, (S)he is the chairperson of the board.
(b) Deputy Governors of the Reserve Bank of India, one of the deputy Governors
shall be nominated
by the Governor as the full time vice chairman.
(c) Four directors from the central board of the Reserve Bank nominated by the
Governor as
55
members, the Governor has to make the nominations to the board in consultation with
the central board of the Reserve Bank (Central Board) for a specified period,
iii. Functions and Powers: The board performs the functions and exercises the powers of
supervision and inspection under the Reserve Bank of India Act a nd the Banking
Regulation Act, in relation to different sectors of the financial system, including banking
companies. The board shall also perform any other function as may be notified by the
central board of the Reserve Bank. The board is assisted by the department of
supervision in the Reserve Bank and may also draw personnel from outside. The
chairman, vice-chairman and members can jointly and severally exercise the powers
vested in the board, as may be specified by the central board from time to time. The
board can also authorise senior officers of the department of supervision with prior
approval of the central board to carry out certain functions. The board has to report to the
central board on a half yearly timeline.
iv. Meetings of the Board: The board meets at least once in a month. Three members, of
whom, one shall be the chairman or the vice chairman shall form a quorum for the
meeting. A member who absents himself/herself without leave of the chairman for three
consecutive meetings of the board, would cease to hold office.
v. Executive Committee: The board has the power to constitute sub-committees. One
such sub¬committee is the executive committee. The vice chairman of the Board, is the
ex-officio chairman of the committee and there shall also be not less than two members
of the board in that committee. The committee meets as often as necessary.
vi. Advisory Council: Governor may constitute an advisory council to tender advice
from time to time to the board. This council will have not less than five members having
- CAIIB DISCUSSION
special knowledge of accountancy, law, economics, banking, finance and management.

The Governor presides over the meetings of the council and the vice-chairman and other
members are members of the council.
4.8 ACQUISITION OF UNDERTAKINGS
The Central Government can acquire the undertakings of banking companies in certain
cases as mentioned in Section 36AE of the Banking Regulation Act. 'Undertaking' means
the entire organisation (See the judgement of the Supreme Court in R.C. Cooper vs
Union of India, AIR 1970 SC 564). Acquisition may be made if on receipt of a report
from the Reserve Bank, the Government is satisfied that it is necessary to acquire any
undertaking on certain grounds. Before passing the order, the Central Government may
make such consultation with the Reserve Bank as it thinks fit. The grounds for
acquisition are as under:
• Banking company has failed on more than one occasion to comply with the
Reserve Bank's directions
under Section 21 or 35A of the Banking Regulation Act.
• Banking company is managed in a manner detrimental to the interests of
depositors and it is
necessary to acquire its undertaking in the interests of depositors or in the interests of
banking
policy or for better provision of credit generally or to any particular section of the
community or
any particular area.
Before acquiring the assets of a banking company, it has to be given a reasonable
opportunity of showing cause against the proposal.
i. On acquisition of the undertaking all the assets and liabilities of the acquired bank
stand transferred to and vests in the Central Government. It is also open to the Central
Government to order the vesting of the undertaking of the acquired bank in a company
or corporation instead of vesting in the Government. In that case, the transferee bank
takes over all the acquired assets and liabilities of the transferer bank.
56
ii. Power to make scheme: The Central Government is empowered under Section 36AF
to make a scheme for any acquired bank. Such a scheme is framed in consultation with
the Reserve Bank. The scheme may provide for all matters relating to property, assets,
liabilities, board of management, service of employees and their terms and conditions,
payment of compensation to shareholders of acquired bank and other matters. The
Central Government may modify or vary any such scheme after consulting the Reserve
Bank. The scheme and any subsequent modification thereof is published in the official
gazette and laid down before the Parliament. The provisions of part IIC of the Act
providing for acquisition of undertakings of banks by the Government and of any
scheme framed there under shall have an overriding effect on other laws. The scheme
shall have binding effect on the Government, the acquired bank, members, creditors and
depositors of the acquired bank and all other persons having any rights or liabilities in
respect of the acquired bank.
iii. Compensation to shareholders: The shareholders of an acquired bank have a right to
get compensation under Section 36AG of the Banking Regulation Act. The amount
thereof will be determined as provided in the fifth schedule to the Act, after consultation
with the Reserve Bank. There is also a provision (Section 36AH) for a reference to a
tribunal for hearing claims relating to compensation. If the compensation offered by the
Government or the transferee bank is not acceptable to any person to whom such
compensation is payable, he may request the Central Government to refer the matter to
the tribunal, and a reference has to be made to the tribunal, subject to the satisfaction of
certain conditions. In the case of acquisition of the undertaking of a foreign bank in
India, a reference has to be made to the tribunal, if requested by the foreign bank.
- CAIIB DISCUSSION
4.9 AMALGAMATION OF BANKS

i. Voluntary Amalgamation: A banking company may be amalgamated with another
banking company under Section 44A of the Banking Regulation Act. For this purpose, a
scheme has to be pr epared, containing the terms of such an amalgamation in a draft and
placed before the shareholders of the two companies separately. The scheme has to be
approved by a resolution passed by majority of members representing two-thirds in value
of the shareholders of each company present in person or by proxy. Notice has to be
given to every shareholder in this behalf. A share holder who votes against such scheme
or dissents to the scheme and gives notice as stipulated, may claim the value of his
shares from the banking company, in the event of sanction of the scheme by the Reserve
Bank. After the scheme is approved by the requisite majority, the scheme has to be
submitted to the Reserve Bank for sanction. On sanction by Reserve Bank, the assets and
liabilities of the amalgamated company pass to the banking company, with which it is to
be amalgamated. The Reserve Bank may also direct that the amalgamated company will
stand dissolved from any specified date and intimate the Registrar of Companies
accordingly. The order of sanction of amalgamation by Reserve Bank will be the
conclusive evidence of amalgamation.
ii. Amalgamation by Government: The Central Government is empowered to order
amalgamation of two banking companies under Section 396 of the Companies Act.
However, such power has to be exercised only after consultation with the Reserve Bank.
iii. Moratorium and Amalgamation: The Reserve Bank is authorised under Section 45 of
the Banking Regulation Act to apply to the Central Government for an order of
moratorium in respect of any banking company where it appears to it that there is good
reason to do so. After considering the application, the Central Government may pass an
order of moratorium staying the commencement or continuation of any action or
proceedings against the banking company for a fixed period. This may be on such terms
and conditions as the Government thinks fit and prefers to impose. The
57
period of moratorium is extendable from time to time. However, the total period of
moratorium
company shall shall
notnot exceed
make six months.
any payment During theor
to depositors period of moratorium,
discharge the or
any liabilities banking
obligations to any other creditors unless otherwise directed by the Central Government
in the order of moratorium or at any time thereafter.
iv. Scheme of Amalgamation:
(a) During the period of moratorium, Reserve Bank may prepare a scheme either
for reconstruction
of the banking company, or for amalgamation of the banking company with any other
banking
institution. Such a scheme may be prepared if the Reserve Bank is satisfied that it is
necessary
to do so:
(i) in the public interest;
(ii) in the interests of the depositors;
(iii) for securing the proper management of the banking company;
(iv) in the interest of the banking system of the country as a whole.
(b) The scheme of amalgamation or reconstruction may contain provisions for all
or any of the
matters specified in the clauses (a) to (I) of the sub-Section (5) of Section 45. These
include:
(i) constitution, name, registered office, capital assets, powers, rights, duties and
obligations
of the banking company after reconstruction of the transferee company; (ii) transfer of
assets from transferrer bank to transferee bank, and terms and conditions
- CAIIB DISCUSSION
thereof in the case of amalgamation; (iii) change in or appointment of board of directors;

(iv) alteration in memorandum and articles; (v) continuation of action by or against the
banking company after amalgamation or
reconstruction; (vi) reduction of the interest or rights of members, depositors or other
creditors considered
necessary in public interest or in the interest of members, depositors or creditors or for
maintenance of the business of banking company; (vii) payment in cash or otherwise to
creditors and other depositors; (viii) allotment of shares of the transferrer bank to the
shareholders of transferrer bank for
shares held by them in the transferrer bank; (ix) continuance of service of employees
after reconstruction or amalgamation.
The scheme has to provide for the continuance of all workmen and other staff (excepting
those specifically excluded by name in terms of the scheme) on the same terms and
conditions of service as before. The scheme should also provide that within three years,
these employees have to be given the same pay and terms and conditions as are
applicable to the other employees of the transferee bank of corresponding rank or status
of equivalent qualifications and experience. See the judgements of the Supreme Court in
State Bank of Travancore vs Elias (1970)2 SCC 761 and also K.I. Shepherd and others
vs Union of India and others AIR 1988 SC 686. In the case of any dispute regarding
rank, status, etc., of employees in this regard, the decision of the Reserve Bank shall be
final.
Scheme has also to provide for payment of terminal benefits to workers who have opted
not to continue in service on amalgamation or reconstruction and other employees, who
have been specifically mentioned in the scheme for exclusion from service. The scheme
may contain other terms and conditions of amalgamation or reconstruction and also
incidental matters.
(c) Sanction of Scheme by Government: A copy of the draft of the scheme
prepared by the
Reserve Bank has to be sent to the Government and also to the banking company,
transferee
58
bank and any other banking company concerned in the amalgamation, for their
suggestions and objections, if any. The Reserve Bank may specify the period for receipt
of such suggestions and objections. In the light of any suggestions and objections
received, modification may be made in the draft, as considered necessary by the Reserve
Bank. Thereafter, the scheme, may be placed before the Central Government for
sanction. The Government may sanction the scheme with such modifications as it may
consider necessary. The scheme shall come into force from the date of the sanction.
(d) Effect of Sanction: On the Central Government sanctioning the scheme, it becomes
binding on the banking company, transferee bank and the members, depositors and other
creditors, employees and any person having any right or liability in relation to the
banking company. The sanction by the Central Government is the conclusive evidence
that the amalgamation or reconstruction has been done in compliance with the provisions
of Section 45 of the Act. The assets and properties of the banking company shall stand
transferred to and vest in, and liabilities shall stand transferred and become liabilities of
the transferee bank as provided in the scheme.
If any difficulty arises in implementing the scheme, the Central Government may pass
the necessary orders for removing the difficulties. A copy of the scheme and any orders
passed for removing difficulties has to be placed before the Parliament.
Consequent to amalgamation, the transferee bank has to carry on the business of the
banking company acquired by the transferee bank, according to the law governing the
transferee bank. The Central Government may give necessary exemptions and
modifications in this behalf on the recommendation of the Reserve Bank. However, such
- CAIIB DISCUSSION
modification or exemption should not last for more than seven years.
A single scheme of amalgamation can be made in respect of several banking companies
under moratorium. The provision of Section 45 and the scheme sanctioned there under
shall have overriding effect on other laws, agreements, awards or instruments.
4.10 WINDING UP OF BANKS
i. Suspension of Business and Winding Up: A banking company which is temporarily
unable to meet its obligations may apply to the High Court under Section 37 of the
Banking Regulation Act for staying the commencement or continuance of any
proceedings against it. Such stay will be for a fixed period and subject to any terms and
conditions imposed by the High Court as it may think fit. The total period of such
moratorium shall not exceed six months. An application for moratorium shall be
supported by a report of the Reserve Bank indicating that the banking company will be
able to pay its debts if the application is allowed. The Court, for sufficient reasons, may
grant the relief, even if the application is not supported by the Reserve Bank's report. In
that case, a report will be called for and the order, may be modified or rescinded based
on the report. On passing of moratorium order the court may appoint a special officer to
take custody and control of the assets, books, etc., of the banking company in the
interests of the depositors.
If the Reserve Bank is satisfied that the affairs of a banking company under moratorium
as above, are being conducted in a manner detrimental to the interests of the depositors,
it may apply to the High Court for winding up of the company. Thereafter, the High
Court shall not extend the period of moratorium.
ii. Winding Up by High Court:
(a) The High Court shall order the winding up of a banking company in the
circumstances mentioned in Section 38 of the Banking Regulation Act. They are:
59
(i) The banking company is unable to pay its debts;
(ii) An application for winding up has been made by the Reserve Bank under Section 37
or Section 38 of the Act.
(b) Theif Reserve

Section 38, directed Bank is bound to make an application for winding up under
by the Central Government under Section 35(4) of the Banking Regulation Act. The
Central
Government may issue such direction under Section 35(4) when, on consideration of the
report of inspection or scrutiny made by the Reserve Bank at the direction of the Central
Government, it is of opinion that the affairs of the bank are being conducted to the
detriment
of the interests of the depositors. However, before giving such direction, the banking
company
has to be given an opportunity to make a representation in connection with the r eport of
inspection or scrutiny.
(c) It is open to the Reserve Bank to apply for winding up of a banking company in
certain other
cases as follows:
(i) failure to comply with the requirements of Section 11 r egarding minimum paid-up
capital
and reserves; (ii) bank being not entitled to carry on banking business in India under
Section 22 of the BR
Act by reason of rejection or cancellation of licence; (iii) prohibition to accept fresh
deposits under Section 35(4) of the BR Act or Section 42
(3A)(b) of the Reserve Bank of India Act; (iv) failure to comply with the requirements of
the BR Act other than Section 11 and
continuance of such failure or contravention beyond the period or periods specified by
- CAIIB DISCUSSION
the Reserve Bank in this behalf and after notice in writing of such failure or
contravention.
In addition to the above, the Reserve Bank may apply for winding up of a banking
company if it is of the opinion that:
(a) a compromise or arrangement sanctioned for a banking company cannot be
worked
satisfactorily with or without modification; or
(b) the returns, statements and information given by the bank under the Act show
that
it cannot pay its debts; or
(c) the continuance of the banking company is prejudicial to the interests of the
depositors.
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 the stipulated time
and the Reserve Bank certifies in writing that the banking company is unable to pay its
debts. If the demand is made at a place where the Reserve Bank has an office, branch or
agency, the time limit is two days and in other cases five days. When the Reserve Bank
makes an application for winding up, the court is bound to allow the application. As held
by the Supreme Court in the Palai Central Bank case (AIR 1962 SC 1371 at 1383), as
between the Court and the Reserve Bank, the momentous decision to wind up in the
interests of depositors may reasonably be left to the Reserve Bank.
iii. Official Liquidator: Section 38A of the BR Act provides for a liquidator to be
appointed by the Central Government, attached to respective High Court, for conducting
the winding up proceedings relating to banking companies. Such a liquidator need not be
appointed where enough cases of winding up of banking companies are not available in
any High Court.
iv. Reserve Bank as Liquidator: Although there is a provision for an official liquidator as
above, if the Reserve Bank applies to the Court under Section 39 of the Act, the Reserve
Bank, State Bank or any other bank notified by the Central Government in this behalf or
any individual stated in the application may be appointed as the official liquidator. The
remuneration
borne of the liquidator
by the banking company. and
Allother costs and
provisions expenditure
of the Companiesof winding up shall be
60
Act, which are not inconsistent with the Banking Regulation Act shall be applicable to
such a liquidator. The liquidator has to make a preliminary report to the High Court
within two months of the winding up order on the availability of assets for making
preferential payments under Section 530 of the Companies Act and for discharging
liabilities to depositors and other creditors. Within fifteen days of the winding up order,
the liquidator has to give notice calling for claims for preferential payment and other
claims from every secured and unsecured creditor. Under Section 43 of the Act, the
depositors need not make claims. The claims of every depositor of a banking company is
deemed to have filed for the amount as shown in the books of the banking company
standing to his credit.
v. Preferential Payment: In the winding up proceedings, the liquidator of a banking
company has to make certain preferential payments under Section 43 A of the Banking
Regulation Act. Accordingly, the preferential payments referred to in Section 530 of the
Companies Act, in respect of which, claims have been made within one month of service
of notice, get the first preference. After that, depositors in savings bank account up to Rs.
250 and then other depositors up to Rs. 250 get priority over all other creditors. After
making these payments, the balance available will be utilised for payment to general
creditors and then for payment of further amounts due to the depositors. The provision
for preferential payment by liquidator will not apply to depositors covered by the
DICGC Act.
- CAIIB DISCUSSION
vi. Voluntary Winding Up: Apart from the provision for compulsory winding up as
above, Section 44 provides for voluntary winding up by banking companies. However,
no such winding up will be permissible unless the Reserve Bank certifies that the bank
will not be able to pay in full all its debts as they accrue. It is open to the High Court to
order during voluntary winding up of a banking company that it shall continue, subject
to the supervision of the Court. The High Court may also order winding up by Court
either on its own motion or on the application by the Reserve Bank, if during voluntary
winding up it becomes clear that the company is not able to meet its debts as they accrue
or if continuing voluntary winding up or winding up under supervision of the court may
be detrimental to the interests of depositors.
4.11 PENALTIES FOR OFFENCES
A banking company has to abide by the requirements of the Reserve Bank of India Act
and the Banking Regulation Act and the subordinate legislation there under, namely
statutory rules, directions, etc., issued under these Acts. Failure to do so invites penalties.
i. Penalties Under the RBI Act: Chapter V of the Reserve Bank of India Act deals with
penalty for violation of the Act. Banking companies have to make applications and
furnish returns, statements, etc., under different provision of the Act, regulations, orders,
directions, etc. While doing so, the making of any statement which is false in any
particular material, knowing it to be false or wilfully omitting to make any material
statement, is punishable with imprisonment up to a period of three years and also a fine.
Failure to produce any books, accounts or other documents or statements, or information
which a person is duty bound to make under the Act, or any order, regulation or direction
is punishable with fine up to Rs. 2,000 for each offence. For continuing offences, there is
a provision for fine of Rs. 100 for each day when the offence continues. There are
penalties under the sub-Section (3) to (5B) of Section 58B for contravention of specific
provisions of the Act or orders, direction, etc., made there under. Apart from this, for
contravention of any other provisions or not complying with any requirements under the
Act, order, regulation or direction, the guilty shall be punishable with fine up to Rs.
2,000, and further Rs. 100 every day for continuing the offence.
In the case of offences by companies, every person who was in charge of or responsible
for conduct
default of he
unless theproves
company's business
that the shall
offence wasbecommitted
deemed guilty of the
without his contravention
knowledge or or
that
he had exercised due diligence to prevent the
61
offence. The court will not take cognizance of an offence under the Act (except offences
relating to acceptance of deposits under the Chapter IIIC) otherwise than on a complaint
by an officer of the bank generally or specially authorised in writing in this behalf by the
Bank. A metropolitan magistrate or magistrate of the first class or court superior thereto
shall try the offences.
ii. Penalties under the BR Act: The provisions of the Banking Regulation Act, relating to
penalties, are provided in Section 46 thereof. Accordingly, making wilfully any false
statement in any return, balance sheet or other document or information given under the
Act is punishable. Similarly, wilful omission to make any material statement is also
punishable. In both cases, punishment is up to three years imprisonment and fine.
Failure to produce any book, account or other document or to furnish a statement or
information that is obligatory to be produced under Section 35(2), during inspection or
scrutiny is punishable with fine up to Rs. 2,000. Similarly, failure to answer any question
relating to the business of the banking company during inspection is also punishable.
Continuance of the offence is punishable with fine of Rs. 100 for every day during which
the offence continues. Acceptance of deposits against an order prohibiting acceptance of
deposits under Section 35(4) is punishable with a fine up to twice the amount of deposits
accepted. Every director or officer is punishable in this case, unless he proves that the
contravention was without his knowledge or that he had exercised all diligence to
- CAIIB DISCUSSION
prevent it. Any contravention of other provisions of the Act, or any rule, order or
direction made or condition imposed, is punishable with fine up to Rs. 50,000 or twice
the amount involved in the contravention. In the case of continuing offences, a fine up to
Rs. 2,500 for each day may be imposed. In the case of offences by companies, every
person who was in charge of the company at the time of commission of the offence is
punishable unless he proves that the offence was committed without his knowledge or in
spite of his exercising due diligence to prevent it.
Under Section 47, the offences are cognizable only by a metropolitan magistrate, judicial
first class or a court superior thereto on a complaint by an officer of the Reserve Bank
and in some cases by the National Bank.
Under Section 47A, the Reserve Bank is empowered to impose a penalty for default or
contravention. If the Reserve Bank exercises that power, no complaint shall be filed in a
Court in respect of the same contravention or default.
4.12 LET US SUM UP
Every banking company has to prepare its balance sheet and profit and loss account
annually as at the end of the calendar year or at the end of twelve months as on a date
notified by the Central Government. The accounts have to be audited by auditors duly
qualified to be auditors of companies. Three copies of the balance sheet, profit and loss
account and the auditor's report have to be submitted as returns to the Reserve Bank and
to the Registrar of Companies. Banking companies have also to furnish other returns like
return on maintenance of cash reserve, maintenance of liquid assets, etc. The Reserve
Bank is authorised to inspect or conduct, scrutiny of banking companies, their books and
accounts. The Board for Financial Supervision set up by the Reserve Bank by statutory
regulations framed under the Reserve Bank of India Act supervises the affairs of banking
companies. The Government may acquire the undertakings of banking companies in
certain circumstances based on a report from the Reserve Bank. The Central
Government may also order moratorium on banking companies on the application of the
Reserve Bank. During moratorium, the Reserve Bank may prepare a scheme for
amalgamation, which may be sanctioned by the Central Government. Such an
amalgamation scheme will have overriding effect on any laws, agreements, etc. The
Reserve Bank
when it is may to
not able also
payapply to theand
its debts High
alsoCourt for winding
in certain up of a banking
other circumstances. company
The Reserve
Bank of India Act and the Banking Regulation Act impose certain penalties for
contravention or default committed by banking companies or other persons.
62
4.13 KEYWORDS
Amalgamation; Board for Financial Supervision; Continuing Offence; Inspection;
Moratorium; Scrutiny; Winding up.
1. Fill in the gaps choosing answers from the brackets.
(i) A banking company has to prepare profit and loss accounts and balance sheet as at the
or at the expiration of twelve months ending with such date as notified by the
Central Government, (end of calendar year, end of March, end of June) (ii) The balance
sheet and profit and loss account shall be audited by a person duly qualified to
be . (a certified financial analyst, auditor of companies, auditor of cooperative
societies)
(iii) Three copies of the balance sheet and accounts along with the auditor's report of a
banking company sent to the Reserve Bank under Section 31 of the BR Act, have also to
be sent to
. (the Central Government, Registrar of Companies, Company Law Board)
(iv) Reserve Bank is empowered to conduct of a banking company under Section
35(1) of the BR Act. (inspection, special audit, audit)
- CAIIB DISCUSSION
(v) A copy of the inspection report, relating to a banking company, to that banking
company, (should be given, need not be given, should be given at request)
(vi) The board for Financial Supervision is constituted by . (the Government,
Reserve
Bank, Indian Banks Association) (vii) Under Section 35(4) of the BR Act, Central
Government can prohibit a banking company
from accepting fresh deposits if the business of the banking company is conducted
. (not profitably, not in compliance with the Act, to the detriment of interest of
its depositors)
2.
Say whether true or false:
(i) Foreign banks have to prepare accounts and balance sheet in respect of all business
transacted
by them in India, (ii) Reserve Bank requires the permission of the Central Government
for ordering special audit
of a banking company, (iii) Three copies of the balance sheet, profit and loss account,
and auditor's report of a banking
company have to be submitted to the Reserve Bank as returns, (iv) A copy of scrutiny
report has to be given to the banking company whether requested by it
or not. (v) The Board for Financial Supervision is set up under the regulations framed by
the Reserve
Bank under Section 58 of the Banking Regulation Act. (vi) The Central Government is
not empowered to order Reserve Bank for inspection of a
banking company, (vii) Central Government has to give notice to the banking company
before publishing its
inspection report or any part of it.
3.
(i) The undertaking of a banking company may be acquired by the Central Government
if it is satisfied on a report from the Reserve Bank that the banking company has failed
on
thanmore
one occasion to comply with the . (directions of the Government, directions
under Sections 21 and 35A of BR Act, provisions of the Companies Act)
(ii) The Central Government may make a after consultation with the Reserve Bank
63
for carrying out the purposes of part IIC of the BR Act, in relation to an acquired bank.
(scheme, plan, memorandum)
may apply to the High Court for winding up of a banking company under
(iii)
Section 38 of the BR Act. (Registrar of Companies, Reserve Bank, Central Government)
(iv) The High Court shall order winding up of a banking company if the banking
company is
unable to (pay its debts, file returns in time, eliminate non-performing assets)
(v) In a winding up proceeding the depositors shall for the amounts shown in the
books of the bank standing to their credit, (be deemed to have filed claim, have to file
claim,
have no claim)
(vi) The may apply to the Central Government for an order of moratorium in
respect of a banking company, (banking company, Registrar of Companies, Reserve
Bank) (vii) The provisions of a scheme of amalgamation sanctioned by the Central
Government under
Section 45 of the BR Act will the provisions of other laws, (not affect, have
overriding effect on, will be subject to).
- CAIIB DISCUSSION
4. Say whether true or false

(i) Central Government can acquire the undertaking of a banking company under Section
36AE of the Banking Regulation Act in the interest of banking policy without any report
from the Reserve Bank on the affairs of the banking company, (ii) The undertaking of an
acquired bank may vest in the Central Government or in any company
or corporation as directed by the Central Government, (iii) On the application of Reserve
Bank, the High Court may stay the commencement or
continuance of proceedings against any banking company for any period, (iv) The
Reserve Bank or State Bank or another person as specified by the Reserve Bank in its
application before the High Court may be appointed as liquidator of a banking company,
(v) On winding up of a banking company, all the depositors as a class get the first
preference
for payment, (vi) The Reserve Bank may prepare a scheme for reconstruction or
amalgamation of a banking
company under moratorium under Section 45 of the BR Act. (vii) Making any false
statement in a return or other document submitted under the provisions of
the BR Act is punishable with imprisonment and fine also.
1. (i) end of calendar year (ii) auditor of companies
(iii) Registrar of Companies (iv) Inspection
(v) should be given (vi) Reserve Bank
(vii) to the detriment of interest of the depositors
2. (i) True; (ii) False; (iii) True; (iv) False; (v) False; (vi) False; (vii) True
3. (i) directions under Sections 21 and 35A of the BR Act
(ii) Scheme (iii) Reserve Bank
(iv) Pay its debts (v) be deemed to have filed claim
(vi) Reserve Bank (vii) have overriding effect on
4. (i) False; (ii) True; (iii) False; (iv) True; (v) False; (vi) True; (vii) True
Fill in the blanks choosing answers from brackets — 1 A banking mmpany has tn
prepare its annual

_. (decided by the accounts in the forms
64
board of the banking company and approved in general meeting; specified by the
Department of Company Affairs; in the form set out in the Third Schedule to the BR Act
or as near thereto as circumstances admit)
2. A banking company has to submit three copies of its accounts and balance sheet
together with
auditors' report . (to the Reserve Bank and also to the Registrar of Companies; only
to the Reserve Bank; only to the Registrar of Companies).
3. The expenses incidental to a special audit under Section 3O(1B) of the BR Act
shall be borne by
. (the Reserve Bank of India; the banking company; the Government of India)
4. The balance sheet and profit and loss account of a banking company, have to be
audited, as
stipulated under Section 30 of the Banking Regulation Act, by . (a person duly qualified
under any law for the time being in force to be an auditor of companies; Reserve Bank;
Registrar of Companies).
5. Reserve Bank shall cause an inspection of a banking company, by one or more
of its officers
. (if so required by shareholders representing at least ten per cent of the shares
of the
bank; if so required by the Central Government; if so required by the Registrar of
- CAIIB DISCUSSION
Companies.)
6. (i) Reserve Bank may publish, if they consider in the public interest to do so,
any information
obtained by them under the BR Act in such consolidated form as it thinks fit. (ii)
Reserve Bank may not publish any information in whatever form collected from a
banking
company in exercise of the powers under the BR Act. (iii) Reserve Bank may not publish
information obtained during inspection of a banking company
even in a consolidated form.
7. (i) Board of Financial Supervision is a body established by the Government
under the provisions
of the BR Act. (ii) Board of Financial Supervision is a body established under the
Reserve Bank of India Act for
the supervision of banks and financial companies, (iii) Board of Financial Supervision is
a body established by the Government for supervising the
securities market.
8. (i) The Reserve Bank may order moratorium in respect of a banking company
when it is satisfied
that there is good reason to do so. (ii) The Central Government may order moratorium on
its own motion when it is satisfied that
the financial position of the banking company is not satisfactory, (iii) The Central
Government may after considering the application made by the Reserve Bank
for an order of moratorium in respect of a banking company, order moratorium staying
the
commencement and continuance of all actions and proceedings against the banking
company.
9. (i) The High Court shall under Section 38 of the BR Act order winding up of a
banking company
if it is unable to pay its debts, (ii) The High Court shall under Section 38 of the BR Act
order winding up ofmakes

if the Government a banking company therefore under Section 37 of the BR Act. (iii)
an application
The High Court shall under Section 38 of the BR Act order winding up of a banking
company
if the continuance of the banking company is prejudicial to the interests of its
shareholders
and the Reserve Bank applies to the court on that ground. 10. (i) No provisions of the
Companies Act apply to the liquidator in the winding up of a banking
company, (ii) All provisions of the Companies Act apply to the liquidator in the winding
up of a banking
company, (iii) All provisions of the Companies Act relating to liquidator, insofar as they
are consistent with
BR Act, apply to a liquidator of a banking company.
UNIT
5
PUBLIC SECTOR BANKS AND CO-OPERATIVE BANKS
STRUCTURE
5.0 Objectives
5.1 Introduction
5.2 State Bank and Its Subsidiaries
- CAIIB DISCUSSION
5.3 Regional Rural Banks

5.4 Nationalised Banks
5.5 Application of Banking Regulation Act to Public Sector Banks
5.6 Disinvestment of Shares by Government
5.7 Co-operative Banks
5.8 Let Us Sum Up
5.9 Keywords
66
5.0 OBJECTIVES
The objectives of this unit are to understand:
• the special laws governing the public sector banks, namely, State Bank and its
subsidiaries,
Nationalised banks, and regional rural banks;
• the applicability of Banking Regulation Act and the Reserve Bank of India Act
to these banks;
• laws governing the co-operative banks, in particular applicability of Banking
Regulation Act to co¬
operative banks;
• extent of legal control of state governments over co-operative banks.
5.1 INTRODUCTION
i. The public sector banks, namely, the State Bank of India and its subsidiaries,
Nationalised banks and regional rural banks are established by special statutes. These
statutes and the rules, regulations and/or schemes framed thereunder provide the powers,
functions and management of these banks. The Banking Regulation Act is applicable to
these banks only in a limited way, as some of the provisions are not applicable.
ii. In the case of co-operative banks, these banks being created and governed by the laws
relating to co-operative
they operate in differentsocieties,
states, theifCentral
they operate only inThe
Act applies. oneBanking
state, theRegulation
State Act and
Actifis
applicable to co-operative banks in a modified manner as provided in Section 56 of the
Act.
iii. In this unit, we study the special laws applicable to the public sector banks and co-
operative banks as also the Banking Regulation Act and Reserve Bank of India Act as
they apply to these banks.
5.2 STATE BANK AND ITS SUBSIDIARIES
i. Establishment of State Bank: State Bank of India was established under Section 3 of
the State Bank of India Act, 1955 for taking over the undertaking of the Imperial Bank
and to carry on the business of banking and other business in accordance with that Act. It
is a body corporate, with perpetual succession and common seal and shall sue and be
sued in its name. The majority of ; shares are held by the GOI. Further, no shareholder
other than the GOI can exercise voting right above ten per cent, unless otherwise
specified by the Central Government in consultation with the Reserve Bank. Now the
complete holding of RBI is acquired by the central government.
ii. Management: The State Bank has its central office in Mumbai and local head offices
at Mumbai, Kolkata, Chennai and other places as decided by its Central Board in
consultation with the Central Government. The superintendence and direction of the
affairs of the bank is vested in the Central Board, which has to function according to the
business principles having regard to public interest. The Central Government can give
directions to the bank on matters of policy involving public interest in consultation with
the Governor of the Reserve Bank and the Chairman of the State Bank. The directions
have to be given through the Reserve Bank. The board is empowered to make
- CAIIB DISCUSSION
regulations for carrying out the purposes of the Act in consultation with the Reserve
Bank and with the previous sanction of the Central Government.
iii. Composition of the Board: The Board shall consist of Chairman, Vice-Chairman, not
more than two Managing Directors appointed by the Central Government, presidents of
local boards and other directors. There are directors falling in different categories,
namely, appointed by the Government to represent workmen and officers, nominated by
the Central Government in consultation with the Reserve Bank from among persons with
special knowledge of co-operatives and rural
67
economy, nominated by Reserve Bank, nominated by Central Government and elected
by shareholders other than Reserve Bank.
The chairman and managing directors are appointed for a period not exceeding five
years and are eligible for reappointment. Their services can be terminated by the Central
Government by giving a three month's notice or notice pay in lieu thereof, after
consultation with the Reserve Bank.
Local boards are set up at each place where there is a local head office to exercise all
powers and to perform the functions and duties of the bank delegated under Section 2 IB
of the Act. The local board consists of the chairman and other elected and nominated
members as specified in Section 21 of the Act.
iv. Business of State Bank: The State Bank shall act as an agent of the Reserve Bank at
the places where it has a branch and where Reserve Bank has no branch, if so required,
by the Reserve Bank, for transacting Government business and other business entrusted
to it by the Reserve Bank. The terms and conditions thereof shall be as agreed between
the Reserve Bank and the State Bank. If agreement is not reached, the terms shall be
decided by the Central Government. The State Bank may transact the work through its
subsidiaries or an agent approved by the Reserve Bank. Apart from this, the State Bank
may carry on the business of banking as defined in Section 5(b) of the Banking
Regulation Act and other business specified in Section 6(1) of that Act. The bank is
permitted to acquire business of other banks with the sanction of the Central
Government
Reserve Bank. or if so directed by the Central Government in consultation with the
v. Accounts and Audit: The State Bank has to close its books and balance accounts each
year as on 31 March or such other date as may be specified by the Central Government.
Within three months of the closing date, it has to furnish to the Central Government and
the Reserve Bank its balance sheet and profit and loss account together with auditors'
report and a report by the Central Board on the working and activities of the bank. The
audit may be conducted by any person duly qualified to be auditors of companies under
Section 226 of the Companies Act. No Director, member of local board, local committee
or an officer of the State Bank shall be eligible to be the auditor. The appointment of
auditors is done by the Reserve Bank in consultation with the Central Government. The
auditors' report and report of the Central Board have to be placed before the Parliament.
The State Bank has also to transmit to the Central Government and the Reserve Bank
within two months of the date of annual closing of accounts, the particulars of its
shareholders as on that date. The balance sheet and profit and loss account, auditor's
report and report of the Central Board shall be open for discussion by the shareholders at
the annual general meeting. The annual general meeting has to be held within six weeks
of the date of sending the balance sheet, etc., to the Central Government and the Reserve
Bank.
vi. Subsidiary Banks: The subsidiary banks of the State Bank of India were established
by different special statutes. The State Bank of Hyderabad was constituted as Hyderabad
State Bank under the Hyderabad State Bank Act and later renamed as State Bank of
Hyderabad under the State Bank of Hyderabad Act, 1956. The State Bank of Saurashtra
was constituted under the Saurashtra State Banks (Amalgamation) Ordinance, 1950. The
- CAIIB DISCUSSION
other banks were established under Section 3 of the State Bank of India (Subsidiary
Banks) Act, 1959. Every subsidiary bank is a body corporate with perpetual succession
and common seal and shall sue and be sued in its own name. The majority of the issued
share capital of the subsidiary banks is held by the State Bank. The shares of the
subsidiary banks are freely transferable as provided in Section 18 of the Act. However,
the State Bank is not entitled to transfer the shares if such transfer would result in
reducing its shareholding to less than fifty per cent of the issued capital.
vii. Management of Suhsidiarv Ranlrs- Tht* opnprai cimonnton/fon^ ^~A ~
,,-,+ ,-v-f-* f*4?£nZ-~r* rt-C ~ . 1-. — 1 .31
68
bank vests in its board of directors and the board may exercise all the powers and carry
out all functions with the assistance of the managing director, subject to the directions
and instructions given by the State Bank from time to time.
The board consists of the chairman (State Bank Chairman, ex-officio), managing
director and other directors. The directors are nominated or appointed by the Central
Government, Reserve Bank or the State Bank except for the directors to be elected by
the shareholders other than the State Bank. The State Bank appoints the managing
director after consulting the board of the subsidiary bank and with the approval of the
Reserve Bank. The day-to-day administration vests in the managing director. The State
Bank may, with the approval of the Reserve Bank and after giving opportunity to show
cause, remove the managing director from office. The Act provides for an executive
committee, consisting of directors, which may deal with any matter within the
competence of the board subject to any regulations made under the Act.
viii. Business of Subsidiary Banks: A subsidiary bank has to act as agent of the State
Bank under Section 36 of the (SBI Subsidiary Banks) Act, at any place as required by
the State Bank to receive, collect and remit money, bullion and Government securities
on behalf of the Government of India, and undertake other business which the Reserve
Bank may entrust the State Bank from time to time, with the approval of the Reserve
Bank. Under Section 36A, a subsidiary bank has also act as an agent of the Reserve
Bank if required
Reserve by terms
Bank. The it, to undertake Government
and conditions work
of agency orthe
with other work entrusted
Reserve Bank willby
bethe
as
agreed between the Reserve Bank and the subsidiary bank and if no agreement is
reached or dispute arises, the decision of the Central Government shall be final. A
subsidiary bank shall also transact the business of banking as defined in Section 5(b) of
the Banking Regulation Act and any other business specified in Section 6(1) of that Act.
The Central Government may after consultation with the State Bank and Reserve Bank,
by order in writing authorise a subsidiary bank to undertake other form of business or
prohibit it from carrying on any business, which is otherwise lawful for it to engage in. It
is open to a subsidiary bank to acquire the business of other banks with the approval of
State Bank. The Reserve Bank may direct the bank in consultation with State Bank to
acquire the business of any bank.
ix. Accounts and Audit: Subsidiary banks have to close and balance their accounts
annually as on 31 March or such other date as may be specified by the Central
Government by notification in the official gazette. After providing for bad and doubtful
debts and other matters specified in Section 40 of the SBI (sub-Banks) Act, a subsidiary
bank may declare a dividend out of its profits.
The audit of accounts has to be done by a qualified auditor of companies as specified
under Section 226 of the companies Act who shall be appointed by the State Bank in
consultation with the Reserve Bank.
The balance sheet and profit and loss account together with auditors' report and report of
the board on the working and activities of the bank have to be submitted as returns to the
State Bank, Reserve Bank and the Central Government within three months of the date
of closing accounts. The Reserve Bank may extend the period by further three months in
- CAIIB DISCUSSION
consultation with the State Bank.

A general meeting of shareholders shall be held annually as required under Section 44 of
the Act within six weeks of sending the accounts, etc., to the State Bank and others. The
shareholders are entitled to discuss the balance sheet, profit and loss account, auditor's
report and the board's report at such meeting.
The State Bank is empowered under Section 47 to inspect the subsidiary banks.
69
x. Rules and Regulations: The Central Government is empowered to make rules under
Section 62 of the Act for giving effect to the purposes of the Act. The State Bank is also
empowered to make regulations under Section 63 with the approval of the Reserve Bank
for giving effect to the purposes of the Act.
5.3 REGIONAL RURAL BANKS
The Regional Rural Banks (RRBs) are public sector institutions, regionally based, rural
oriented and engaged in commercial banking. They were first set up in 1975 under the
Regional Rural Banks Ordinance, 1975. The ordinance was later replaced by the
Regional Rural Banks Act, 1976. The formation of these banks was the result of the
growing realisation that the ethos and attitude of the existing public sector banks were
not fully conducive to meet the credit needs of the rural people. As stated in the
preamble to the Act, the object of setting up regional rural banks is to develop rural
economy by providing credit and other facilities for the purpose of development of
agriculture, trade, commerce, industry and other productive activities in r ural areas,
particularly to small and marginal farmers, agricultural labourers, artisans and small
entrepreneurs.
i. Establishment of RRBs: Section 3 of the Act authorises the Central Government to
establish regional rural banks by notification in the official gazette at the request of a
sponsor bank to operate within specified local limits. 'Sponsor Bank' is a bank by which
a regional rural bank is sponsored and it holds 35 per cent of the issued capital of the
RRB, while the Central Government holds 50 per cent and the State Government holds
the remaining fifteen per cent of the issued capital. Every RRB is a body corporate with
perpetual succession
property and andbecommon
to sue and sued in seal with power
its name. to acquire,
Generally, holdrural
a regional and bank
dispose of
is allotted a
compact area of operation comprising a few districts with homogeneous agro-climatic
conditions and rural clientele: These banks may accept all types of deposits from the
public and engage in the business of 'banking' as defined in Section 5(b) of the Banking
Regulation Act.
ii. Management of the Affairs of an RRB: The management of RRB vests in the board of
directors. The board has to function on business principles with due regard to public
interest. The board is empowered to make regulations for giving effect to the provisions
of the Act in consultation with the sponsor bank and with previous approval of the
Central Government. The Central Government is empowered to give directions to RRBs
on matters of policy involving public interest.
The board consists of a chairman appointed by the sponsor bank from among its officers
in consultation with the National Bank, or otherwise in consultation with the Central
Government. The chairman holds office on whole-time basis and is removable by the
sponsor bank, where the chairman is an officer of the sponsor bank, in consultation with
the National Bank and in other cases in consultation with the Central Government.
A person who is adjudged insolvent or is convicted of an offence involving moral
turpitude is disqualified to be a director and has to vacate office. Absence from three
meetings consecutively without leave of the board also results in vacation of office.
iii. Business of Regional Rural Banks: Regional rural banks may transact the business of
banking as defined in Section 5(b) of the Banking Regulation Act and any other business
permissible for a bank to undertake under Section 6(1) of that Act. However, the main
thrust of the business would be granting of loans and advances to small and marginal
- CAIIB DISCUSSION
farmers, agricultural labourers, agricultural marketing societies, farmers' service

societies, artisans, small entrepreneurs, etc., within the notified area of operation.
70
other date as the Central Government may specify. The auditors have to be appointed
with the approval of the Central Government. A person qualified to act as an auditor of
companies under Section 226 of the Companies Act is qualified to be an auditor of a
regional rural bank. The auditor's report and report on the working of the bank has to be
laid before the Parliament. The sponsor bank is empowered to monitor the progress of
the RRBs by inspection, internal audit and scrutiny and suggest corrective measures.
v. Amalgamation: Two or more RRBs may be amalgamated by the Central Government
by notification in the official gazette. Such notification shall provide for all terms and
conditions of amalgamation including continuation of service of employees and shall be
binding on the banks and all other parties concerned.
5.4 NATIONALISED BANKS
The Bank Nationalisation Acts [Banking Companies (Acquisition and Transfer of
Undertakings) Act, 1970 and Banking Companies (Acquisition and Transfer of
Undertakings) Act, isfeO] transferred the undertakings of then existing private banks to
the corresponding new banks established under these Acts. These corresponding new
banks, are popularly known as Nationalised banks. Originally, the entire paid-up capital
(equity shares), of the Nationalised banks were held by the Central Government. Some
of these banks have r ecently made public issues of shares, but the Central Government
still holds the majority of shares in all these banks. The Banking Companies
(Acquisition and Transfer of Undertakings) and Financial Institutions Laws
(Amendment) Act, 2006 enables these banks to raise capital by way of public issue or
preferential allotment or private placement of equity shares or preference shares. The
Central Government shall, however, at all times hold not less than fifty one per cent of
the equity of these banks. The shares other than those held by the Central Government
are freely transferable. The guidelines for issue of preference shares (including those on
the classes of preference shares) shall be issued by the Reserve Bank. No equity
shareholder
one per cent other
of thethan
totalthe Central
voting Government
rights can exercise voting
of all the shareholders. rightsofinthe
In the case excess of
preference
shareholders, they shall have a right to vote in respect of those shares only on resolutions
which directly affect the rights attached to the preference shares. Further, no preference
shareholder shall be entitled to exercise voting rights in respect of the preference shares
held by him in excess of one per cent of the total voting rights of all the shareholders
holding preference share capital only.
Every Nationalised bank is a body corporate having perpetual succession and common
seal and power to acquire, hold and dispose of property and enter into contracts and to
sue and be sued in its name. These banks may carry on the business of banking as
defined in Section 5(b) of the Banking Regulation Act and other forms of business
specified in Section 6(1) of that Act. The Nationalised banks have also to act as agents of
the Reserve Bank, if so required by the Reserve Bank to undertake the banking business
of Central Government and any other business entrusted by the Reserve Bank.
a. Management: The general superintendence, direction and management of the affairs
of a Nationalised bank vests in the board of directors. The board can exercise all the
powers and functions of the bank and shall be entitled to discuss, approve and adopt the
annual accounts. The Central Government is empowered to issue directions to the bank
in the discharge of its functions on matters of policy involving public interest after
consultation with the Governor of the Reserve Bank, to supersede the board on the
recommendation of the Reserve Bank and also to appoint an administrator. Further,
under Section 9 of both the Nationalisation Acts, the Central Government has the power
to make a scheme for carrying out the provisions of the Act after consultation with the
Reserve Bank. The
- CAIIB DISCUSSION
71
Government may also amend or vary the scheme in consultation with the Reserve Bank.
Such a scheme has to be laid before Parliament and is binding on the bank and any
person having any right or liability in relation to the bank.
b. Directors: The directors of Nationalised banks are nominated by the Central
Government or elected
from the shareholders. The nomination of directors is as under:
(i) not more than four whole-time directors (as against two earlier);
(ii) one director who is an official of the Central Government to be nominated by the
Central
Government; (iii) one director, possessing necessary expertise and 'experience in matters
relating to regulation
or supervision of commercial banks, to be nominated by the Central Government on the
recommendation of the Reserve Bank; (iv) a director representing workmen employees
of the bank; (v) a director representing officers of the bank; (vi) one chartered accountant
with not less than fifteen years experience nominated in consultation
with Reserve Bank; (vii) not more than six directors to be nominated by Central
Government.
The other shareholders can elect up to a maximum of three directors to the board. No
person shall be eligible to be elected as director, unless he is a person having fit and
proper status based upon track record, integrity and such other criteria as the Reserve
Bank may notify from time to time in this regard. The Reserve Bank may also specify in
the notification, the authority to determine the fit and proper status, the manner of such
determination, the procedure to be followed for such determination and such other
matters as may be considered necessary or incidental thereto.
The directors nominated under Item (vii) and the elected directors should have special
knowledge or practical experience of agriculture and rural economy, banking,
cooperation, economics, finance, law, small scale industry or other knowledge or
experience useful to the bank in the opinion of the Reserve Bank or must represent the
interest
Reserveof depositors
Bank's or farmers
opinion does notor workers
qualify theand artisans. An
r equirements, elected
can director,
be r emoved bywho
the in the
Reserve Bank after giving an opportunity of being heard. The board can co-opt any other
qualified persons in his place who will continue until another director, is duly elected in
the next annual general meeting. Apart from the direction and management of affairs of
the bank, the board has also the power to frame regulations under Section 19 for giving
effect to the provisions of the Act. This has to be done in consultation with the Reserve
Bank and with the sanction of the Central Government.
c. Additional directors: The Reserve Bank may appoint one or more additional
directors on the board
of a Nationalised bank, if it is of the opinion that in the interest of banking policy or in
the public
interest or in the interests of the bank or its depositors, it is necessary to do so. The
appointment
may be made from time to time, by order in writing, with effect from such date, as may
be
specified in the order and the additional directors 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. They shall not
incur any
obligation or liability by reason only of being a director or for anything done or omitted
to be done
- CAIIB DISCUSSION
undertaking in Part C (Sections 36AE to 36AJ) and winding up in Part III and Part IIIA
(Sections 36B to 45X).
i. Public Sector Banks as Scheduled Banks: All the public sector banks are scheduled
banks under Section 42 of the Reserve Bank of India Act and have to comply with the
requirements of maintaining cash reserve as provided therein.
5.6 DISINVESTMENT OF SHARES BY GOVERNMENT
In the context of the Government policy to dilute the holdings in public sector banks,
certain amendments
72
upon the balance sheet as stipulated in Section 10 of the Act. The auditor shall send
copies of the report to the bank and the Reserve Bank. The bank has to furnish copies of
the balance sheet, profit and loss account and auditor's report along with the report of the
board of directors on the working and activities of the bank to the Central Government
and the Reserve Bank. The auditor's report and report of the board have to be laid before
the Parliament. Without prejudice to the above, the Central Government is also
empowered to appoint auditors as it thinks fit at any time to examine and report on the
accounts of a Nationalised bank.
A Nationalised bank may pay dividends out of profits after making the necessary
provisions under the law or as usually provided by banking companies. An annual
general meeting of shareholders has to be held within six weeks of the date of
forwarding the balance sheet, etc., to the Central Government. In such meeting, the
shareholders will be free to discuss the balance sheet, accounts, auditors' report and
report of the board. For the purpose of Income Tax Act, a Nationalised bank is treated as
an Indian company.
e. Schemes of Management: In exercise of the powers under Section 9 of the Banking
Companies (Acquisition and Transfer of Undertakings) Act, 1970 and Section 9 of the
Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980, the Central
Government has framed two schemes, namely:
(i) Nationalised Banks (Management and Miscellaneous Provisions) Scheme, 1970. (ii)
Nationalised
These schemes Banks (Management
provide in detail forand Miscellaneous
constitution Provisions)
of board Scheme,
of directors, 1980. of
appointment
chairman and managing director, term of office of whole-time director including
managing director, term of office of other directors, disqualifications of directors and
vacation of office, meetings of board and committees of the board (management
committee and advisory committee), regional consultative committees, increase in paid-
up capital and other miscellaneous matters.
5.5 APPLICATION OF BANKING REGULATION ACT TO PUBLIC SECTOR
BANKS
Section 51 of the Banking Regulation Act provides that certain provisions of the Act
would apply to State Bank and its subsidiaries, Nationalised banks and Regional Rural
Banks as they apply to banking companies. The applicable provisions are Sections 10,
13 to 15, 17, 19 to 21 A, 23 to 28, 29 [excluding the sub-Section (3)], the sub-Sections
(IB), (1C) and (2) of Sections 30, 31, 34, 35, 35A, 36 [excluding clause (d) of the sub-
Section (1)], 45Y to 45ZF, 46 to 48, 50, 52 and 53. The proviso to Section 51 also gives
certain exemptions from the applicable provisions regarding holding of office in
approved institutions under Section 10(l)(c), to the chairman and the managing director
of State Bank, granting of loan, etc., under Section 20(l)(b)(iii) to all banks and nominee
directors in respect of Sections 46 and 47A.
The provisions which are not made applicable, are mainly the pr eliminary provisions up
to Section 9, provisions relating to capital (Sections 11 and 12), prohibition of common
directors (Section 16), licensing (Section 22) audit except special audit (Section 30),
control over management [Part IIA (Sections 36AA to 36AD)], acquisition of
undertaking in Part C (Sections 36AE to 36AJ) and winding up in Part III and Part IIIA
- CAIIB DISCUSSION
(Sections 36B to 45X).

i. Public Sector Banks as Scheduled Banks: All the public sector banks are scheduled
banks under Section 42 of the Reserve Bank of India Act and have to comply with the
requirements of maintaining cash reserve as provided therein.
5.6 DISINVESTMENT OF SHARES BY GOVERNMENT
In the context of the Government policy to dilute the holdings in public sector banks,
certain amendments
were made in the statutes governing public sector banks. The State Bank of India Act,
was amended by the State Bank of India (Amendment) Act, 1993. Section 4 was
modified to divide capital into shares of Rs. 10 each instead of Rs. 100. The restriction
on voting rights (which existed under Section 11, being up to two hundred shares only)
was modified as up to ten per cent of the issued capital and restriction on dividends was
deleted.
The Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 (and also
the 1980 Act) were modified by Amendment Acts of 1994 and 1995, for facilitating
public holding of shares. Section 3 was amended to provide for an authorised capital of
Rs. 1,500 crore, divided into shares of Rs. 10 each, to increase or reduce the authorised
capital between Rs. 1,500 crore and Rs. 3,000 crore, for transferability of shares, other
than those held by the Government, raising of capital through public issue, voting rights
of shareholders (limited to one per cent per shareholder) and keeping register of
shareholders including in floppies. Section 10A was amended to declare dividends, as
earlier balance of profits was to be transferred to the Central Government..
5.7 CO-OPERATIVE BANKS

i. Applicability of BR Act:
(a) Co-operative banks are registered either under the state laws governing co-
operatives or under
the multi-state Co-operative Societies Act. If a co-operative bank operates only in one
state,
the state law applies and in the case of co-operative banks operating in more than one
state, the
Central Act applies. While the state law/Central law governs the constitution and related
matters,
the business of banking is regulated by the Banking Regulation Act as applicable to co-
operative
societies.
(b) The Banking Regulation Act is applicable to co-operative societies subject to
the modifications
stipulated in Part V (Section 56) of the Act. The Act was made applicable to co-
operative
societies by the Banking Laws (Application to Co-operative Societies) Act, 1965. As
defined in
Section 5 (cci) of the BR Act (as applicable to co-operative societies), a co-operative
bank
means a state co-operative bank, a central co-operative bank and a primary co-operative
bank.
A primary co-operative bank is a co-operative society other than a primary agricultural
credit
society, which satisfies the following criteria;
(i) The primary object or principal business is the transaction of banking business, (ii)
The paid-up share capital and reserves are not less than Rs. 1 lac. (iii) The byelaws do
- CAIIB DISCUSSION
not permit admission of any other co-operative society as a member (except the
membership of a co-operative bank by subscribing to the share capital of the society out
of the funds provided by the state Government).
(c) A state co-operative bank is the principal co-operative society in a state with the
primary
objective of financing other societies. A central co-operative bank is the principal co-
operative
society in a district with the primary objective of funding other co-operative societies in
the
district
The reference to banking company in the Act shall be construed as a reference to co-
operative banks unless the context otherwise requires.
ii. Bank, Banker, Banking: No co-operative society other than a co-operative bank is
permitted to use as part of its name or in connection with the business, the words 'bank',
'banker' and 'banking'. Further, a co-operative society carrying on banking business has
to use at least one of such words as part of its name. However, certain categories of co-
operative societies are exempt from these provisions as follows:
(a) a primary credit society;
74
(b) a co-operative society formed for the protection of the mutual interest of co-
operative banks
or co-operative land development banks;
(c) a co-operative society other than a primary credit society formed by employees
of the State
Bank, a subsidiary bank, a Nationalised bank or a co-operative bank, a primary credit
society,
or a co-operative land development bank.
iii. Paid-up Capital and Reserves: The minimum paid-up capital and reserves required to
commence or carry on banking business by a co-operative bank is not less than Rs. 1
lakh under Section

not applicable 11 (as applicable
to a primary to co-operative
credit society, banks).
which becomes However,
a primary this provision
co-operative bankis
after the commencement of the Act, for a period of two years from the date it becomes a
primary co-operative bank. The Reserve Bank may give a further period of one year in
the interests of depositors of the primary co-operative bank in any particular case. For
calculating the value of paid-up capital and reserves, the real and exchangeable value
and not the nominal value would be considered. In the case of a dispute regarding the
value of paid-up capital and reserves, Reserve Bank's decision shall be final.
iv. Cash Reserve: Co-operative banks other than scheduled Co-operative Banks and
scheduled state co-operative banks have to maintain in India by way of cash reserve with
itself or by way of balance in current account with the Reserve Bank or the state co-
operative bank of the state concerned or district Co-operative Bank or by way of net
balance in current accounts or any one or more of these ways a sum equivalent to at least
three per cent of its total demand and time liabilities in India. In the case of a primary co-
operative bank the balance in current accounts with the central co-operative bank of the
district concerned may also be taken into account. The balance has to be reckoned as on
the last Friday of the second preceding fortnight. The co-operative bank has to submit a
return every month showing such amount held by it on alternate Fridays during a month
along with the particulars of its demand and time liabilities in India on such Fridays.
When the relevant Friday is a holiday under the Negotiable Instruments Act, the return
shall be required as at the close of business on the preceding working day. The demand
and time liabilities have to be calculated as stipulated in Section 18 (as applicable to co-
operative societies). For scheduled Primary Co-operative Banks and State co-operative
Banks, CRR has to be maintained as per Section 42 of RBI Act.
- CAIIB DISCUSSION
v. Restrictions on Loans and Advances:

(a) Section 20 of the Banking Regulation Act (as applicable to co-operative societies)
lays down certain restrictions on loans and advances by co- operative banks.
Accordingly, a co-operative bank shall not grant loans and advances as under:
(i) loans and advances on the security of its own shares; (ii) unsecured loans or advances
to any of its directors;
(iii) unsecured loans or advances to firms or private companies in which any of its
directors are interested as partner, managing agent or guarantor, or to individuals in
cases where any of its directors is a guarantor for the loans or advances;
(iv) unsecured loans or advances to any company in which the chairman of the co-
operative bank is interested as managing agent or chairman or managing director.
However, these restrictions do not apply to unsecured loans or advances made by a
co¬operative bank against bills for supplies or services made to Government or bills of
exchange arising out of bona fide, commercial or trade transactions. Further, unsecured
loans or advances in respect of which trust receipts are furnished to the co-operative
bank and loans to directors or any other persons within the limits and on terms and
conditions approved by the Reserve Bank are also exempted.
i
Ii
ij
75
(b) Every co-operative bank has to submit a return in the prescribed form showing the
unsecured loans and advances granted by it to companies in which its directors are
interested as director, managing agent, or guarantor. Such returns have to be filed before
the close of the month succeeding to which the return relates. If it appears to the Reserve
Bank on examination of any return that the loans or advances were granted to the
detriment of the interest of depositors, Reserve Bank may prohibit granting of such
further loans or advances. The Reserve Bank may also impose other restrictions on the
grant of such
or advance loansaand
within direct the
stipulated co-operative bank to secure the repayment of the loan
time.
Note: It must be noted here that RBI with effect from 1 October 2003, has prohibited co-
operative banks from providing, renewing secured or unsecured loans and advances or
any other funded or non-funded financial accommodation to their directors or their
relatives and firm/companies in which their relatives are interested.
vi. Licensing of Co-operative Banks:
(a) Every co-operative society requires a licence from the Reserve Bank under
Section 22
of the Banking Regulation Act (as applicable to co-operative societies) to carry on
banking business in India. However, primary credit societies are exempt from the
requirement.
The Reserve Bank may impose such conditions as it may deem fit while granting licence
to a co-operative bank. Co-operative societies carrying on banking business at the
commence¬
ment of the Banking Laws (Application to Co-operative Societies) Act, 1965 were given
exemption for a period of one year. Every co-operative society carrying on banking
business at the commencement of the Act had to apply for a licence within three months
from such commencement and every primary co-operative society, which becomes a
primary co-operative bank after such commencement has to apply for a licence before
three months from the date of it becoming a primary co-operative bank. After applying
for licence the co-operative bank can continue to carry on banking business unless its
licence is rejected.
(b) A co-operative bank requires the prior permission of the Reserve Bank for
- CAIIB DISCUSSION
opening a new place

of business or changing an existing place of business otherwise within the same city,
town or
village where it has an existing place of business. However, opening of temporary
branches for
a period not exceeding one month within the city, town or village where it has a place of
business, on the occasion of an exhibition, conference, mela or any like occasion is
permissible.
The opening or changing of location of branches by a central co-operative bank within
its area
of operation is also exempt. The application of a co-operative bank for permission to
open a
branch, other than of a primary co-operative bank, has to be routed through the National
Bank.
However, an advance copy of the application has to be sent directly to Reserve Bank.
vii. Liquid Assets: Co-operative banks have to maintain liquid assets as provided in
Section 24(1) of the Banking Regulation Act. In computing the amount of liquid assets
any balances maintained by a co¬operative bank in current account with the Reserve
Bank or by way of net balances in current accounts would be taken into account. In the
case of state co-operative banks, which are scheduled banks, the balances required under
Section 42 of the RBI Act will also be accounted. In the case of the Central co-operative
banks, balances maintained with the state co-operative bank concerned and in the case of
primary co-operative banks the balances maintained with Central co-operative banks or
the state co-operative bank concerned shall be accounted. The co-operative banks have
also to maintain as specified in Section 24(2A) liquid assets being not less than 25 per
cent or such other percentage not exceeding forty per cent as the Reserve Bank may
stipulate by notification in the Gazette. The amount has to be maintained as at the close
of business on any day. For this
76
purpose,
operativeany
bankbalance maintained
with the by a scheduled
Reserve Bank in excess ofprivate co-operative
the balance banks
required and
under state co-
Section 42
of the RBI Act shall be accounted. Similarly, cash or balances maintained in India by a
non-scheduled co-operative bank with itself or with the state co-operative bank or in
current account with Reserve Bank or net balance in current accounts in excess of the
requirement of Section 18 would be accounted. In the case of primary co-operative
banks, such balances maintained with the Central co-operative bank of the district
concerned will also be taken into account.
The co-operative banks have to file a return with the Reserve Bank and every co-
operative bank, other than a primary co-operative bank has also to furnish a copy thereof
to the National Bank.
viii. Accounts and Audit: Every co-operative bank has to prepare a balance sheet and
profit and loss account of its business as on the last working day of the year. The balance
sheet and accounts have to be prepared in the forms set out in the third schedule to the
Act or as near thereto as circumstances admit. Three copies of such balance sheet and
accounts, along with statutory auditor's report has to be submitted to the Reserve Bank
within six months. A state co-operative bank and a central co¬operative bank have to
submit such return to the National Bank also.
ix. Inspection: The provisions of Section 35 relating to inspection are applicable to co-
operative banks with minor modifications. It is also open to Reserve Bank to call for
inspection of a primary co¬operative bank by one or more officers of the state co-
operative bank in the state where the primary co-operative bank is registered. The
Reserve Bank may supply a copy of the report on any inspection or scrutiny to the state
co-operative bank or the Registrar of Co-operative Societies concerned.
- CAIIB DISCUSSION
x. Insured Co-operative Banks:

(a) Registration with DICGC: The Deposit Insurance and Credit Guarantee
Corporation Act, 1961,
which provides for insuring deposits of banks, is applicable to co-operative banks also.
Accordingly, under Section 13C of the Act, co-operative banks have to be registered
with the
corporation for this purpose. The registration of a co-operative bank may be cancelled if:
(i) it is prohibited from accepting deposits;
(ii) its licence is cancelled;
(iii) it has been ordered to be wound up;
(iv) it has ceased to be a co-operative bank under the sub-Section (2) of Section 36A of
the
BRAct;
(v) it has converted into a non-banking co-operative society; (vi) it has been
amalgamated with any other co-operative society; (vii) it has transferred its deposit
liabilities to any other institute or; (viii) it ceases to be an eligible co-operative bank.
(b) Eligible Co-operative Bank: An eligible co-operative bank is defined in Section
2(gg) of the Act.
Accordingly, for a co-operative bank to become an eligible co-operative bank, the law
governing
that co-operative bank should have the following provisions:
(i) An order for the winding up, or an order sanctioning a scheme of compromise or
arrangement or of amalgamation or reconstruction of the bank, may be made only with
the previous sanction in writing of the Reserve Bank.
(ii) An order for the winding up of the bank shall be made, if so required by the Reserve
Bank in the circumstances referred to in Section 130.
(iii) An order shall be made for the supersession of the committee of management or
other managing body of the bank and the appointment of an administrator therefore for
such period or periods not exceeding five years in the aggregate as may be specified by
the
77
Reserve Bank if so required by the Reserve Bank in the public interest or for preventing
the affairs of the bank being conducted in a manner detrimental to the interests of the
depositors or for securing the proper management of the bank.
(iv) An order for the winding up of the bank, or an order sanctioning a scheme of
compromise or arrangement or of amalgamation or reconstruction or an order for the
supercession of the committee of management or other managing body of the bank and
the appointment of an administrator therefore made with the previous sanction in writing
or on the requisition of the Reserve Bank shall not be liable to be called in question in
any manner.
(v) The liquidator or the insured bank or the transferee bank, as the case may be, shall be
under an obligation to repay the corporation as provided in Section 21 of the Act.
(c) Requisition by Reserve Bank for Winding Up: Section 130 of the DICGC Act
mentions the circumstances in which Reserve Bank may require winding up of a co-
operative bank. Such circumstances are that:
(i) the co-operative bank has failed to comply with the requirements as to minimum
paid-up
capital and reserves specified in Section 1 ] of the Banking Regulation Act; (ii) the co-
operative bank has under Section 22 of the Act (dealing with licence) become disentitled
to carry on banking business in India;
(iii) the co-operative bank has been prohibited from receiving fresh deposits by an order
under Section 35(4) of the Act or under Section 42(3A)(b) of the Reserve Bank of India
Act;
- CAIIB DISCUSSION
(iv) the co-operative bank having failed to comply with any requirement of the Banking
Regulation Act, 1949, other than the requirements laid down in Section 11 thereof, has
continued such failure or having contravened any provisions of the Act, has continued
such contravention beyond such period or periods as may be specified by the Reserve
Bank, after notice in writing of such failure or contravention has been conveyed to the
co-operative bank;
(v) the co-operative bank is unable to pay its debts;
(vi) in the opinion of the Reserve Bank, a compromise or arrangement sanctioned by a
competent authority in respect of the co-operative bank cannot be worked satisfactorily
with or without modification, or the continuance of the co-operative bank is prejudicial
to the interests of its depositors.
A co-operative bank, shall be deemed to be unable to pay its debts if, (i) on the basis of
the returns, statements or information furnished to the Reserve Bank under or in
pursuance of the provisions of the Banking Regulation Act, the Reserve Bank is of
opinion that the co-operative bank is unable to pay its debts, (ii) if the co-operative bank
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, in either case, the Reserve Bank certifies in writing that the co-operative
bank is unable to pay its debts
5.8 LET US SUM UP
1. The public sector banks, namely, State Bank and its subsidiaries, the Nationalised
banks and the regional rural banks are statutory corporations (or body corporate)
established under special statutes. State Bank and its subsidiaries, as Nationalised banks,
are commercial banks engaged in the business of banking and other forms of business
permissible for banking companies. The regional rural banks are also commercial banks
but operating in limited local areas to cater to rural industries,
71
trade, farmers, artisans, etc. The State Bank and its subsidiaries and the Nationalised
banks
Centralalso act as agents
Government. Allofpublic
the Reserve Bank to
sector banks aretransact theby
governed banking business ofstatutes
their respective, the
and the rules, regulations or schemes made under these statutes. In addition to this, these
banks are also governed by certain provisions of the Banking Regulation Act as
stipulated in Section 51 of that Act. The provisions of the Reserve Bank of India Act are
also applicable to them.
2. The co-operative banks, functioning in one state only are registered under the state
laws on co-operative societies. The co-operative banks operating in more than one state,
are registered under the multi-state Co-operative Societies Act. The Banking Regulation
Act is applicable to co-operative banks as provided in Section 56 of that Act with certain
modifications. For this purpose, a co-operative bank means a state co-operative bank,
Central co-operative bank and a primary co-operative bank. While, the constitution of
the bank is governed by the co¬operative laws, the business of banking undertaken by
them is regulated by the Reserve Bank under the BR Act.
5.9 KEYWORDS
Nationalised Bank; Subsidiary Bank; Primary Co-operative Bank; Regional Rural Bank;
Sponsor Bank; Co-operative Bank; Central Co-operative Bank; State Co-operative Bank;
Co-operative Credit Society.
1. Fill up the blanks choosing answers from the brackets.
(i) The State Bank of India is a
constituted under the State Bank of India Act.
(ii) (iii)
- CAIIB DISCUSSION
in consultation with the Reserve

(banking company, body corporate, society) The Chairman of the State Bank is
appointed by.
Bank, (the Central Board, Banking Service Recruitment Board, Central Government)
State Bank has to act as and carry out Central Government business and other
business entrusted by the Reserve Bank, (agent of Reserve Bank, agent of Central
Government,
advisor to the Central Government)
(iv) The provisions of the are applicable to State Bank as stipulated in Section 51 of
_. (Reserve Bank, Central
the BR Act. (RBI Act, Banking Regulation Act, Companies Act)
(v) The majority of shares of subsidiary banks are held by
Government, State Bank)
(vi) Regional rural banks operate in . (a notified area, the whole of a state, only a
district)
(vii) The management of the affairs of a regional rural bank vests in . (the Sponsor
Bank, its board of directors, the National Bank)
2.
Say whether true or false
(i) The State Bank can make statutory regulations for carrying out the purposes of the
State
Bank of India Act, in consultation with Reserve Bank and with previous approval of the
Central Government, (ii) The Central Government is not authorised to give any
directions to the State Bank in matters
of policy involving public interest, (iii) The provisions of Section 42 of the Reserve
Bank of India Act relating to cash reserve apply
to State Bank.
(iv) Subsidiary banks do not have to maintain liquid assets under Section 24 of the BR
Act. (v) Regional rural banks may transact the business of banking as defined in Section
5(b) of the
BR Act and also other business specified in Section 6(1) of that Act.
2. 3.
79
3.
4.
(vi) Two regional rural banks may be amalgamated by the Reserve Bank by notification
in the
gazette, (vii) The management of Nationalised Banks is governed by the Nationalised
Banks (Management
and Miscellaneous Provisions) Schemes of 1970 and 1980.
in the Banking
(i) Unless the context otherwise requires, the reference to a
Regulation Act shall be construed as reference to a co-operative bank, (co-operative
society,
banking company, body corporate)
(ii) in relation to a co-operative society, for the purpose of BR Act, includes a
member of any committee or body for the time being vested with the management of the
affairs of that society. (Director, Member, Manager) (iii) The r equirement of minimum
paid-up capital and reserves for a co-operative bank to
- CAIIB DISCUSSION
commence or carry on banking business is . (Rs. 1 crore, Rs. 1 lakh, Rs. 10 lakh)
(iv) There are restrictions on co-operative banks on in other co-operative societies
under Section 19 of the BR Act. (holding of shares, keeping deposits, acquiring any
interest) (v) Central and state co-operative banks have to submit their returns under
Section 31 of BR
Act to . (Reserve Bank and National Bank, National Bank only, Reserve Bank only)
(vi) Under Section 23 of the BR Act, without the permission of Reserve Bank, a
can open a new place of business within the area of its operation, (central co-operative
bank, state co-operative bank, primary co-operative bank) (vii) Co-operative banks have
to prepare their balance sheet and profit and loss account in the
forms set out in the Third Schedule to . (Banking Regulation Act, Reserve Bank
of India Act, State Co-operative Societies Act)
Say whether true or false.
(i) Banking Regulation Act was made applicable to co-operative banks by the Banking
Laws
(Application to Co-operative Societies) Act, 1965. (ii) A primary co-operative bank does
not require licence from the Reserve Bank to carry on
banking business, (iii) The provisions of the Banking Regulation Act as provided in
Section 56 of the Act apply to
co-operative banks, (iv) A 'Co-operative Bank' means a primary co-operative bank,
central co-operative bank and a
state co-operative bank, (v) There are no restrictions under the BR Act on lending by co-
operative banks to their directors
or firms in which they are interested, (vi) A scheduled co-operative bank has to maintain
cash reserve as stipulated in Section 42 of
the Reserve Bank of India Act (as applicable to co-operative societies).
(vii) Inspection of co-operative banks is done by the state Government under the Co-
operative Socie¬ties Act and the Reserve Bank has no power to inspect under the
Banking Regulation Act.
Central Government
BRAct
notified area
1. (i) body corporate (ii)
(iii) Agent of Reserve Bank (iv)
(v) SBI (vi)
(vii) its board of directors
2. (i) True; (ii) False; (iii) True; (iv) False; (v) True; (vi) False; (vii) True
3. (i) Banking company (ii) Director
(iii) Rs. 1 lakh (iv) Holding of shares
(vi) Central co-operative bank (vii) Bunking Regulation Act 4. (i) True; (ii) False; (iii)
True; (iv) True; (v) False; (vi) True; (vii) False
Fill in the blanks choosing answers from brackets. 1. State Bank may act as agent of the
Reserve Bank
. (for transacting only Government
business; for transacting Government business and other business entrusted by the
Reserve
Bank; only for collection of taxes)
2.
- CAIIB DISCUSSION
shall be the ex-officio chairman of the subsidiary banks. (Chairman of State

Bank;
Finance Secretary to Central Government; Managing Director of the State Bank)
3. The thrust of business of regional rural banks is to make loans and advances
available 'in rural
areas' (only to farmers; only to small enterprises; small and marginal formers,
agricultural labourers,
artisans and small entrepreneurs in particular).
4. Nationalised banks can undertake (only such business as permitted by the
Government from time to time; only such business as permitted by the Reserve Bank in
consultation with Central Government; banking business and any other business
permissible for banks under Section 6(1) of the BR Act.
5. The auditor of a Nationalised bank has to be (an officer of the Central
Government
under the C&AG; an officer of the Reserve Bank; a person duly qualified to be an
auditor of a company under Section 226 of the Companies Act.
6. (i) The provisions relating to licensing under Section 22 of the BR Act are
applicable to Nationalised
banks, (ii) The provisions of Section 22 of the BR Act relating to licensing are not
applicable to Nationalised
banks, (iii) The provisions relating to cancellation of licence under Section 22 of the BR
Act are applicable
to Nationalised banks.
7. (i) All public sector banks are scheduled banks.
(ii) All regional rural banks are not scheduled banks, (iii) Some public sector banks are
not scheduled banks.
8. (i) BR Act is not applicable to primary agricultural credit societies.
(ii) Primary credit societies are required to hold a licence under the BR Act. (iii) BR Act
is applicable to co-operative land development banks (Agricultural and Rural
Development
9. (i) A Banks)
co-operative bank is not eligible for insurance under the DICGC Act.
(ii) An eligible co-operative bank under Section 2(gg) of the DICGC Act has to be
registered with the DICGC for insurance.
(iii) The registration of a co-operative bank for insurance with DICGC cannot be
cancelled even
if it converts into a non-banking co-operative society.
10. (i) Reserve Bank can direct the Registrar of co-operative societies to wind up an
insured co¬operative bank if it is unable to pay its debts.
(ii) Reserve Bank can suo moto wind up a co-operative bank if the bank is unable to pay
its debts.
(iii) The Registrar can suo moto wind up a co-operative bank in the circumstances
mentioned in Section 13D of the DICGC Act.
MODULE -B
LEGAL ASPECTS OF BANKING OPERATIONS
Unit 6. Case Laws on Responsibility of Paying Bank
Unit 7. Case Laws on Responsibility of Collectin g Bank
Unit 8. Indemnities
Unit 9. Bank Guarantees
Unit 10. Letters of Credit
Unit 11. Deferred Payment Guarantee
Unit 12. Laws Relating to Bill Finance
Unit 13. Various Types of Securities
- CAIIB DISCUSSION
Unit 14. Law Relating to Securities and Modes of Charging -1

Unit 15. Law Relating to Securities and Modes of Charging - II
Unit 16. Different Types of Borrowers
Unit 17. Types of Credit Facilities
Unit 18. Secured and Unsecured Loans, Registration of Firms, Incorporation of
Companies
Unit 19. Registration and Satisfaction of Charges
CASE LAWS ON RESPONSIBILITY OF PAYING BANK
STRUCTURE
6.0 Objectives
6.1 Introduction
6.2 Negotiable Instruments Act and Paying Banks
6.3 Liability of Paying Banker when Customer's Signature on Cheque is Forged
6.4 Payment to be in Due Course for Bank to Seek Protection
6.5 Payment in Good Faith, without Negligence of an Instrument on which
Alteration is not
Apparent
6.6 Payment by Bank Under Mistake Whether Recoverable
6.7 Let Us Sum Up
6.8 Keywords
' L.K.A.D-7
84
6.0 OBJECTIVES
After studying this unit, you should be able to:
•
• explain
explain the various laws applicable
the responsibilities to abank
of a paying paying bank;
based on case laws;
• explain the protection given under law to a paying bank as decided by Courts.
6.1 INTRODUCTION
The Negotiable Instruments Act, 1881 lays down the law relating to payment of a
customer's cheque by a banker and the protection available to a banker. The relationship
between a banker and customer being debtor-creditor relationship the banker is bound to
pay the cheques drawn by his customer. This duty on the part of the banker, to honour
his customers' mandate, is laid down in Section 31 of the Negotiable Instruments Act.
Sections 10, 85, 85A, 89 and 128 of the Negotiable Instruments Act, 1881, grant
protection to a paying banker. We shall in detail, examine individually these sections and
with the help of case laws apply the provisions of these sections to a given set of facts.
6.2 NEGOTIABLE INSTRUMENTS ACT AND PAYING BANKS
As stated in Part 1.1 of this unit, the customer who has deposited money with a bank
being a creditor has the right to ask back the money from the banker who is a debtor.
The duty on the part of the banker to pay has been laid down in Section 31 of the
Negotiable Instruments Act, 1881 in the following terms:
'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.'
The following points are important to note:
i. Section 31 Applies Only to Bankers: This is because as per Section 6 of the Negotiable
Instruments
- CAIIB DISCUSSION
Act, 1881 'cheque' has been defined as a "bill of exchange drawn on a specified banker
and not
expressed to be payable otherwise than on demand'", ii. Sufficient Funds: The banker
should have sufficient funds of the drawer, i.e. there should be
sufficient credit balance in the customer's account, iii. Properly Available: The funds
available in the customer's account should also be properly available
for the payment of the cheque. The funds may not be available to pay the cheque if:
(a) the banker has exercised his right of set off for amounts due from the customer,
or
(b) there is an order passed by a Court, competent authority or other lawful
authority restraining
the bank from making payment.
iv. When Duly Required to Do So: The banker is duty bound to pay the cheque only
when he is duly required to do so. It means that the cheque must be properly drawn and
signed by the drawer.
v. Compensate the Drawer: In case the banker refuses payment wrongfully, then he is
liable only to the drawer of the cheque and not to any endorsee or holder, except when
(a) the bank is wound up, in which case the holder becomes a creditor entitled to
make a claim;
(b) the banker pays a cheque disregarding the crossing, wherein the true owner can
hold the
banker liable.
vi. Loss or Damage Caused by Default: A banker is liable to the drawer for any loss or
damage, which may have occurred to the drawer due to the wrongful dishonour of the
customer's cheque.
85
Protection to paying banker: For a paying banker to claim protection under the
Negotiable Instruments Act, one of the criteria he has to satisfy, is that the payment is in
due course. As to what is, payment in due course has been stated in Section 10, which
reads
Paymentas follows:
in due course: '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 does not afford a reasonable ground for
believing that he is not entitled to receive payment of the amount therein mentioned.
From the above definition, it can be seen that payment in due course requires the
payment to be made
(a) in accordance with the apparent tenor of the instrument;
(b) in good faith;
(c) without negligence;
(d) to the person in possession of the instrument; and
(e) while making payment the banker should not have reasons to 'believe' that the
person in possession
of the instrument is not entitled to receive payment of the amount mentioned in the
instrument.
Section 85 of the Negotiable Instruments Act, 1881 grants protection to a banker on his
making payment of a cheque. Though this principle may sound as a simple logic, it is to
be noted that the protection granted as per Section 85 is not absolute.
Section 85 of the Negotiable Instruments Act, 1881 can be explained as follows:
1. Where a cheque payable to order purports to be endorsed by or on behalf of the
payee, the drawee
is discharged by payment in due course.
2. Where a cheque is originally expressed to be payable to bearer, the drawee is
discharged by payment
- CAIIB DISCUSSION
in due course to the bearer thereof, notwithstanding any endorsement whether in full or
in blank
appearing thereon, and notwithstanding that any such endorsement purports to restrict or
exclude
further negotiation.
Section 89 of the Negotiable Instruments Act states the effect of making payment on
instrument on which alteration is not apparent and reads as follows:
Section 89
Payment of instrument on which alteration is not apparent: Where a promissory note, bill
of exchange or a 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 sum 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.
6.3 LIABILITY OF PAYING BANKER WHEN CUSTOMER'S SIGNATURE ON
THE CHEQUE IS FORGED
Section 128
Where the banker on whom a crossed cheque is drawn has paid the same in due course,
the banker paying cheque, and in case such cheque has come to the hands of the payee
the drawer thereof, shall respectively be entitled to the same rights, and be placed in the
same position in all respects as they would r espectively be entitled to and placed in if the
amount of the cheque, has heen pair! tn and received by the true owner thereof.
i. When the customer's signature on the cheque is forged there is no mandate to the hank
tn
86
pay. As such a banker is not entitled to debit the customer's account on such forged
cheque: Canara Bank vs Canara Sales Corporation and Others [(1987) 2 Supreme Court
Cases 666]: The

the company's companyDirector.
Managing had a current account with
The Company's the bank which
accountant in whosewascustody
operated
theby
cheque book was, forged the signature of the Managing Director in forty-two cheques
totalling Rs. 3,26,047.92 over a period of time. This was detected by another accountant.
The company immediately on detection of the fraud demanded the amount from the
bank. The bank refused payment and therefore the company filed a suit against the bank.
The bank lost the suit and took the matter up to the Supreme Court. The Supreme Court
dismissed the appeal of the bank and held that:
"Since, the relationship between the customer and the bank is that of a creditor and
debtor, the bank had no authority to make payment of a cheque containing a forged
signature. The bank would be acting against the law in debiting the customer with the
amount of the forged cheque, as there would be no mandate on the bank to pay. The
Supreme Court pointed out that the document in the cheque form on which the
customer's name as drawer was forged was a mere nullity. The bank would succeed only
when it would establish adoption or estoppel."
In deciding the case, the Supreme Court relied on its earlier judgement in Bihta Co-
operative Development and Cane Marketing Union Ltd. vs Bank of Bihar (AIR 1967
Supreme Court 389).
ii. In a joint account if one of the signatures is forged then there is no mandate and
banker cannot make payment: The case law in this case is of Bihta Co-operative
Development and Cane Marketing Union Ltd. vs Bank of Bihar: The Co-operative
Marketing Union had an account with the bank, which was authorised to be operated by
the joint secretary and treasurer of the Co-operative Marketing Union. On 16 April 1948,
the bank made payment of Rs. 11,000 on a loose leaf cheque and not on a cheque from
- CAIIB DISCUSSION
the cheque book issued to the Society. Though the two signatures appeared on the
cheque, one of them, the signature of the Joint Secretary was forged. The bank made
payment, whereupon the Co-operative Marketing Union sued the bank for recovery of
the money. Though the bank admitted negligence on its part, it argued that the
employees of the Co-operative Marketing Union were dishonest in the discharge of their
duties and as such it cannot succeed. The matter went up to the Supreme Court and the
Supreme Court, while allowing the case of the Co-operative Marketing Union held that
'one of the signatures was forged so that there never was any mandate by the customer at
all to the banker and the question of negligence of the customer in between the signature
and the presentation of the cheque never arose.'
6.4 PAYMENT TO BE IN DUE COURSE FOR BANK TO SEEK PROTECTION
i. The Supreme Court in Bank of Bihar vs Mahabir Lai (AIR 1964 Supreme Court 397)
held that a banker can seek protection under Section 85 only where payment has been
made to the holder, his servant or agent, i.e. payment must be made in due course.
In this case, the bank had agreed to grant the firm a cash credit facility against the pledge
of cloth bales, on the firm fulfilling certain conditions, one of which, was that the money
for purchasing the cloth would not be directly given to the firm, but instead, the supplier
would be paid the amount by the bank and the cloth bales would be kept by the bank as
pledge for the loan. The firm thereafter was required to draw a cheque on itself which
was handed over to the bank. The bank instead of handing over cash to the firm's partner
to be paid over to the wholesalers, entrusted it with one of the bank's employees (Potdar)
who accompanied the partner to the wholesalers. However, before the rnoney could be
paid to the wholesalers the Potdar absconded. The bank
87
sought repayment of the money, which was refused by the firm. The bank therefore sued
the firm for the money relying on Sections 85 and 118 of the Negotiable Instruments
Act, 1881. The matter reached the Supreme Court and it was held that, before the
provisions of Section 85 can assist the bank it had to be established that payment had in
fact, been made to the firm or to a person on behalf of the firm. Payment to a person who
had nothing
payment to do
to the with the firm or a payment to an agent of the bank would not be a
firm.
ii. The Calcutta High Court had occasion to consider as to whether a bank had made
payment in due course or not in the case of Bhutoria Trading Company (BTC) vs
Allahabad Bank (AIR 1977 Cal. 363) the facts of which are as follows:
BTC, a limited company, had sold some jute to WFD another limited company, for
payment of which WFD issued an un-crossed cheque payable to BTC or order which
was delivered to one of the officials of BTC. The official using the company's seal
endorsed the cheque as manager and encashed it over the counter. BTC later sued the
bank for recovery of the money on the grounds of damages or in the alternative on the
grounds of money had and received by the bank. The Court held that:
'The Expression payment in due course has been defined in Section 10 of the Negotiable
Instruments Act to mean 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 reasonable ground for believing that he is not
entitled to receive payment of the amount therein mentioned. It can hardly be questioned
that the payment by the defendant bank of the cheque in question has been made by the
defendant bank in accordance with its apparent tenor. The cheque is an un -crossed
cheque payable to the plaintiff or order. The cheque was endorsed by the plaintiff
through its Manager. The fact that Jethmall is the Manager is borne out by the seal of the
company which is unquestionably an authentic seal. The seal of the Manager is also
equally authentic. That the payment was made in good faith has not been disputed for all
practical purposes. There is not a grain of evidence before the Court from which it
remotely appears that the payment was not made in good faith. Now that the entire
- CAIIB DISCUSSION
evidence is before the Court, the question of onus to prove good faith loses much of its
importance. No negligence has been proved against the bank. The defendant bank
insisted on identification of Jethmall and Jethmall was, in fact, identified by Kishanlal
Maheswari, a constituent of the bank, the defendant No. 3. The defendant bank therefore
took all reasonable precautions even though the circumstances in which the cheque was
presented for payment did not afford any reasonable ground for believing that Jethmall
was not entitled to receive payment of the amount mentioned therein. The plaintiff
having failed to prove the trade practice which he alleged and the bank having paid the
cheque, in accordance with the apparent tenor of the instrument, in good faith, and
without negligence, to Jethmall who was in possession thereof, the defendant is entitled
to succeed. There were no circumstances which afforded any reasonable ground for
believing that he was not entitled to receive payment of the cheque. It must be held that
the bank made the payment in due course. The learned Judge, in our opinion has rightly
pointed out that payment in due course is necessarily payment in the ordinary course.
iii. Whether payment made by a bank was payment in due course would depend on the
facts of a given case. In Madras Provincial Co-operative Bank Ltd. vs Official
Liquidator, South Indian Match Factory Ltd. (AIR 1945 Mad 30) the Court held that
payment to a liquidator against the cheque presented across the counter was not a
payment in due course and the bank was not entitled to seek protection under Section 85
of the Negotiable Instruments Act.
In this case the Official Liquidator of the Company had sold certain properties of the
company, for which payment was made by the purchaser by giving a cheque in favour of
the liquidator. The liquidator presented the cheque over the counter and obtained
payment in cash which he
88
!!
misappropriated. He was later prosecuted and convicted and removed from office. His
successor
bank was proceeded against
negligent and the bankwas
the amount forwrongly
recoverypaid.
of the amount
The Courton thethat
held ground that
under the
Section
244A of the Indian Companies Act, 1913, an official liquidator was required to open an
account with a bank and pay therein moneys received by him in the course of the
liquidation. Rule 66 of the Rules framed by the Madras High Court under the Act
required that all bills and other securities payable to the company or to the liquidator
should, unless the judge otherwise directs, shall as soon as they came into the hands of
the liquidator, be deposited by him in the bank. From the cheque itself the bank had
noticed that it was payable to the liquidator in his official capacity. That the bank
realised this in full was shown by the fact that it called for the order of his appointment.
The learned judge therefore concluded:
We have no doubt that the officers of the bank did not r ealise, as they should have done,
that the bank was doing something improper, but in the circumstances there was
negligence. They knew or must have deemed to have known that this money could only
be collected by the payee through his own bank and therefore it was most improper on
his part to ask for payment over the drawee's counter. In our judgement there was a clear
breach of a statutory duty placed upon the bank and the learned judge was right in
holding the bank liable.
6.5 PAYMENT IN GOOD FAITH WITHOUT NEGLIGENCE OF AN
INSTRUMENT ON WHICH ALTERATION IS NOT APPARENT
i. The effect of Sections 10 and 89, and Section 31 was considered by the Supreme Court
in Bank of Maharashtra vs M/s Automotive Engineering Co. (1993) 2 SCC 97.
The question, which arose for consideration in this appeal, was whether the paying bank
was bound to keep an ultraviolet ray lamp and to scrutinise the cheque under the said
- CAIIB DISCUSSION
lamp even if no infirmity on the face of the said cheque on visual scrutiny was found.
Briefly stated, the respondent, a partnership firm, opened a current account with the
Wagle Industrial Estate branch of the appellant bank. The said branch was in the
industrial area on the outskirts of City of Bombay, where forgery of cheques were
rampant and although other branches of the appellant bank were provided with
ultraviolet ray lamps, the said branch was not provided with such lamp. On 26 May
1967, one Shri Shah, as a proprietor of Messrs Imperial Tube and Hardware Mart,
opened an account, in the name of his firm, with a branch of the Union Bank of India.
Shri Shah presented a cheque dated 29 May 1967 for Rs. 6,500 in favour of his firm to
Union Bank of India. On presentation of the cheque through clearing, the appellant bank
passed the cheque and debited the amount to the account of the respondent. Later on, on
receipt of the objection from the respondent-defendant, the said cheque was examined
under the ultraviolet ray lamp when it transpired that the original cheque was issued in
favour of Shri G.R. Pardawala and the amount of the said cheque was Rs. 95.98. The
writing on the cheque was chemically altered with regard to date, the name of the payee
and also the amount. The respondent made demands to the appellant bank to credit the
amount to its account.
The appellant bank filed a suit in which the agent of the appellant bank was examined,
who stated that before passing the said cheque for payment he had checked the serial
number and date of the cheque and had compared the signature of the respondent with
the specimen signature and that from visual appearance of the cheque no infirmity was
noted by him and from the tenor of the cheque it appeared to be a genuine one.
The Trial Court dismissed the suit on the ground that by not providing the facility of
ultraviolet ray lamp, the appellant bank had failed to discharge proper care and,
therefore, did not pass the said cheque with the due diligence.
89
On appeal, the District Judge, while agreeing that no abnormal features to suspect the
genuineness of the cheque could be found on visual inspection of the cheque, was of the
view that the appellant bank was not entitled to protection for the lapse in subjecting the
said chequeappeal,
On further for scrutiny under
the High the of
Court ultraviolet
Bombay,ray lamp.
while accepting the finding that the
cheque in question apparently did not show any sign of alteration, held that the appellant
bank did not act with proper care and caution in not providing necessary device for
detecting forged cheques. Since the absence of such a lamp amounted to negligence on
the part of the appellant bank, no protection was available because payment was not
made in due course.
The appellant bank preferred this appeal to the Supreme Court. The Supreme Court
allowed the appeal of the bank on the following grounds:
(i) Section 89 of the Negotiable Instruments Act gives protection to the paying banker of
a cheque which has been materially altered but does not appear to have been so altered,
if payment was made according to the apparent tenor thereof at the time of payment and
otherwise in due course.
(ii) Section 10 of the said Act defines payment in due course to mean 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 believing that he is not entitled to receive payment of the
amount therein mentioned.
(iii) Section 31 of the said Act obliges the drawee bank having sufficient funds of the
drawer in its hands properly applicable to the payment of such cheque to make payment
of the cheque when duly required to do so.
(iv) On analysing the evidence, the Courts below have held that on visual examination
no sign of forgery or tampering with the writings on the cheque could be detected. It was
found that the agent of the appellant bank had verified the serial number and signature
- CAIIB DISCUSSION
on the cheque and had compared the signature on the cheque with the specimen
signature of the respondent and on scrutiny of the cheque visually, no defects could be
detected by him. There were sufficient funds of the drawer with the appellant bank,
which had no occasion to doubt about the genuineness of the cheque from the apparent
tenor of the instrument. There was no evidence to hold that, the payment was not made
in good faith. Simply, because the ultraviolet ray lamp was not kept in the branch and the
said cheque was not subjected to such lamp would not be sufficient to hold the appellant
bank guilty of negligence, more so when it has not been established on evidence that the
other branches of the appellant bank or the other commercial banks had been following a
practice of scrutinising each and every cheque or cheques involving a particular amount
under such lamp by way of extra precaution.
(v) In such circumstances, it is not a correct legal proposition that the bank, in order to
get absolved from the liability of negligence, was under an obligation to verify the
cheque for further scrutiny under advanced technology or for that matter, under
ultraviolet ray lamp, apart from visual scrutiny even though the cost of such scrutiny was
only nominal and it might be desirable to keep such lamp at the branch to take aid in
appropriate case.
(vi) The Courts below were not justified in holding that the bank had failed to take
reasonable care in passing the cheque for payment without subjecting it to further
scrutiny under ultraviolet ray lamp because the branch was in the industrial area where
such forgery was rampant and other branches of the appellant bank were provided with
such lamp.
The appeal was, therefore, allowed and the Suit of the appellant bank was decreed only
for the principal amount without any interest on the same.
ii. The protection granted to a banker under Section 89 had come up for consideration
before the Calcutta High Court in Brahma Shumshere Jung Bahadur vs Chartered Bank
of India, Australia and China (AIR 1956 Cal. 399):
90
In this case B who was a member of the royal family of Nepal had an overdraft account
with
limit the
wasbank,
not afor which
fixed limitcertain securitiesdepending
and fluctuated were deposited
on thewith the bank.
securities The overdraft
deposited. In April
1946, B requested the bank to enhance the overdraft limit which however, was not
agreed to by the bank and the limit was Rs. 70,000. In July 1946, B sent a cheque by
post, drawn on the overdraft account which was intercepted in the mail and the amount
was raised from Rs. 256 to Rs 2,34,081. The cheque was put for collection in another
bank which was paid by B's bank. B on coming to know about the forgery, sued both the
paying and collecting bank, contending that though the cheque was signed by him it was
written out by some other person and as such it should have aroused the suspicion of the
bank. The Court, however, held that since no alteration or obliteration was visible at the
time of payment, the payment was made according to the apparent tenor at the cheque.
Further since B had on other occasions also issued cheque signed by him and written by
others, the bank's suspicion could not have aroused. The Court also held that the words
'liable to pay' appearing in the third paragraph of Section 89 included a liability to pay
under an overdraft agreement as much as it applied to an ordinary deposit account.
As regards exceeding the overdraft limit, the Court held that no definite limit was fixed
at any time and it fluctuated according to the securities deposited by B. In this case the
collecting bank was liable for other reasons for which we shall see in the next unit.
iii. In the case of Tanjore Permanent Bank vs S.R. Rangachari (AIR 1959 Madras 119)
the High Court was called upon to decide a case in which cheque was materially altered
and the bank sought protection under Section 89. In this case R had an overdraft account
with the bank and r equested the Manager to advance him Rs. 16,000 to the debit of his
account. The Manager asked R to send him three blank cheques signed.
R accordingly did the same. However, of the three cheques only one was utilised for the
- CAIIB DISCUSSION
payment of Rs. 16,000. The other two cheques were alleged to have been filled by the
accountant of the bank for Rs. 7,600 and Rs. 4,200 and the names of two clerks were
written as the payees. In both the cheques the alterations were apparent and visible but
the bank paid these cheques. On R not clearing the debit because of his overdraft
account, the bank sued him. R contended that the two debit entries for Rs. 7,600 and
4,200 were made by the bank wrongly and as such he cannot be held liable.
The Court held that since the material alteration on both the cheques were visible and
since they were not authenticated by the drawer's initials, the payment made by the bank
was not according to the apparent tenor of the instrument and as such the bank cannot
claim protection under Section 89 of the Negotiable Instruments Act. The Court in
coming to the above conclusion relied on the following paragraph of Bhashyam and
Adiga's Negotiable Instruments Act:
The bank has also to see whether there are any alterations in the cheque and whether
they have been properly authenticated. Therefore, where an alteration in a cheque is
initialled not by all the drawers but only some of them, the bank will be paying the
amount on the said cheque at its own risk. In this connection it is necessary to notice that
under Section 89 protection is afforded to the bank paying a cheque where the alteration
is not apparent.
It is to be noted that as per Section 89, the bank can seek protection only if there is no
material alteration in the cheque and does not appear to have been altered. This,
however, does not protect a banker in case the signature of the customer is forged. As
stated earlier a forged cheque is no mandate of the customer and as such the bank cannot
make payment on a cheque where the signature of the customer is forged. The question
whether a signature is forged or not depends on the evidence and the court in coming to
a conclusion that the signature is forged would look into the facts and circumstances that
led to the payment of the cheque.
91
iv. Bareilly Bank Ltd. vs Naval Kishore (AIR 1964 All 78): N opened an account with
the bank by making a cash deposit of Rs. 19,900. N was issued a cheque book containing
25
timecheques.
for Rs. 17 months
5,900 whichafter
wasthe opening ofby
dishonoured thethe
account
bank. N
Ondrew a cheque
enquiries for informed
N was the first
that 11 months back three cheques aggregating Rs. 19,500 were paid by the bank and the
present balance in the account was a mere Rs. 437. N denied issuing of the cheques and
sued the bank.
In evidence it came out that 3 cheques used to withdraw the amounts were not from the
cheque book issued to N and were from a different cheque book. Though bank was not
in a position to explain this lapse, they made an attempt to counter the contentions of N
by producing his specimen signature which appeared to be similar to the ones on the
cheques. N however denied that the specimen signature was his and the Court concluded
that the alleged specimen signature were totally different from N's regular signature.
Evidence also was led to show that the bank's own employees were involved in the
forgery since the ledger page of N's account showed that certain erasures and scorings
were made and the signature of N missing in the cheque book issue register.
Therefore the Court refused to accept the bank's contention.
6.6 PAYMENT BY BANK UNDER MISTAKE WHETHER RECOVERABLE
The question whether a bank paying a forged cheque can recover the same from the
payee was considered by the Calcutta High Court in United Bank of India vs AT Ali
Hussain & Co. (AIR 1978 Calcutta 169).
In this case, a cheque for Rs. 5,000, purportedly drawn by a company was presented by
the collecting bank to the paying bank, and was paid. The signature as well as all other
writings on the cheque were forged. The forgery was so perfect that it was not possible
even for a trained eye to detect it. The paying bank, having subsequently come to know
of the forgery, filed a suit against the collecting bank and the payee of the cheque, for
- CAIIB DISCUSSION
recovery of the amount paid, on the ground of payment under mistake. Defending the
suit, the collecting bank contended that it received the cheque in the ordinary course of
its business, and presented the same for encashment in good faith. The payee contended,
that he received the cheque from some persons claiming to be representatives of a
company, in the ordinary course of business, towards payment of the price of the goods
to be supplied by him, that he acted in good faith, having no reason to suspect that the
cheque was forged, and that he parted with the goods only on receipt of intimation from
the collecting bank that the cheque had been encashed.
The Trial Court having dismissed the suit on the ground that the paying bank had no
cause of action, an appeal was preferred to the High Court.
Decision: The High Court dismissed the appeal and held that both from the point of view
of equitable principles and the doctrine of estoppel, the paying bank was disentitled to
recover the money either from the collecting bank or the payee. In the course of his
judgement, M.M. Dutt. J. said:
The evidence on record supports the findings of the learned Judge that the forgery was
so accurate that it was not possible even to a trained eye to detect the same. In these
circumstances, it is difficult to hold that the plaintiff bank had acted carelessly or
negligently. The encashment was made by the plaintiff bank on the mistaken belief that
the cheque was a genuine one. The defendant United Bank had nothing to do with the
question as to whether the cheque was genuine or forged. In due course of business, it
presented the cheque to the plaintiff bank for collection and after the cheque was
encashed, intimation was given by it to its constituent, namely, the defendant No.l, and
the latter, in its turn, sold goods to the persons who came with the forged cheque as the
representatives of the Metal Alloy Co. Thus, it appears that the parties in the suit acted in
good faith in due course of business. It was due to
92
the mistake that was committed by the plaintiff bank that it had to suffer the loss of the
said sum of Rs. 5,200. Upon the consideration of the principles of law as noticed above,
it seems to us that so long as the status quo is maintained and the payee has not changed
his position
there to his
has been detriment,
a change in theheposition
must repay the
of the money
payee back
who, to the
acting inpayer. If, however,
good faith, parts with
money to another without any benefit to himself before the mistake is detected, he
cannot be held liable. Equity disfavours unjust enrichment. When there is no question of
unjust enrichment of the payee by reaping the benefit of an accidental windfall he should
not be made to suffer, for he would be as innocent as the payer who paid the money
acting under a mistake.
6.7 LET US SUM UP
The Negotiable Instruments Act, 1881 lays down the law relating to the payment of a
customer's cheque and the protection that is available to a banker making payment of a
cheque in due course. Sections 10, 85, 85A, 89 and 128 of the Act deal with the
protection available to a banker whereas Section 31 lays down the condition as to when a
bank has to make payment on a cheque drawn by the customer. The banker on making
the payment in due course is entitled to seek protection provided the cheque has not been
altered or the alteration, if altered, is not apparent. However, the banker does not get
protection, if signature of the customer is forged
6.8 KEYWORDS
Apparent Tenor of the Instrument; Material Alteration.
1. State whether true or false.
(i) The law relating to the payment of cheques and protection to a banker is contained in
the
Indian Contract Act. (ii) The responsibility of a banker to pay back the money of the
customer specifically stated in
Facebook Groups
- CAIIB DISCUSSION
the Negotiable Instruments Act, 1881.

(iii) Section 31 of the Negotiable Instruments Act applies only to the banker, (iv) The
banker is first bound to honour a customer cheque and only thereafter exercise his
right of set off.
(v) A forged signature is no mandate of the customer, (vi) A customer is bound to inform
the bank about lost cheque leaves, (vii) In a joint account if one of the signatures is
forged, the bank and the customer are equally
liable, (viii) Payment to be made in due course need not always be made to holder but
can be made to
his agent or servant, (ix) In case bank makes payment by mistake it can recover the same
even if the payee has
changed his position, (x) If a bank makes payment without checking the instrument
under an ultraviolet lamp, it can
be held liable on the grounds of negligence.
1. (i) False; (ii) True; (iii) True; (iv) False; (v) True; (vi) False; (vii) False; (viii) True;
(ix) False; (x) False
Rs.
;as >ay ho,
:is of ide
UNIT
7
CASE LAWS ON RESPONSIBILITY OF COLLECTING BANK
r's se. ;as he he

lOt
STRUCTURE
7.0 Objectives
7.1 Introduction
7.2 Statutory Protection to Collecting Bank
7.3 Duties of the Collecting Bank
7.4 Let Us Sum Up
7.5 Keywords
94
7.0 OBJECTIVES
After studying this unit you should be able to understand:
• the duties of a collecting banker when opening an account and collecting
cheques in the account;
• the protection granted under the Negotiable Instruments Act to a banker
collecting a cheque.
7.1 INTRODUCTION
- CAIIB DISCUSSION
In the earlier unit, we had studied the duties imposed on a paying banker under the
Negotiable Instruments Act and the protection granted to him. In this unit, we will be
studying the duties of a collecting banker that has been imposed, more by the practice
adopted by bankers over a period rather than by law. We shall also be studying the
protection available to a collecting banker which is granted by certain provisions under
the Negotiable Instruments Act. Before we delve into the subject, it would be worth
trying to understand who a collecting bank is by an illustration.
Illustration
Ram has an account with Ideal Bank Ltd. The bank has issued a cheque book to Ram to
withdraw money from the account. Ram owes Rs. 400 to Shyam and to repay this
amount, Ram draws (issues) a cheque in favour of Shyam. Shyam has two ways to
obtain payment of the cheque. He can go straight to the Ram's bank (Ideal Bank Ltd.)
and collect cash against the cheque if it is not crossed or he can deposit the cheque in his
account with his banker, who would send the same to Ram's banker (Ideal Bank Ltd.)
and collect the amount. Here, Shyam's banker is the collecting bank and Ram's bank, i.e.
Ideal Bank Ltd. is the paying bank. If in the above illustration, Ram were to post the
cheque to Shyam and the same were stolen by X in transit and X were to open an
account in the name of Shyam and collect the cheque, the bank that opened the account
of X to collect the proceeds of the cheque would be the collecting bank.
7.2 STATUTORY PROTECTION TO COLLECTING BANK
Section 131 of the Negotiable Instruments Act grants protection to a collecting banker
and reads as follows:
Section 131
i. Non-liability of a Banker Receiving Payment of Cheque: 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 crossed cheque for a customer within the
meaning of this section notwithstanding that he credits his customer's account with the
amount of the cheque

The provisions beforesection
of the above receiving
haspayment thereof.
been applied to drafts as per Section 131A of the
Negotiable Instruments Act.
ii. Conditions for Protection: Though Section 131 grants protection to a collecting
banker, the protection is conditional. For the collecting banker to claim the protection
under Section 131 he has to comply with certain conditions and they are:
1. The collecting banker should have acted in good faith.
2. He should have acted without negligence.
3. He should receive payment for a customer.
4. The cheque should be crossed generally or specially to himself.
95
7.3 DUTIES OF THE COLLECTING BANK
Since no specific enactment has been laid down prescribing the nature of duties a banker
will have to observe while acting as a collecting banker, Section 131 of the Negotiable
Instruments Act, which affords protection to the collecting bank requires amongst other
conditions that the bank should not have been negligent. To show that the bank has not
been negligent the bank will have to prove that it has taken all precautions that would be
required of a prudent banker in collecting a cheque. Over the years based on practice and
judicial pronouncements, these precautions have been laid down as duties imposed on
bankers, the non-compliance of which can make the bank liable on the grounds of
- CAIIB DISCUSSION
negligence. We shall now individually examine these duties.

i. Duty to Open the Account with References and Sufficient Documentary Proof: The
duty to open an account only after the new account holder has been properly introduced
is too well ingrained in the today's banker's mind that it would be impossible to find an
account without introduction. The necessity to obtain introduction of a good customer is
to keep off crooks and fraudsters who may open accounts to collect forged cheques or
other instruments. As an added precaution, RBI has insisted that while opening accounts
photograph of the customer and sufficient documentary proofs for constitution and
address be obtained under the applicable KYC norms.
In this regard, the English Decision Ladbroke vs Todd (1914) 30 TLR 433 can be
referred to. In this case, a thief stole a cheque in transit and collected the same through a
bank, where he had opened an account without reference and by posing himself as the
payee whose signature the thief forged. After collection of the cheque, the thief
withdrew the amount. The bank was held liable to make good the amount since it acted
negligently while opening the account inasmuch as it had not obtained any reference.
In Syndicate Bank vs Jaishree Industries and Others AIR 1994 Karnataka 315, the
appellant opened an account in the name of M/s Axle Conductor Industries Ltd. by the
Proprietor, R.K. Vyas. A person Mr Nanjunde Gowda, who was having a small shop at
the address given by the account holder, gave the introduction. The address of the
account holder, given by the account holder, was just opposite the appellant bank. In the
account opening form, the name of the account holder was given as M/s Axle Conductor
Industries by the Proprietor R.K. Vyas. No information was sought or inquiry neither
held as to the incorporation of the account holder nor was the memorandum of
association, resolution, etc., scrutinised. On 3 January 1979, partners of Firm 'A'
purchased a draft for Rs. 2,51,125 from State Bank of India, Ahmednagar, in favour of
M/s Axle Conductor Industries Ltd. The draft was deposited in the account with the
appellant on 5 October 1979 and the amount was collected by the appellant and credited
to the account on 9 October 1979. On 10 October 1979, the monies were withdrawn
from the account. The partners of 'A filed a suit against the appellant and State Bank of
India for recovery of Rs. 2,51,125 wrongly collected by appellant and paid by State
Bank of India.
The High Court held that there was failure to follow the proper procedure for opening
account in the name of a limited company, that the account was opened as if it was a
proprietary concern, the staff of the appellant bank did not bestow sufficient care even to
notice the word 'Ltd.' on several occasions, such as, at the time of opening of the account
or withdrawal of amounts from the account. The High Court felt that having accepted the
application as if it was an application by a proprietary concern, strangely the appellant
bank allowed the account to operate in the name of the limited concern. There was,
therefore, lack of care on the part of the appellant bank in the entire transaction.
The conditions to be satisfied for claiming protection under Section 131 of the
Negotiable Instruments Act are:
(a) that the banker should act in good faith and without negligence in receiving payment,
i.e. in the process of collection;
96
(b) that the banker should receive payment for a customer, i.e. act as mere agent in
the collection of
the cheque, and not on his account as holder;
(c) that the person for whom the banker acts must be his customer;
(d) that the cheque should be one crossed generally or specially to himself.
The High Court stated that if the draft was drawn in favour of a fictitious person, it could
not be said that the ownership stood transferred to a non-existent person for the purpose
of examining the question whether the bank as a collecting banker acted negligently or
not. The ownership would pass to the true owner. The High Court did not consider it
- CAIIB DISCUSSION
necessary to decide as to what extent a person obtaining a draft in favour of a fictitious

person would lose the ownership in favour of a bona fide 'holder in due course'.
In view of the aforesaid, the appellant bank was held to have acted without taking any
care, and was found negligent throughout and was not entitled to the protection under
Section 131 of the Negotiable Instruments Act.
In Indian Bank vs Catholic Syrian Bank AIR 1981 Mad 129, the Madras High Court had
occasion to consider negligence of the collecting banker, which had opened an account
after proper introduction.
Briefly, the facts were that one D had opened an account with Salem branch of bank 'A'.
A customer of that branch had taken D to the said branch and had informed the manager
that D was a man from Indore and that .he wanted to open a bank account to enable him
to purchase carpets from Salem. Although the bank A had claimed that the customer,
who had introduced D, was a well-known customer of the bank A and was a leading
merchant of Salem and had a large volume of business, it was found in the evidence
recorded by the Court that these claims were not true. The introducer had an account and
had some fixed deposits with the bank A. The transactions were for paltry amounts and
the amount standing to the credit of the introducer at the relevant time, was only Rs.
192.57.
On 12 June 1969, M obtained a demand draft for Rs. 20 from the branch at Singanallur
of the bank B. The draft was drawn on the branch office of bank B in favour of D and
company. By means of a clever forgery, the draft was altered for Rs. 29,000 drawn in
favour of D. D presented the draft on 13 June 1969 for credit to his a ccount opened with
Salem branch of bank A and the amount was collected by bank A from bank B and
credited to the account of D.
On 14 June 1969, the Salem branch of bank B came to know from its Singanallur branch
that the draft issued for Rs. 20 and was drawn in favour of D and company, payable at
Cochin and that no draft for a sum of Rs. 29,000 had been issued. At once the Salem
branch of bank A was contacted and was informed of the fraud, but unfortunately by
then bank A had already paid a large part of the draft amount to D under a self cheque.
Bank B (Paying banker) filed the suit against bank A (collecting banker) for recovery of
Rs. 29,000
account on the
in the nameground that by
of D and thereason
collecting
of itsbanker had been
negligence andnegligent while
want of good opening
faith, the an
forged draft got to be wrongly converted.
The High Court observed that the collecting banker had opened the account in the name
of D on a mere introduction of one of its account holders, knowing fully well that the
said account holder was not a well known leading merchant and had no large business
with it at the relevant time. Further, the collecting banker had not independently
questioned D about his business and his creditworthiness before allowing him to open an
account. When D stated that he had come from Indore, the manager of the collecting
banker did not even care to find out his permanent address, more so, when in the
application for opening account filed by D, the address given was of that of the
introducer. Moreover,
97
when D told the manager of collecting banker that he had not until then opened any
account although he had come from Indore to Salem to do business, the collecting
banker, before opening the account, should have been more alert.
ii. Duty to Confirm the Reference where the Referee is not known or has given
Reference in Absentia: However, as a matter of practice, bankers in India require
introduction by an existing customer of the bank, this may not always be possible
especially when the branch is newly opened. In such cases, the customers are required to
get references from known persons in the locality or from the existing bankers. In such
case, the banker is required to make enquiries with the referee to confirm that the person
whose account is newly opened is a genuine person. Under the current KYC norms, the
- CAIIB DISCUSSION
authenticity of the customer is required to be verified by calling for a direct identification

document like a copy of passport, PAN number issued by IT department, Identity
certificate issued by Election authorities or identification issued by the employer if the
company is a prominent one. The address can be authenticated by obtaining a copy of a
electricity or Telephone bill, or copy of ration card, or copy of any bank statement where
the customer has already an account. Only in the case of very small customers, this
requirement is waived and a third party introduction is accepted.
In Harding vs London Joint Stock Bank [1914] 3 Legal Decision Affecting Bankers 81,
an account was opened for a new customer after complying with the necessary
formalities. The account was not opened by deposit of cash, as is the usual practice but
was opened by paying in a third party cheque. The bankers in the case made enquiries
with the customer who thereupon produced a forged letter issued by his employer giving
him power to deal with the cheque. It was thereafter found that the cheque was stolen by
the customer and credited to his account. The bank was held negligent for failure to
make necessary enquiries from the employer as to whether the customer who was an
employee had, in fact, the necessary power to deal with the cheque.
iii. Duty to Ensure Crossing and Special Crossing: It is the duty of the banker to ensure
that the cheque is crossed specifically to himself and if the cheque is crossed to some
other banker they should refuse to collect it. Similarly, where the cheque is crossed to a
specific account then crediting the same to another account without necessary enquiries
would make him liable on the grounds of negligence. In case of 'non-negotiable' crossing
a banker cannot be held negligent merely because of collection of such instruments. In
the case of Crumpling vs London Joint Stock Bank Ltd. [1911-13] All England Rep 647.
It was held that a non-negotiable crossing is only one of the factors amongst others to be
considered to decide about the bankers, negligence and that the mere taking of a non-
negotiable cheque cannot be held to be evidence of negligence on the part of the bankers.
iv. Duty to Verify the Instruments or any Apparent Defect in the Instruments: Sometimes
the instrument, which is presented for collection would convey to the banker a warning
that a customer who has presented the instrument for collection either is committing a
breach of trust or is misappropriating the money belonging to some other. In case the
banker
be held does
liablenot
onheed the warning,
the grounds which is as
of negligence required
can beof a prudent
seen banker,
from the then cases:
following he could
(a) In Underwood Ltd. vs Bank of Liverpool Martin Ltd. [1924] 1 KB 775, the
Managing Director
of a company paid into his private account large number of cheques which were to be
paid into
the company's account and the bank was held negligent since it did not make enquiries
as to
whether the managing director was, in fact, entitled to the amounts r epresented by these
cheques.
(b) In Savory Company vs Llyods Bank [1932] 2 KB 122, the cheques which were
payable to the
employer was collected by the employee in a private account opened by him and the
bank was
98
held liable for negligence. In this case, two dishonest clerks of a stock broker stole
bearer cheques belonging to their employer which were collected in an account
maintained by one of the clerks and in another account in his wife's name. It was held
that the bank had been negligent in opening the clerk's account inasmuch as they had not
obtained his employer's name while opening the account and that in the case of his wife's
account the bank was negligent inasmuch as it had not obtained the husband's occupation
and his employer's name while opening the account.
(c) In the case of Australia and New Zealand Bank vs Ateliers de Constructions
- CAIIB DISCUSSION
Electriques de
Cherleroi [1967] 1 AC 86 PC, an agent paid his principal's cheque into his personal
account
and the bank was charged with conversion. However, the bank defended the same
because
there was implied authority from the principal to his agent to use his private account for
such
purpose. Though the banker was negligent in dealing with the cheques without specific
authority
the bank escaped liability since it was found that the principal had, in fact, authorised his
agent
to use his private account.
(d) In Morrison vs London County and Westminster Bank Ltd. [1914-5] All ER
Rep 853, the
manager of the plaintiff was permitted to draw cheques per pro his employer and he
drew
some cheques payable to himself which he collected into his private account. The bank
was
held negligent for collecting such cheques without making necessary enquiries even
though
there was a clear indication that the manager was signing as an agent of the firm.
v. Duty to take into Account the State of Customer's Account: The collecting banker is
required to take into account the status of the customer and the various transactions that
have taken place in the customer's account to know the circumstances and the standard
of living of the customer. If for example, a person is an employee and the nature of his
employment is that of a clerk, his salary would be approximately known to the bank and
any substantial credits by way of collection of cheques would be suspected and it would
be the duty of the banker to take necessary precautions while collecting such cheques.
In Nu-Stilo Footwear Ltd. vs Lloyds Bank Ltd. [1956] 7 Legal Decisions Affecting
Bankers P. 121, the plaintiffs who were manufacturers of ladies footwear were defrauded
by their secretary

plaintiffs and works
into his account. accountant
The secretary who converted
opened nine cheques
the accounts payable to bank
in the defendant's the in a
false name and as reference gave his real name. The bank thereupon called the reference
and got a satisfactory reply, which included the fact that the account holder had recently
come down from Oxford and intended setting up a business of his own. The secretary
thereupon presented nine cheques totally aggregating to £ 4855. Since these cheques
were drawn on the plaintiffs, they sued the defendant bank who had collected the
cheques. The Court held that the collecting bank was negligent inasmuch as the
collecting bank did not take necessary precautions because the amounts collected were
inconsistent with the business of the account holder and therefore necessary enquires
should have been made by the bank.
vi. Negligence of Collecting Bank in Collecting Cheques Payable to Third Parties: The
collecting bank has to make necessary enquiries before any third party cheques, are
collected on behalf of its customer. In Ross vs London County Westminster and Parrs
Bank Ltd. [1919] 1 KB 678, cheques payable to 'the Officer in charge, Estate Office,
Canadian Overseas Military Force' were used by an individual to payoff his debts. There
was an instruction in all the cheques that it was negotiable by the concerned officer.
However, it was held that the fact that the cheques were drawn in favour of the officer in
charge should have put the banker on enquiry and since no such enquiry was made by
the banker the bank is liable on the grounds of negligence.
99
7.4 LET US SUM UP
However, the Negotiable Instruments Act does not specifically lay down the duties of a
- CAIIB DISCUSSION
collecting banker while collecting cheque, it gives protection to a collecting banker

under Section 131. From Section 131, it can be deduced that a banker to claim protection
should comply with certain basic duties failing which he will not be entitled to seek
protection under Section 131. These duties are:
1. The collecting banker should have acted in good faith.
2. He should have acted without negligence.
3. He should receive payment for a customer.
4. The cheque should be crossed generally or specially to himself.
In concluding whether the bank had been negligent or not the following matters would
be relevant and if the banker has failed to carry out any of the following duties then he
can be liable on the grounds of negligence. These duties are:
(i) To open the account with proper references and documentary proof.
(ii) To confirm the reference, where the referee is not known and or does not come
personally.
(iii) To ensure crossing and special crossing.
(iv) To verify the instruments or any apparent defect in the instruments.
(v) To take into account the state of customer's account.
(vi) To make enquiries by the collecting bank in collecting cheques payable to third
parties.
7.5 KEYWORDS
Conversion; Non-negotiable crossing.
(i) The statutory protection to a collecting banker is as per Section 6 of the Indian
Contract Act. (ii) Section 131A of the Negotiable Instruments Act extends the protection
granted to a banker
while receiving payment of a cheque, and drafts, (iii) The duties of collecting bank to
claim protection has been laid down under the Indian Contract
Act and Banking Regulation Act.
(iv) In the absence of proper reference the banker can be held liable on the grounds of
negligence,
given by the(v) It is necessary for the banker to make enquiries regarding the reference
customer.
1. (i) False; (ii) True; (iii) False; (iv) True; (v) True
L.K.A.B.8
INDEMNITIES
STRUCTURE
8.0 Objectives
8.1 Introduction
8.2 Contract of Indemnity Defined
8.3 Distinctive Features of Indemnity Contract and Guarantee
8.4 Scope and Application of Indemnity Contracts to banks
8.5 Rights of an Indemnity Holder
8.6 Let Us Sum Up
8.7 Keywords
102
8.0 OBJECTIVES
After studying this unit, you should be able to understand:
- CAIIB DISCUSSION
• the definition and concept of indemnity;

• distinctive features of an Indemnity Contract and how it differs from a
guarantee;
• when and why bankers take indemnities;
• know the rights of an indemnity holder;
• know the liabilities of the indemnifier.
8.1 INTRODUCTION
The word indemnity means 'to save from loss'. This loss could be either due to the act of
the party giving the indemnity or due to the act of a third party. The law regarding
indemnity as laid down in Sections 124 and 125 of the Indian Contract Acts, is not
exhaustive. The law of indemnity is much wider than as stated in the Contract Act, since
Courts applying the principles of equity have developed it. A Contract of Indemnity is a
contingent contract, i.e. its performance is made dependent upon the happening or non-
happening of some event.
8.2 CONTRACT OF INDEMNITY DEFINED
Section 124 of the Indian Contract Act, 1872 defines contract of indemnity as follows:
Sectionl24. 'Contract of Indemnity' defined: A contract by which one party promises to
save the other from loss caused to him by the conduct of the promisor himself or by the
conduct of any other person, is called a 'Contract of Indemnity'.
Section also gives an illustration of a Contract of Indemnity as follows:
A contract to Indemnify B against the consequences of any proceedings which C may
take against B in respect of a certain sum of Rs. 200, is called a contract of Indemnity.
In the above definition, the person giving the promise is called the indemnifier and the
person to whom the promise is made is called the indemnified or the indemnity holder.
As stated, earlier the contract of indemnity as defined in the contract is narrow and not
exhaustive and the law regarding indemnity is much wider than that as defined in the
Contract Act. For example, all insurance contracts come within the ambit of a contract of
indemnity, but are not dealt with under Section 124 of the Contract Act. Section 124
deals only with one particular type of indemnity, viz., where a person gives a promise to
save another person from loss caused by either the conduct of the person giving the
promise
stated in or by the124,
Section conduct
thereof any
are other
cases person.
where the Over
Courtsand above the
applying the kind of indemnity
principles of general
law have held a person liable to indemnify, though the person never did undertake such a
liability. The decision of the Privy Council in Secretary of State vs Bank of India Ltd.
(AIR 1938 PC 191) best illustrates this point. In this case, Ms. G was the holder of a
Government promissory note which she had handed over to Mr. A, her broker. Mr. A
forged Ms. G's signature and endorsed it in his favour. Mr. A then endorsed it for value
to the bank. The bank in good faith applied to the Government Public Debt Office to
have the note exchanged in their name, which was done. Ms. G on being aware that she
has been defrauded, sued the Government and recovered the appropriate damages. The
Government in turn sued the bank to indemnify the Government against the loss suffered
by them. The Court held the bank to be liable because under common law covering right
of indemnity, the bank is responsible for an injury to a third party's rights.
A contract of indemnity, though similar to a contract of guarantee differs on various
counts. To know the difference between these two types of contracts we shall examine
their respective features one by one in the next part.
103
8.3 DISTINCTIVE FEATURES OF INDEMNITY CONTRACT AND
GUARANTEE
i. Number of Parties to the Contract of Indemnity: In a contract of indemnity there are
two parties, viz., the indemnifier and the indemnified whereas in a contract of guarantee
there are three parties, viz., the debtor (the person on whose behalf the guarantee is
given), the creditor (the beneficiary, the person to whom the guarantee is given) and the
- CAIIB DISCUSSION
In case the indemnity holder does not violate the above two conditions, he is then
entitled to be indemnified by the indemnifier to the extent of:
(a) the damages paid by him;
(b) the costs required either to file the suit or defend it;
(c) any amounts paid by him pursuant to a compromise in the suit provided that the
compromise
was not contrary to any of the order or directions of the indemnifier and the compromise
was
such that it was an act of prudence in the absence of a contract of indemnity.
1. Damages: As regards damages, it is to be noted that High Courts have differed

in the views as to
when the indemnifier's liability commences. Some High Courts have held that the
liability commences
only from the time the indemnity holder actually incurs loss, whereas some others have
held that an
indemnity holder can compel the indemnifier to put him in a position to meet the
liability. The
former view is to be preferred.
2. Costs: As regards costs, costs paid to solicitors, travelling expenses and also
costs reasonably
incurred in resisting or reducing or ascertaining the claim, may be r ecovered. The
general principle
in computing the costs is that it should be such as, would a reasonable man think if
necessary to
incur.
3. Sums paid on Compromise: As per Section 125, if the indemnity holder acts
within the scope of his
authority, then he is entitled to recover from the indemnifier all the sums that he may
have paid
pursuant to a compromise in a suit, provided however that

(a) such compromise was not contrary to the orders of the indemnifier;
(b) such compromise was prudent to be made by the indemnity holder in the
absence of any
contract of indemnity;
(c) the indemnifier had authorised the indemnity holder to compromise the suit.
The Madras High Court in Venkataramana vs Mangamma AIR 1944 Mad. 457, has held
that even in the absence of a notice to the indemnifier (promisor), the compromise would
bind him, if not contrary to the orders of the promisor, and is entered bona fide and
without any collusion and is not imprudent.
8.6 LET US SUM UP
Sections 124 and 125 of the Indian Contract Act respectively, lays down the laws of
indemnity and the rights of indemnity holder. These sections are not exhaustive and the
general law of indemnity, which is wider, has been applied in cases not covered by
Sections 124 and 125. The indemnifier has to compensate the indemnity holder who is
entitled to the damages suffered, costs incurred and to recover any sums paid in a
compromise of any suit. Bankers obtain indemnities to protect themselves from any loss
that they may incur while issuing duplicate of instruments like demand drafts or
travellers' cheques, FDRS, pay-orders, etc.
8.7 KEYWORDS
Indemnity; Indemnifier; Indemnity holder.
105
- CAIIB DISCUSSION
A. 1. Fill in the blanks,

(i) Section
of the Indian Contract Act defines an indemnity.
(ii) A person promising to save another from loss is called
(iii) is a person who is promised to be saved from loss.
2. State whether the statements are true or false.
(i) Contract of Indemnity as defined in the Contract Act is exhaustive, (ii) Insurance
Contracts are not contracts of indemnity.
B. 1. Fill in the blanks.
(i) There are parties to a contract of indemnity.
(ii) Indemnifiers liability in a contract of indemnity is .
2. State whether the following statements are true or false.

(i) There are three parties to a contract of indemnity, the indemnifier, the indemnity
holder and
the person on whose behalf the indemnity is given, (ii) Indemnifter's liability occurs only
if the indemnity holder suffers loss.
C. 1. State whether the statements are true or false.
(i) Customers as a matter of right and without an indemnity can obtain duplicate of
demand
drafts or travellers' cheques.
(ii) Indemnities are required by banks purely as a formality and does not serve any other
purpose, (iii) The indemnity obtained by banker only protects him from the actual value
of the instrument.
D. 1. What are the two conditions that an indemnity holder is bound to comply
before being indemnified
for a loss?
2.
3. To whatofextent
In case is the indemnity
compromise holderholder
the indemnity entitled
hastotobesatisfy
indemnified?
certain conditions
before recovering
the loss from the indemnifier, what are these conditions?
4. State whether the statements are true or false.
(i) An indemnity holder can act beyond his authority.
(ii) An indemnity holder can be compensated only for damages and not for the costs
incurred
by him. (iii) An indemnity holder is entitled to compromise a suit as thought fit by him
though contrary
to the orders of the indemnifier.
A. 1. (i) 124; (ii) Indemnifier; (iii) Indemnity holder
2. (i) False; (ii) False
B. 1. (i) 2; (ii) Primary
2. (i) False; (ii) True
C. 1. (i) False; (ii) False; (iii) False.
D. 1. (i) He should act within the scope of his authority and should not
contravene any directions
of the indemnifier.
2. To the extent of the damages suffered, costs incurred and sums paid for
compromise of any
suit.
3. (i) The compromise was not contrary to the orders of the indemnifier.
- CAIIB DISCUSSION
(ii) Such compromise was prudent.

(iii) the indemnifier had authorised the indemnity holder to compromise the suit.
4. (i) False; (ii) False; (iii) False
BANK GUARANTEES
STRUCTURE
9.0 Objectives
9.1 Introduction
9.2 Bank Guarantees
9.3 Various Ttypes of Bank Guarantees
9.4 Banker's Duty to Honour Guarantee
9.5 Issuance of Bank Guarantee - Precautions to be taken
9.6 Payment Under Bank Guarantee - Precautions to be taken
9.7 Let Us Sum Up
9.8 Keywords
108
9.0 OBJECTIVES
• various kinds of bank guarantees, their nature and scope;
• the precautions to be taken while issuing a bank guarantee;
• the precautions to be taken on invocation of a bank guarantee.
9.1 INTRODUCTION
In commercial transactions, bank's customers are sometimes required to give a bank
guarantee. This is mostly as an alternative to keep cash as a security deposit. The third
party who seeks the guarantee, not being aware of the customer's financial standing,
prefers
standinga of
bank
the guarantee.
customer, In turn, the to
undertakes bank, which the
guarantee verycustomer's
well understands
financialthe financial
commitments
or the performance of contracts by him. The bank charges a commission for this service
which depends on the security available and the financial stability of the customer. In
this Chapter, you will learn what exactly is a bank guarantee, the various types of bank
guarantees, the precautions to be taken while issuing a bank guarantee and on making
payment on a bank guarantee the distinction between a bank guarantee and an ordinary
guarantee, why in a bank guarantee the banker's duty to honour the guarantee is of prime
importance and the limit to which this duty can be extended.
9.2 BANK GUARANTEES
The term 'bank guarantee' briefly stated means:
a guarantee given by a bank to a third person, to pay him a certain sum on behalf of the
bank's customer, on the customer failing to fulfil any contractual or legal obligations
towards the third person.
From the above, it can be seen that there should first be a commitment on the part of the
customer to fulfil certain obligations to a third party. This could be contractual or legal,
i.e. imposed by law. This commitment of the customer is guaranteed by a bank and if the
customer fails to honour his commitment the banker pays the amount, it has promised to
pay. Once the bank gives a guarantee, then its commitment to honour the guarantee is
onerous and as such, it is prudent that a banker before issuing a guarantee on behalf of
his customer takes appropriate security and understands his rights and duties. Before we
embark on a study of the banker's duty to honour guarantees and the onerous obligation
he undertakes on behalf of the customer when he issues a guarantee, it would be
necessary to understand the various kinds of guarantees that a banker usually issues.
- CAIIB DISCUSSION
9.3 VARIOUS TYPES OF BANK GUARANTEES

Though under law, bank guarantees have not been classified by the nature of the
underlying contract entered into by the customer, in practice such classification has been
made. Though there are various types of guarantees, the important ones, which a banker
would be regularly required to issue in the course of his business are as follows:
i. Financial Guarantee: These are guarantees issued by banks on behalf of the customers,
in lieu of the customer's requirement to deposit a cash security or earnest money. These
kinds of guarantees are mostly issued on behalf of customers/contractors dealing with
Government departments. Such guarantees are also issued in situations where a party is
required to deposit cash as a part of contract. Most Government departments insist that
before the contract is awarded to contractor he should show that he is willing to perform
the contract and to ensure that now frivulous tenders
109
are mad, insist on an Earnest Money Deposit. However in lieu of the earnest money
government departments are generally willing to accept a bank guarantee. This also
helps the contractor who can utilise the funds for fulfilling his obligations under the
contract. In case the contractor does not take up contract of awarded then the
Government departments invoke the guarantee and collect the money from the banks.
ii. Performance Guarantee: These are guarantees issued by the bank on behalf of its
customer whereby the bank assures a third party, that the customer will perform the
contract entered into by the customer as per the condition stipulated in the contract,
failing which the bank will compensate the third party up to the amount specified in the
guarantee. These types of guarantees are usually issued by bankers on behalf of their
customers, who have entered into contracts to do certain things on or before a given date.
Though the bank assures, that the conditions as stipulated in the contract will be
complied with by the customer in practice, the banks on being served a notice of default
by the third party pays over the amount guaranteed without going into the technicality of
the contract. This is because, after a guarantee is issued, the contract of guarantee is
independent of underlying commercial transaction and any claim as per terms of
guarantee is required
clause is inserted, thattoproof
be honoured.
of defaultThough, in certainisperformance
of the customer guarantees
necessary, most bank a
guarantees do not insist on such proof. A mere demand from the beneficiary that there
has been a default by the bank's customer is sufficient for the bank to make payment.
This is so, since banks by the nature of their expertise prefer to deal with documents and
they would not like to go beyond the contract and verify whether there has been a breach
of the contract or not. This is because, generally the guarantee document makes it
obligatory on the part of the issuing bank to honour their guarantee without going into
the points of differences between the beneficiary and the principal on whose behalf he
had issued the guarantee.
iii. Deferred Payment Guarantee: Under this type of guarantee, the banker guarantees
payment of instalments spread over a period. This type of guarantee is required, when
goods or machinery are purchased by a customer on long-term credit and the payment is
to be made in instalments on specified dates spread over more than a year. In terms of
the contract of sale, the seller draws drafts (bills of exchange) of different maturities on
the customer which are to be accepted by the customer. The banker guarantees due
payment of these drafts. A deferred payment guarantee constitutes an undertaking on the
part of the bank to make payments of deferred instalments to the seller (beneficiary) on
the due dates, in the event of default by the customer (buyer). While issuing a deferred
payment guarantee, the banker has to assess the ability and sources of funds of the
customer to honour the payment of instalments on due dates.
9.4 BANKER'S DUTY TO HONOUR GUARANTEE
Bank guarantees are called 'the life blood of national and international commerce' and
even though they are an offshoot of a primary contract between the debtor and cre ditor,
- CAIIB DISCUSSION
these guarantees are independent commitments taken by bank on the behalf of their
customers. In most bank guarantees, banks undertake to make payment merely on
demand by the beneficiary. It is therefore absolutely necessary that irrespective of the
underlying contract and any dispute between the parties to the contract, the bank makes
payment, if the guarantee has been invoked properly. We shall now examine this duty of
the banker to honour his commitment under a guarantee and the grounds on which
payments can be refused.
i. Bank's Obligation to Pay Primary
(a) The obligation of a banker, to honour his commitment on a guarantee given by him
being primary, casts a duty on the bank to honour it irrespective of the disputes between
the beneficiary
110
and the debtor. The first of the cases wherein the bank's commitment to honour its
guarantee was discussed was the English case of R.D. Harbottle Ltd. vs National
Westminster Bank Ltd. (1978) OB 146, wherein Justice Kerr held as follows:
Such guarantees even though having their genesis in the primary contract between the
parties are nevertheless autonomous and independent contracts and a bank, which has
given a performance guarantee must honour that guarantee according to its terms. It is
not concerned in the least with relations, between the supplier and the customer, nor with
the question whether the supplier has performed his contracted obligations or not, nor
with the question whether the supplier is in default or not and the only exception is when
there is a clear fraud, of which the bank has notice.
(b) The above principle has been accepted by Courts in India and they have refused to
grant injunctions against banks from making payment under the guarantee except in
cases of fraud or special equities in favour of the person on whose behalf the guarantee
has been issued. The decision of the Calcutta High Court in Texmaco Ltd. vs State Bank
of India AIR (1979) Cal 44, the first among the Indian cases illustrates the duty imposed
on a bank to honour its guarantee. In this case, the bank had issued a guarantee to STC
on behalf of M/s Texmaco Ltd., wherein the bank irrevocably and unconditionally
guaranteed the by
case of default dueTexmaco,
performance of the on
the bank, contractual obligations
first demand by STC,ofguaranteed
M/s Texmaco and in
payment of
the amount without any contestation, demur or protest and/or without reference to
Texmaco and/or without questioning the legal relationship subsisting between Texmaco
and STC. The guarantee was invoked by STC upon which Texmaco filed a suit for
injunction to restrain the bank from making any payment. The High Court held that:
In the absence of such special equities and in the absence of any clear fraud, the bank
must pay on demand, if so stipulated, and whether the terms are such must have to be
found out from the performance guarantees as such. Here though the guarantee was
given for the performance by Texmaco in an orderly manner their contractual obligation,
the obligation was taken by the bank to repay the amount on 'first demand' and 'without
contestation, demur or protest and without reference to Texmaco and without
questioning the legal relationship subsisting between STC and Texmaco'. It further
stipulated, as I have mentioned before, that the decision of STC as to the liability of the
bank under the guarantee and the amounts payable thereunder shall be final and binding
on the bank. It has further stipulated that the bank should forthwith pay the amount due
'notwithstanding any dispute between STC and Texmaco'. In that context, in my opinion
the moment, a demand is made without protest and contestation, the bank has obliged
itself to pay irrespective of any dispute as to whether there has been performance in an
orderly manner of the contractual obligation by the party.
The Supreme Court has also considered the liability of a banker on a guarantee and after
referring to the various English decisions and the decisions of various High Courts held
in UP Co-operative Federation vs Singh Consultant [1988 (1) SCC 174] that
commitments of banks must be honoured free from interference by the Courts.
- CAIIB DISCUSSION
Otherwise, trust in commerce, internal and international, would be irreparably damaged.

It is only in exceptional cases, that is to say, in case of fraud or in case of irretrievable
injustice be done, the Court should interfere.
LIABILITY OF BANK UNDER A GUARANTEE GIVEN ON BEHALF OF A
COMPANY ORDERED TO BE WOUND UP
In Maharashtra Electricity Board, Bombay vs Official Liquidator, High Court of
Ernakulam and Another (AIR 1982 SC. 1497), the Supreme Court had occasion to
consider the liability of a bank on a guarantee
111
given by it on behalf of a company that was being wound up, the facts of which; in a
nutshell are as follows:
The Cochin Malleable Private Limited (Company) entered into a contract with
Maharashtra State Electricity Board, Bombay (Board) for supply of goods from time to
time. As per the terms of the contract, the company furnished a bank guarantee for Rs.
50,000 as earnest money deposit. As per the guarantee given by Canara Bank Limited
(Bank), the bank agreed unequivocally and unconditionally to pay within forty-eight
hours on demand in writing from the board a sum not exceeding Rs. 50,000. On 30 July
1973, a petition for winding up of the company was presented and the High Court,
Kerala, on 16 September 1974, ordered the company to be wound up. On 27 August
1973, the board called upon the bank to pay the guarantee amount of Rs. 50,000
followed by several reminders and final demand was made on 23 July 1974.
On 4 November 1974, the Bank wrote to the official liquidator stating that the company
was liable to the bank for payment of Rs. 1,64,353.12 which included the guaranteed
amount. Thereupon, the official liquidator filed an application before the company
Judge, praying for an order restraining the board from realising the amount covered by
the bank guarantee on the ground that since the company was ordered to be wound up,
the board could not claim payment under the bank guarantee.
The learned company Judge upheld the plea of the official liquidator and issued an order
restraining the board from realising the amount from the bank. The board filed an appeal
to the Division
thereupon Bench of
approached thethe High Court,
Supreme Court.which was also Court
The Supreme dismissed. The board
held that:
Where under a letter of guarantee the bank has undertaken to pay any amount not
exceeding Rs. 50,000 to the board, within forty-eight hours of the demand and the
payment of the amount guaranteed by the bank was not made dependent on the proof of
any default on the part of the company in liquidation, the bank was bound to make
payment to the board. The board was not concerned with what the bank did in order to
reimburse itself after making the payment under the bank guarantee. It was the
responsibility of the bank to deal with the securities held by it in accordance with law.
The Supreme Court observed that under Section 128 of the Contract Act, the liability of
the surety is co-extensive with that of the principal debtor, unless, it is otherwise
provided in the contract. Further, a surety is discharged under Section 134 by any
contract between the creditor and the principal debtor by which the principal debtor is
released or by any act or omission of the creditor, the legal consequence of which is the
discharge of the principal debtor. But a discharge which a principal debtor may secure
by operation of law in bankruptcy (or in liquidation proceedings in the case of a
company) would not absolve the bank from its liability under the bank guarantee.
LIABILITY OF BANKS UNDER A GUARANTEE WHEN THE MAIN CONTRACT
IS SUSPENDED
The question whether the bank is absolved of its liability under a guarantee issued by it
when the main contract is suspended by a statute was considered by the Bombay High
Court in Messrs SCII (India) Limited vs Indian Bank and Another (AIR 1992 Bom.
121). The facts of the case are as follows:
For carrying out erection, testing and commissioning of IP pipe works, the company
- CAIIB DISCUSSION
engaged the services of a contractor. At the request of the contractor, the bank furnished
a performance guarantee where under the bank undertook to pay to the company on
demand 'any and all monies payable by the contractor to the extent of Rs. 10,72,806 at
any time up to 30 June, 1989 without demur, reservation, contest, recourse of protest
and/or without reference to the contractor'.
The Government of West Bengal had issued a notification under which the contractor
was declared as an unemnlovment relief undertaking under the West Bengal Act, 1972,
and had suspended all contracts
112
On invocation of the guarantee the contractor, therefore, submitted that the contract of
erection, etc., entered into by the contractor with the company stood suspended.
On behalf of the company, it was submitted that the bank guarantee was an independent
contract between the bank and the company and was not affected or suspended by
operation of the above referred to Act or the notification.
The High Court observed that the company had not invoked the guarantee fraudulently
or mala fide. The High Court pointed out that according to the decision of the Bombay
High Court and Supreme Court, the contract of bank guarantee is an independent and
separate contract. The High Court noted, that in several Supreme Court decisions,
particularly in M.S.E.B. Bombay vs Official Liquidator, AIR 1982, S.C. 1497, and in
State Bank of India vs Messrs Saksaria Sugar Mills Limited, AIR 1986, S.C. 868, it was
held that the liability of the guarantor to pay was not affected by suspension of liability
of the principal debtor under some statutory provisions. In the result, the High Court
refused to grant any injunction restraining the bank from making payment under the
bank guarantee more so when there was no special equity in favour of the contractor.
From the above decisions, it can be seen that the liability of the bank is not dependent on
the underlying contract but is an independent contract which the Courts would enforce
except in case of fraud.
ii. Exceptions
(a) Cases of fraud: The Supreme Court in United Commercial Bank vs Bank of India
AIR 1981
Except SC 1426
possibly observed
in clear as fraud
case of follows:
of which the banks have notice, the Courts will
leave the merchants to settle their disputes under the contracts by utilisation or
arbitration as available to them or as stipulated in the contracts.
Fraud, has been held to be one of the exceptions to the general rule regarding the
contracts of guarantee. A banker, who has knowledge of fraud, can therefore refuse
payment of the amount guaranteed. The question however, would arise as to how a
banker can decide as to whether a fraud has been committed or not. In such cases, it is
advisable that the banks inform their customer about the invocation of the guarantee by
the creditors and the banks intention to pay within a given time if the unless restrained
by an injunction order of a court. This would relieve the bank of the task of judging as to
whether a fraud has been committed or not. On this point the observations of Supreme
Court in UP Co-operative Federation vs Singh Consultants 1988 (1) Section 174 is worth
noting, whether it is a traditional letter of a credit or a new device like performance bond
or performance guarantee, the obligation of banks appears to be the same. If the
documentary credits are irrevocable and independent, the banks must pay when demands
are made. Since the bank pledges its own credit involving its reputation, it has no
defence except in the case of fraud. The bank's obligations, of course should not be
extended to protect the unscrupulous seller, that is, the seller who is responsible for the
fraud. However, the banker must be sure of his ground before declining to pay. The
nature of the fraud that the Courts talk about, is fraud of an 'egregious nature as to vitiate
the entire underlying transaction'. It is fraud of the beneficiary, not the fraud of
somebody else. If the bank detects, with a minimal investigation, the fraudulent action of
the seller the payment could be refused. The bank cannot be compelled to honour the
- CAIIB DISCUSSION
credit in such cases. However, it may be very difficult for the bank to take a decision on
the alleged fraudulent action. In such cases, it would be proper for the bank to ask the
buyer to approach the court for an injunction. M/s Escorts Limited vs Messrs Modern
insulators and Another AIR 1988 Delhi 345 also illustrates the point that banks in case
of doubt should seek appropriate direction from the Court. In this case, the
113
Escorts supplied generator sets to Modern Insulators the performance of which were
guaranteed by the bank. Modern invoked the guarantee, whereupon Escorts moved the
Court to restrain Modern from recovering the amount and the bank from making
payment of the guaranteed sum. The Court granted injunction since the guarantee was
not invoked properly. Thereafter Modern invoked the guarantee once again but the bank
did not pay. The matter came before the High Court and Escorts pleaded that Modern
had played a fraud and hence were not entitled to the guaranteed amount. The High
Court held that averments of fraud have to be pleaded and proved, which was not done
by Escorts. Of importance in this judgement is the Court's remark as regards the conduct
of the bank. The Court remarked that the bank should have approached the Court for
appropriate directions if it had any doubts. Merely because an application for injunction
was made, would not be a ground for the bank not to honour its commitment under the
bank guarantee.
It is therefore important to ensure that a clear cut case of fraud is established before a
bank can refuse payment.
(b) Special equity in favour of debtor: If there is a possibility of an irretrievable harm or
injustice to one of the parties concerned, the Courts would adjunct the bank from making
payment. As an illustration to the exception the Supreme Court cited and approved the
decision of the US Court in Itek Corp. vs First National Bank of Boston (566 Fed. Supp
1210). In this case, an exporter in USA entered into an agreement with the Imperial
Government of Iran and sought an order terminating its liability on stand by letters of
credit issued by an American Bank in favour of an Iranian Bank as part of the contract.
The relief wasGovernment

the American sought because of the situation
cancelled the exportcreated after
licences the Iranian
in relation revolution
to Iran and thewhen
Iranian Government had forcibly taken 52 American citizens as hostages. The US
Government had blocked all Iranian assets under the jurisdiction of the United States and
had cancelled the export contract. The Court upheld the contention of the exporter that
any claim for damages against the purchaser if decreed by the American Courts would
not be executable in Iran under these circumstances and realisation of the bank
guarantee/letters of credit would cause irreparable harm to the Plaintiff. This contention
was upheld. To avail of this exception, therefore, exceptional circumstances, which
make it impossible for the guarantor to reimburse himself if he ultimately succeeds, will
have to be decisively established. Clearly, a mere apprehension that the other party will
not be able to pay, is not enough. In the Itek case there was a certainty on this issue.
Secondly, there was good reason, in that case for the Court to be prima facie satisfied
that the guarantors, i.e. the bank and its customer would be found entitled to receive the
amount paid under the guarantee.
9.5 ISSUANCE OF BANK GUARANTEE - PRECAUTIONS TO BE TAKEN
The liability of a bank under a guarantee depends on two fundamental criteria, viz., the
amount guaranteed and the period of the guarantee. These two factors have to be
specifically stated since in the absence of any one or both of these factors, the bank's
liability could be unlimited either in the amount guaranteed or the period during
guarantee. The banker should also obtain a counter guarantee from his customer on
whose behalf he has given the guarantee, so that in case he is required to pay the
guarantee he can fall back on the counter guarantee to claim the amount paid by him. We
shall study these aspects in detail since in your day-to-day practice as a banker you will
- CAIIB DISCUSSION
come across these aspects quite frequently.

i. Amount Guaranteed: When the bank issues a guarantee, the first and foremost
consideration that should weigh in a banker's mind is the amount of the guarantee he is
called upon to issue. In the guarantee agreement, the amount has to be specifically
stated, both in figures and words. While
114
stating the amount, that the bank would guarantee to pay, care should be taken to state
whether or not the amount is inclusive of all interests, charges, taxes and other levies.
This is important to avoid unnecessary disputes regarding the liability of the bank. On
invocation, the bank is liable to pay the whole amount of the guarantee unless as stated
earlier a case of fraud has been brought to its notice.
ii. Period of Guarantee: Banks always specify the period for which their guarantee
subsists and an additional period during which a claim has to be made on the bank to
make payment. The former period during which the guarantee subsists, is called the
validity period and the latter, the claim period. If any default has been committed by the
debtor (i.e. the bank's customer) it should be within the validity period. The claim period
is only to facilitate the beneficiary to prepare and lodge claim, if any, under the
guarantee. It is thus, necessary as a matter of great caution that this period be specified to
the exact date, for example, 'this guarantee is valid up to 31 December 2007.'
Once this outer limit for the bank to guarantee a default of the debtor is fixed, then the
creditor can make a claim only if the default has occurred within this period, and for any
default beyond this date the bank cannot be held liable. Once a default is made then the
beneficiary has to make a claim on the bank to make good the loss within the claim
period.
Claim period in a guarantee: In a guarantee, it is necessary to provide for a period
slightly longer than the validity period for the beneficiary to make a claim. The claim
period is usually a few months more than the validity period of the guarantee. Since if
the debtor were to commit a default on the last day of the validity period, then the
beneficiary, at the earnest, invoke the same only on the next day. Taking into account the
time
thirtytodays
communicate the invocation,
after the validity etc.,example,
period. For the claim
if period should
the validity at least
period be fifteen
of the to
guarantee
is up to 31 December 2007, then the claim period would normally be up to 31 January
2008.
Amendment to Section 28 of Indian Contract Act and its effect on Bank Guarantee: Prior
to the amendment of Section 28 of the Indian Contract Act, 1872 most bank guarantees
had a standard clause at the end of their guarantee agreements. As per this clause, the
beneficiary was required to enforce his claims within a period of three to six months,
failing which, the bank's liability was extinguished and hence the rights of the
beneficiary. The above clause was necessitated due to the fact that in the absence of it,
Government departments and municipal bodies can file a suit against the bank under a
bank guarantee within a period of thirty years after making a claim. The banks would
therefore be required to carry forward this liability for a long period and thereby required
to make provisions for the same in their balance sheets. Added to this, the customers
cash margin and security would have to be retained either until the guarantee is returned
by the beneficiary or until the expiration of the period of limitation. However, this
clause, had been challenged before various High Courts and the High Courts have held
that such clauses in the bank guarantees to be valid, and not violative of Section 28 of
the Contract Act.
However, from 1 January 1997, Section 28 of the Indian Contract Act has been amended
due to which the standard limitation clauses in the bank guarantees by which the bank
extinguished their liability as been declared illegal. As such, at present if a beneficiary
were to invoke the guarantee within the claim period, for a default committed by the
debtor during the validity period then in case the bank did not make payment, the
- CAIIB DISCUSSION
beneficiary can sue the bank within the normal period as provided in the Limitation Act,
1963. This period under the Limitation Act is thirty years in case the beneficiary is
Government department or municipal body and three years in all other cases.
As such it is prudent to insist that the bank guarantee be returned after the claim period
duly cancelled by the beneficiary or a certificate be obtained from the beneficiary that
there are no claims under the
115
guarantee, and until such time the cash margin and the security of the debtor (customer)
has to be retained.
iii. Counter Guarantee and Other Security: Though a bank guarantee is a contingent
liability, it is always prudent for a banker to secure this contingent liability to cover
himself in case it is enforced. This can be done by obtaining a counter guarantee-cum-
indemnity executed by the customer in favour of the bank. The counter guarantee-cum-
indemnity, should be carefully drafted to ensure, that in case the bank were to make
payment on behalf of the customer, then the customer in turn 1 should not only make
good the amounts paid by the bank to the creditor but also any expenses connected
therewith including costs of attorney, any interest on delayed payment, taxes and other
levies. It is to take care of all the above payments that the counter guarantee also
includes an indemnity aspect. The counter guarantee should also include a clause that it
would remain in force until the guarantee given by the bank subsists, viz., until the bank
is duly discharged by the beneficiary or a certificate to this effect is issued by the
beneficiary.
Though a counter guarantee-cum-indemnity is taken as a security for every guarantee
issued by the bank, its value would depend on the financial standing of the
person/company giving the counter guarantee. As such, it is preferable that keeping in
mind the financial worth of the counter guarantor necessary security in the form of
tangible securities like fixed deposits, other paper securities or immovable properties,
etc., are obtained or the existing charge of the debtor be also extended to cover the
guarantee.
9.6 PAYMENT
Before UNDER aBANK
making payment, bankerGUARANTEE - PRECAUTIONS
has to ensure that the invocation ofTO theBE TAKENhas
guarantee
been properly made; failing which he may not have any recourse against the debtor. The
banker should also see that no order of injunction has been passed by any Court of law
prohibiting the bank from making payment. In case, a banker makes payment ii1 spite of
there being an order by a competent Court in which the bank is a party, then the bank
will be answerable for Contempt of Court.
i. Proper Invocation of Guarantee: The bank while making payment on its guarantee has
to be careful and ensure that the invocation has been properly made. There are divergent
views as regards the proper manner in which a bank guarantee should be invoked. The
Delhi High Court, in M/s Harprashad and Co. Ltd. vs Sudarshan Steel Mills, AIR 1980,
Delhil74, had occasion to consider this question. In this case, the High Court took the
view that:
The duty of the beneficiary in making the demand on the bank is like the duty of the
plaintiff to disclose the cause of action in the plaint. Just as a plaint is liable to be
rejected for non-disclosure of the cause of action, a demand by the beneficiary of the
bank guarantee is liable to be rejected by the bank if it does not state the facts showing
that the conditions of the bank guarantee have been fulfilled.
However, in contrast to the above views of the Delhi High Court, the Calcutta High
Court in Road Machines (India) Pvt. Ltd. vs The Project and Equipment Corporation of
India Ltd. and Another (AIR 1983 Cal91) held that:
It is not necessary that a bank guarantee should be invoked in an exact and punctilious
manner setting out the entire case of the beneficiary under the guarantee in the same way
as setting out a cause of action in a plaint. A bank guarantee is a commercial document
- CAIIB DISCUSSION
and is neither a statutory notice nor a pleading in a legal proceeding. A bank guarantee
may be invoked in a commercial manner. The invocation would be sufficient and proper
if the bank concerned understands, that the guarantee is being invoked by the
beneficiary, in terms of the guarantee.
As a banker, it would be prudent to verify that the invocation made is proper and in
deciding whether the invocation made is proper the banker has to see among other things
that the following requirements are satisfied:
116
1. The invocation is within validity period.
2. The invocation amount is not more than the guaranteed amount. In case it is
more then only the
maximum amount stipulated in the guarantee need be paid.
3. The authority invoking the guarantee is competent or empowered to invoke the
guarantee. In
guarantees issued to Government departments the authority to invoke is usually
designated by the
post, so as to avoid any later problems by change in the person holding the post. The
banker has to
ensure that the person invoking has the powers to do so.
The Supreme Court in its decision in Hindustan Construction Co. Ltd. vs State of Bihar
(1999) 8 SCC436 has held that where as per the terms of the guarantee the invocation
was to be done by the chief engineer, the invocation by the executive engineer was
wholly wrong and the refusal of the bank to make payment was valid.
ii. No Injunction Prohibiting Payment: Though Courts are reluctant to interfere with the
bank guarantee, there have been instances where Courts have granted injunction
restraining the banks from making payment under a guarantee. In one such case that
came up before the Calcutta High Court injunction was granted. The facts of the case in
Messrs G.S. Atwal Co. Engineers Pvt. Ltd. vs Hindustan Works Construction Limited
(AIR 1989 Cal 184) is as follows:
Under the was

Petitioner termstoof the contract
furnish a bankentered intofor
guarantee between the HWC
mobilisation Ltd. and
advance madetheby
GSA
the Co, the
Respondent to the Petitioner for Rs. 32.50 lakh. The contract did not require the
Petitioner to give any bank guarantee for the due performance of the contract. The
Petitioner requested the bank to issue a guarantee for Rs. 32.50 lakh to cover the
mobilisation advance received by the Petitioner from the Respondent. The bank made
use of its standard format of guarantee and did not delete certain clauses therein because
of which the guarantee issued by it became a mobilisation advance-cum-performance
guarantee. Since the bank and the Respondent, as beneficiaries, were the only parties to
the bank guarantee, the Petitioner never knew of the mistake on the part of the bank. The
Respondent took advantage of the mistake and although the mobilisation advance was
recovered in full, it invoked the bank guarantee for recovery of its claim for damages for
loss suffered, as a result of non-performance of the contract by the Petitioner and
demanded payment from the bank. On the bank showing its willingness to make
payment of the amount guaranteed by it, the Petitioner approached the High Court for an
order restraining the bank from making payment.
The High Court held that: The Respondent was aware of the mistake on the part of the
bank and with ulterior motive took advantage of the mistake by demanding payment in
respect of its claim for damages for non-performance and not in respect of any amount
due for mobilisation advance given to the Petitioner.
The bank has no right to saddle its customer with any additional liability under the
guarantee by issuing the same contrary to the instructions by its customer.
The Respondent has invoked the guarantee for recovery of loss and damages, alleged to
have been suffered due to alleged breach of contract by the Petitioner.
- CAIIB DISCUSSION
Though the general principle of non-interference by the Court in cases of bank guarantee
and letter of credit is for the smooth functioning of international trade and commerce,
this principle would not apply where the bank has acted negligently and issued bank
guarantee contrary to the customer's instructions.
Whether the invocation of the bank guarantee was in terms of the guarantee or not will
depend upon the terms of the guarantee and the letter of invocation. The bank cannot act
arbitrarily or whimsically in deciding whether the invocation was in terms of the
guarantee when in fact it was not.
In the instant case, the bank guarantee" was for mobilisation advance and not for
performance of the contract and the invocation of the bank guarantee was admittedly for
recovery of damages for the
alleged non-performance of the contract. The High Court, therefore, held that there was
special equity in favour of the Petitioner and he can prevent the beneficiary from
enforcing the bank guarantee.
It is, therefore, absolutely necessary for the bank to confirm that no injunction order has
been issued restraining the bank from making payment.
9.7 LET US SUM UP
A bank guarantee is a contract by which the bank guarantees a certain sum to a
person/entity on the customer failing to fulfil any contractual or legal obligation to the
said person/entity. Guarantee issued by banks mainly are financial guarantees,
performance guarantees, deferred payment guarantees and statutory guarantees. Bank
under a contract of guarantee is bound to honour its guarantee and its obligations to pay
is primary and independent of the underlying contract between the customer on whose
behalf the guarantee is given and the beneficiary. This has been settled by the various
decisions of the Courts. The only exception for a bank not to make payment under a
guarantee is when a fraud exists, which must be proved beyond doubt or special equity is
in favour of the debtor.
While issuing a guarantee a bank has to ensure that, the amount guaranteed and the
period of the guarantee is specifically stated in the guarantee. Pursuant to the amendment
to Section
cannot 28 of the to
be restricted Indian Contract
less than Act, the
the period limitation
provided period
under on a contract
the Limitation of As
Act. guarantee
such, if
the guarantee is invoked in time then the beneficiary can sue the bank within thirty years
in case the beneficiary is a Government or municipal body or three years in all other
cases. The bank while making payment under a guarantee has to ensure that the
invocation is proper and that the person invoking the guarantee has the authority to
invoke the guarantee. The bank while issuing a guarantee has to obtain a counter
guarantee from its customer and if necessary, additional security to protect the bank in
case it is required to pay under the guarantee.
9.8 KEYWORDS
Bank guarantee; Beneficiary; Counter guarantee; Debtor; Surety.
1. State briefly what is a bank guarantee?
2. What purpose does a bank guarantee serve?
3. List the various types of bank guarantees and explain in brief their specific
nature.
4. Explain in brief- 'On a bank guarantee the banks duty to pay is primary.'
5. There are two exceptions to the general rule that banks must pay on a
guarantee. What are these
two exceptions? Explain in brief.
6. Choose the right answer from the choices given:
(i) In bank guarantees the bank makes payment on:
(a) being convinced that the beneficiary has incurred loss;
(b) on being sued by the beneficiary;
- CAIIB DISCUSSION
(c) on the guarantee being invoked and after seeking concurrence of the debtor;
(d) merely on demand by the beneficiary.
(ii) In case of bank guarantees on behalf of company that is in liquidation the bank on
invocation of the guarantee by the beneficiary:
(a) must pay the amount to the Liquidator and not the beneficiary;
(b) must deposit the amount in the court to avoid any controversy;
(c) must pay the beneficiary;
(d) need not pay, since the bank guarantee lapses on the company being liquidated.
118
7. State in brief the precautions to be taken while issuing a bank guarantee.
8. While issuing a guarantee the bank omits to mention the amount and the period
of the guarantee.
Can the bank still be held liable? What would be the extent of the liability?
9. What is a validity period and claim period in a bank guarantee?
10. Can the bank in a guarantee issued by it restrict the claim period so as to avoid
its liability?
11. What is a counter guarantee and when is it obtained?
6. (i) d; (ii) c.
LETTERS OF CREDIT
STRUCTURE
10.0 Objectives
10.1 Introduction
10.2 Letters of Credit - General Consideration
10.3 Parties to a Letter of Credit
10.4
10.5 Types of Letters
Documents Under ofaCredit
Letter of Credit
10.6 Uniform Customs and Practice for Documentary Credits - UCPDC 600
10.7 Payment Under Letter of Credit - Banks Obligation Primary
10.8 Let Us Sum Up
10.9 Keywords
120
10.0 OBJECTIVES
• what is a letter of credit and its purpose;
• the parties involved in a letter of credit transaction;
• the various types of letters of credits;
• the various documents involved in a letter of credit transaction;
• the law as laid down in UCP 600.
10.1 INTRODUCTION
The simplest form of payment in a business transaction is payment by cash, and then
comes payment by cheques, drafts, travellers cheques, etc. However, all these modes of
payment require proximity between the buyer and seller and the element of trust between
them. In international trade, the buyer and seller are miles apart, having different legal
systems and each unaware of the other's financial position. In such cases, it would be
preferable that both parties deal through their bankers. This is done when the documents
- CAIIB DISCUSSION
covering the goods traded re-routed through the bankers. However, in this method the
seller should have confidence that the buyer would pay for the goods as and when the
same is due either immediately or after the agreed period of credit. In case the seller is
not fully satisfied about this he may ask for an assurance from a banker that the terms of
trade would be complied with and his interest would be protected. One of the methods of
achieving this assurance more in international trade is by completing the transaction
through the system of a letter of credit. Due of the devices used by the bankers to effect
payment for goods supplied or services provided is called Banker's Commercial Credit
or Letter of Credit (LC for brevity). Though this device for payment is the creation of the
British merchants, it has now become a universally accepted method of payment. As a
banker, you will at some point of time in your career, be required to deal with letters of
credit. As such, it is necessary that you understand the various provisions relating to LC
and the legal aspects involved therein.
In this chapter, unless specifically stated so, the term letters of credit is used
interchangeably as LC or credits and should not be mistaken as a different term.
10.2 LETTERS OF CREDIT - GENERAL CONSIDERATION
An LC can be compared to a guarantee given by a bank on behalf of its customer to the
effect that the bank would make payment to the beneficiary when the beneficiary
presents the documents as is required in the LC. They are not negotiable instruments.
To understand better a LC transaction, let us consider a practical situation.
M/s Bharath & Co. in India want to import certain machinery, which they know is
manufactured by M/s Edward & Co. in England. They enter into a contract for purchase
of the machinery, payments for which are required to be made by a LC. Since neither
party knows the other, they are not sure whether the other will fulfil his part of the
obligation. In such a situation, M/s Bharath & Co. will approach its banker, Bank of
India and make a request by an application for opening a letter of credit (LC) in favour
of M/s Edward & Company. Bank of India, after opening a letter of credit LC in favour
of M/s Edward & Co., informs another bank in England, the UK bank with whom Bank
of India has an arrangement, to forward the letter of credit LC to M/s Edward & Co. The
UK bank (say Barclays Bank) after verifying the authenticity of the LC (letter of credit)
and
that finding it asbeen
the LC has genuineness forwards to
drawn according thethe
same
saletocontract
M/s Edward & Co. After
M/s Edward & Co.verifying
ships the
machinery to M/s Bharath & Co. M/s Edward & Co. now collect the bills of lading
handed over by the shipping Co. and other documents required as per the LC and draws
a bill of
121
exchange (Bills) under the LC and presents it to its bankers, the Barclays Bank, for
negotiating the bill and to obtain the payment. Barclays Bank, on their part, receive the
bill and the documents from M/s Edward & Co. and checks that they are as per the terms
of the LC. On finding them to be in order, Barclays Bank negotiates the bill and makes
payment to M/s Edward & Co. Barclays Bank thereafter sends the bill and documents to
Bank of India. Bank of India on its part verifies the bill and documents and if found in
order sends the bill to M/s Bharath & Co. for payment. M/s Bharath & Co. on receiving
the bills checks the documents or pays the bill. On M/s Bharath & Co. making payment,
Bank of India will release the shipping document so that M/s Bharath & Co. can collect
the goods from the shipping company.
The above illustrates the simplest form of payment under a letter of credit. The terms of
an LC are sometimes complicated and various kinds of LCs have been devised since the
concept of LC was introduced, which requires a banker to be very well versed in this
aspect of financing.
Before we proceed to understand the parties to a letter of credit and the various types of
letters of credit, it would be worthwhile to examine the advantages of a letter of credit
(LC). As regards the Buyer, i.e. M/s Bharath & Co. in the above illustration the major
- CAIIB DISCUSSION
advantages are as follows:

(a) No payment has to be made in advance to the seller.
(b) The buyer can induce the seller to give credit from his supplier, which he may
not be otherwise
willing to give, since there is a guarantee from a banker regarding payment on due date.
(c) In most cases the bills are payable over a period of time (called usance bills)
thereby giving additional
credit to the buyer.
(d) The buyer can, while opening the LC insist that the quality of goods are
certified by an independent
body and such certificate be sent along with the bill for negotiation, thereby assuring
himself that
the goods meet with the required quality as specified. In case the seller does not enclose
such a
document then the banks will not make payment on the Bills. He can also stipulate other
terms and
conditions to protect his interests and which are also acceptable to the seller.
As regards the seller, i.e. M/s Edward & Co. in the illustration the advantages are as
follows:
(a) The seller is assured that he will receive payment on his complying with the
terms of the LC.
(b) On shipment of the goods the seller can draw and negotiate the bills thereby
getting immediate
payment in his country, which payment otherwise would be made only after the goods
are received
by the buyer, which would cause delay in payment.
(c) The seller need not bother himself about the import regulations of the buyer's
country since this is
the responsibility of the buyer.
(d) The seller also need not bother about the fluctuations in currency since this will
be the buyer.

of the responsibility
10.3 PARTIES TO A LETTER OF CREDIT
You have learnt by now that in a letter of credit transaction various parties are involved.
Various terms, have been coined to identify these parties, which you, as a banker, will be
required to know since, in all transactions involving letters of credit, the terminology
used to identify parties will be on these lines. To help us better understand the parties we
shall be making use of the illustration given in Para 10.2.
(i) Applicant-Buyer-Importer-Opener: He is the person who applies to the bank to open a
letter of credit, since he would be either purchasing goods or availing services for which
payment has to be made. In the illustration - M/s Bharath & Co.
(ii) Issuing Bank: The bank which opens the letter of credit LC on the request of the
applicant/ buyer. Also called the opening bank or importers bank. In the illustration -
Bank of India.
122
(iii) Beneficiary-Exporter-Seller: Is the person who is entitled to receive the benefit
under a LC (letter of credit), i.e. the right to receive payment or to draw bills and receive
payment as per the terms of the LC. In the illustration - M/s Edward & Co..
(iv) Advising Bank: The bank in the beneficiary/exporters country through which the
letter of credit is advised to the beneficiary. The advising bank only forwards the LC to
the beneficiary, thereby enabling the beneficiary to rely on its authenticity and
genuineness. The advising bank is also sometimes termed as the Notifying Bank. In the
illustration - The UK Bank.
- CAIIB DISCUSSION
(v) Negotiating Bank: The bank in the beneficiary/exporters country which negotiates
the bills (i.e. makes payment on the bills drawn by the seller and accepts the documents).
If the LC specifies a bank then that bank is the negotiating bank and is also called the
nominated bank or paying bank. If the LC however does not specify a bank, then any
bank can be the negotiating bank, since the issuing banks open invitation contained in
the credit is an offer, which is accepted as soon as the negotiating bank negotiates the
bills and accepts the documents. In the illustration, Barclays Bank would be the
negotiating bank. If Barclays Bank was also specifically mentioned in the credit as the
negotiating bank, then Barclays Bank will also be the nominated Bank.
(vi) Confirming Bank: The advising bank is only required to advise the credit to the
beneficiary. If the seller is not conversant with the issuing bank or not satisfied with his
financial position, he may ask for an additional assurance/guarantee from another bank
located in his country/place and the second guarantee is called confirming the LC. The
seller would look to the confirming bank to pay the amount covered by the bill if drawn
as per terms of the LC. If however in addition to' advising the credit the advising bank
were to confirm it, then the advising bank will also be the confirming bank. In such case,
the confirming bank is deemed to undertake on its part the liabilities of the credit vis-a-
vis the beneficiary or the Negotiating bank.
(vii) Reimbursing Bank: It is the bank, which is appointed by the Issuing bank to make
reimbursement to the negotiating, paying or confirming bank.
10.4 TYPES OF LETTERS OF CREDIT
i. Acceptance Credit: Ordinary letters of credit are usually sight credits, i.e. immediate
payment should be made of the bills drawn by the beneficiary. However, sometimes as
per the terms of the letter of credit (LC) the bills will be payable after an agreed period
of time (such bills being called usance bills). Such an LC under which usance bills can
be drawn is an acceptance credit or time credit. The bills drawn on the various dates, will
be honoured on their maturity. This is one of the methods by which, a buyer can obtain
credit from the seller. The seller can either wait until the date of maturity to receive
money or he can discount the bills and obtain immediate value for the goods supplied.
ii. Irrevocable Credit: An irrevocable credit is a credit, that can neither be amended nor
cancelled withoutgiven
the commitments the consent
in the of the beneficiary.
credit. The issuing/opening
As per the latest uniform customsbank
and is boundfor
practice by
documentary credits 600, all credits are irrevocable.
iii. Confirmed Credit: If a bank advising the credit to the beneficiary adds its own
confirmation to the credit, then the credit would be called a confirmed credit. Only
irrevocable letters of credit can be confirmed, since in a revocable credit the issuing bank
can amend or cancel the credit without notice, and as such if an advising bank were to
confirm it, it would be liable without having any recourse to the 'issuing bank'.
Confirmation here means that the confirming bank would fulfil the obligation under the
letter of credit if the beneficiary complies with the terms contained therein. A confirming
bank accepts this responsibility only on instructions by the issuing bank and as such, if
123
any of the terms in the LC have to be changed then the concurrence of all the parties
would be necessary.
iv. With Recourse and Without Recourse Credits: When a beneficiary draws a bill under
a letter of credit, he is generally liable to any negotiating LC bank if the drawee fails to
make payment under the Negotiable Instruments Act. In other words, his liability is
extinguished only on the drawee making payment. LC calling for these kinds of bills is
with recourse LCs. However, the beneficiary can exclude this liability by adding to the
bill the following words 'without recourse', which means that the right (recourse) against
the drawer under the bill is not available to any endorsee of the bill of exchange. This
defence however is available to the beneficiary only on the bills drawn by him. In case
there is any discrepancy in the documents submitted then the beneficiary cannot avail
- CAIIB DISCUSSION
any protection on a bill with the endorsement 'without recourse'. However, as per the
current guidelines from RBI, banks are not supposed to accept any inland bill drawn
'without recourse' for negotiation.
v. Transferable Credits: As stated earlier, a letter of credit is not a negotiable instrument,
though the bills of exchange drawn under it are negotiable. As such, the rights under an
LC cannot be transferred and is vested in the beneficiary. A transferable credit is one
under which the beneficiary can transfer his rights to third parties (secured
beneficiaries). Unless specifically stated an LC is not transferable.
vi. Back-to-Back Credits: This a credit which is an offshoot of the credit issued to the
beneficiary. In a back-to-back credit, the beneficiary in whose favour an LC is issued
uses the same to open another credit from his (beneficiary's) bank in favour of his
supplier. There are thus three banks involved in a back-to-back credit. First, the bank
issuing the original credit to the beneficiary, the second, the advising bank through
which the credit has been advised to the beneficiary and the third the bank, which issues
an ancillary credit against the security of the original credit, vii. Anticipatory Letter of
Credit:
(i) Red Clause letter of credit: In a usual LC transaction, the beneficiary will be entitled
to receive payment only on his handing over the documents and the bills drawn under
the LC to the negotiating bank. However, in certain credits the beneficiary will be
entitled to get an a dvance of the price. These credits contain a 'red clause' (because the
clause is printed in red) which authorises an intermediary bank to make an advance to
the beneficiary before shipment. Red Clause LCs are however dying out.
(ii) Green Clause letter of credits: This is a refinement of the 'Red Clause'. This type of
LC not only permits pre shipment advance but also permits advances to the exporter to
cover storage at the port of shipment. The red clause and green clause credit are called
anticipatory credits since payment of an advance is provided for in anticipation of the
seller making shipment.
ix. Revolving Letter of Credit: In a regular LC transaction, once the bills are negotiated
the entire transaction comes to an end. If fresh shipment is to be made, another LC will
have to be drawn. This procedure becomes time consuming especially when there is
regular
letter oftrade between
credit. the same
In this type parties.
of credit In such
though the cases,
amountit is
is fixed,
preferable
it cantobe
open a revolving
renewed as
soon as the earlier bills have been paid.
10.5 DOCUMENTS UNDER A LETTER OF CREDIT
One of the two basic doctrines that underlie the letter of credit transaction is the principle
of strict compliance. The other being the independent nature of the letter of credit
transaction.
As per the strict compliance doctrine all the parties to a letter of credit transaction should
strictly observe the terms and conditions under which the credit is issued and on failure
to do so, the defaulting party would be either liable to the others or have no cause of
action to recover any payment if made by the defaulting party.
124
Within the sweep of the strict compliance doctrine comes the duty of a banker to "ensure
that the documents tendered are strictly those specified in the letter of credit. In this
regard it would be worth noting the observation given more than half a century back by
LORD SUMNER in Equitable Trust Co. vs Dawson Partners (27 Lloyds Law Reports
49).
There is no room for documents which are almost the same or which will do just as well.
In this case, the credit required inter alia a certificate testifying to the quality of the
purchase that was to be signed by (experts). However, due to a decoding error, the
message received by the advising bank required only a certificate signed by 'an expert'.
The beneficiary therefore, while presenting the documents submitted a certificate signed
by a single expert, which was honoured by the advising bank and accepted by the issuing
- CAIIB DISCUSSION
bank. However, since the goods were defective, the applicant refused to reimburse the
issuing bank, which was upheld by the Courts.
The issuing bank owes a duty to its customer to ensure that the documents tendered by
the beneficiary under the credit comply with the instructions given by its customer. Any
default, on the part of issuing bank would forbid the bank from claiming reimbursement
from its customer with the added disadvantage that it would not be entitled to claim any
remuneration for the transaction. The matter of strict compliance as far as a bank is
concerned has been emphasised by Courts of Law all over the world. A bank is not
compelled to honour the credit unless the beneficiary pursues and conforms in every
material particular to the authority conferred therein. Due to the prime importance given
to documents under a letter of credit transaction, it is necessary for a banker to
understand the documents that accompany a letter of credit.
i. Bill of Exchange: This is a financial document. Payment is made on this document.
This for brevity sake is called 'bill' and is sometimes referred to as 'draft' (to be
distinguished from a 'demand draft'). In a letter of credit transaction the right to draw a
bill is conferred only on the beneficiary. The bill amount should be within the limit fixed
in the letter of credit. The tenor, endorsement and the drawee should be the same as
given in the letter of credit. This document should be distinguished from 'bills of lading',
which is a transport document and is discussed later on in this chapter. Bills or drafts can
be payable on presentation (sight bills) or on a certain date (usance bill).
ii. Invoice: This is the basic commercial document. This document gives details of the
sale. It should be made in the name of the opener/importer unless required otherwise in
the letter of credit. All the details mentioned in the invoice must tally with those
mentioned in the letter of credit, failing which it may amount to a discrepancy, making
the documents liable for rejection. Where the quantities are specified in a letter of credit,
the form in which they are specified should be adhered to. For example, if the letter of
credit calls for 100 kg of tea, the invoice should be made accordingly and converting the
measure to equivalent pounds or quintals would make it liable to be rejected. A further
problem posed is whether it would be in order, whereas per the credit the value of the
shipment is Rs. 15 lakh and the goods shipped is worth Rs. 20 lakh, with a request that
Rs. 15 lakh
comply withbethe
paid andterms
credit excessand
Rs.the
5 lakh collected to be repaid
opener/buyer/importer later.
would be This would
legally not to
entitled
reject the documents.
iii. Transport Documents: The mode of despatch of goods or the transporting of goods
would depend on the terms of contract between the buyer and the seller and the same is
incorporated in the letter of credit. The two main modes of transport of goods are either
by sea or by air. In case the goods are shipped, the document evidencing the shipment of
the goods is called the 'Bill of Lading'. In case the goods are transported by air, the
documents evidencing receipt of goods would be the 'Airway Bill' in case the goods are
directly handed over to an Airline or its agent. In case goods are transported through
postal system or courier service, the document evidencing receipt of goods would be
either the 'Post Parcel Receipt' or the 'Courier Receipts'.
125
iv. Bills of Lading: Bills of Lading are of two types - one, the traditional ship bill of
lading and the other, the 'Combined Transport Bill': a creation of modern age
containerisation of shipments which permits more than one means of carriage and is also
known as 'Multimodal Transport'. Bill of lading is a document to title to goods, i.e. they
are representatives of the goods and holder of the same is entitled to get possession of
the goods. A bill of lading, to a certain extent is negotiable inasmuch as a bona fide
transfer of the same by endorsement entitles the transferee the right to the goods. A bill
of lading is issued in sets of 2, 3, or 4 and all are termed as originals. A banker should
see that all the originals are received. Unless otherwise specified in the letter of credit, a
bill of lading must be a 'shipped' bill of lading and a 'received for shipment' or
- CAIIB DISCUSSION
'transportation' bill of lading or a 'charter party' bill of lading is not acceptable. This is
because the shipped bill indicates that the goods have been taken on board of a specified
ship and the journey has commenced while in the case of received for shipment bill
though the goods have been delivered to the transporter the journey is yet to commence.
v. Airway Bill: This is a document, which evidences that the goods have been received
by an airline company or its agent. Unlike a bill of lading an airway bill does not carry
with it the right to the goods, i.e., it is not a document of title to the goods. If however
the letter of credit terms permit acceptance of an airway bill then the banker is within his
rights to accept it.
vi. Post Parcel Receipt and Courier Receipts: When the goods to be sent are small in
quantity, then they can be sent through post or courier. The document issued by the
postal department or the courier are similar in nature to the airway bill. They are not title
to goods and only evidence that the goods have been entrusted for transportation to
either the postal department or the courier company and most often than not the goods
are addressed directly to the buyer.
vii. Insurance Documents: The goods shipped, if required to be insured under the terms
of the letter of credit should be so insured and the insurance document as required in the
letter of credit should be enclosed with the other documents. Either an insurance
company or underwriter or their agents should sign it. The type of insurance cover
should be the same as specified in the credit. The requirements of the buyer regarding
the amount of the policy, the currency, the risk to be covered and the place of payment in
case of claim are to be strictly complied with.
viii. Other documents: Over and above, the major documents discussed above which are
required in all letters of credit transaction, the letter of credit may also call for certain
other documents among which include certificate of origin, certificate of weight or
quality or analysis, Health authorities certificate, etc. Such documents/enclosures are
mandatory with the other documents, failing which payment can be refused. In
interpreting these documents too, the Courts have applied the principle of strict
interpretation.
10.6 UNIFORM CUSTOMS AND PRACTICE FOR DOCUMENTARY CREDITS -
UCPDC
The ICC 600
Banking Commission, approved the UCP 600, ICC's new rules on documentary
credits, on 25 October 2006. UCP 600, which came into effect on 1 July 2007, contains
significant changes, including:
• A reduction in the number of articles from 49 of UCP 500 to 39.
• New articles on 'Definitions' and 'Interpretations' to provide more clarity and
precision in the
rules.
• The replacement of the phrase 'reasonable time' for acceptance or refusal of
documents by a
definite period of five banking days.
• New provisions which allow for the discounting of deferred payment credits.
• A definitive description of negotiation as 'purchase' of drafts of documents.
126
The new UCP 600 also contains within the text the 12 Articles of the eUCP, ICC's
supplement to the UCP governing presentation of documents in electronic or part-
electronic form.
10.7 PAYMENT UNDER LETTER OF CREDIT - BANKS OBLIGATION
PRIMARY
We had earlier while studying the various aspects pertaining to bank guarantees, noted
that under a bank guarantee the liability of the bank to make payment is primary and
unless a case of fraud is made out or there are special equities in favour of the debtor,
Courts would not adjunct a bank from making payment under a guarantee. The same
- CAIIB DISCUSSION
analogy applies to payment by banks under a letter of credit. The Supreme Court had
occasion to consider this aspect in various cases and in all these cases, the Court has held
that the obligation of a bank to pay under a letter of credit is primary, irrespective of the
underlying contract. We shall now refer to some of the decisions of Supreme Court,
which have been the touch stone for later judgements of the Supreme Court and also the
High Courts.
I. Tarapore and Company, Madras vs Messrs v/o Taractor.expert, Moscow, Another
(AIR 1970 Supreme Court 891)
(i) Facts of the case: The Indian firm opened in favour of the Russian firm a confirmed,
irrevocable and divisible letter of credit with the Bank of India for the entire value of the
machinery. Under the letter of credit, the bank was required to pay to the Russian firm
twenty-five per cent on presentation of documents specified therein and the balance of
seventy-five per cent on the expiry of one year from the date of first payment. The
Russian firm supplied, and the Indian firm took possession of, the entire machinery to be
supplied under the contract. After using the machinery for some time, the Indian firm
complained that the performance of the machinery was not satisfactory and was causing
considerable loss. With a view to preventing the Russian firm from realising the balance
of the amount payable under the letter of credit, the Indian firm filed a suit against the
Russian firm, but the same was withdrawn on an agreement having been arrived at
between the parties. In pursuance of the said agreement, it was agreed that the Russian
firm would instruct its bankers not to make a demand for further payment against the
letter of credit for a period of six months from the due dates of the drafts and that, during
this period the parties would do their best to reach an amicable settlement. It would
appear that the parties did not amicably settle the dispute and when the extended time
was about to come to a close, the Indian firm instituted another suit praying that the
Russian firm and the Bank of India be restrained from taking any further steps in
pursuance of the letter of credit opened by the Indian firm in favour of the Russian firm.
(ii) Decision: Rejecting the contention of the Indian firm that the Russian firm should not
be allowed to take away the money secured by the letter of credit, since the Russian firm
had no assets in India and the Indian firm might not be able to enforce its claims under
any decree that might

'An irrevocable becredit
letter of passed in aitsdefinite
has favour,implication.
the Supreme It Court observed: of great
is a mechanism
importance in international trade. Any interference with that mechanism is bound to
have serious repercussions on the international trade of this country. Except, under
exceptional circumstances, the Court should not interfere with that mechanism.'
The Supreme Court considered some of the important decisions of the Courts in England
and America and observed:
'A letter of credit is independent of an unqualified contract of sale or underlying
transaction. The autonomy of an irrevocable letter of credit is entitled to protection. As a
rule, Courts refrain from interfering with that autonomy.'
127
II. In United Commercial Bank vs Bank of India (AIR 1981 SC 1426)
(i) Facts of the case: The question, considered by the Supreme Court in this appeal was
whether the Court should grant injunction at the instance of the beneficiary of an
irrevocable letter of credit, restraining the issuing bank from recalling the amount paid
under reserve from the negotiating bank, acting on behalf of the beneficiary, against a
document of guarantee/indemnity at the instance of the beneficiary.
Facts were rather complicated, but briefly, the relevant facts were that G agreed to
supply to B 1000 metric tonnes of 'Sizola Brand Pure Mustard Oil'. A letter of credit was
opened in favour of G by the appellant bank. The goods were supplied in two lots. When
the documents were presented by G for payment of the amount against first lot, the
appellant bank refused to make payment except under reserve on the ground of
discrepancies in the documents presented to it. The main discrepancy was that the goods
- CAIIB DISCUSSION
were described in the railway receipts as 'Sizola Brand Pure Mustard Oil "Unrefined"'.
Bank of India, under instructions of G, accepted payment under reserve. Regarding the
second lot, also payment was made and accepted under guarantee in favour of United
Commercial Bank, whereby the Bank of India unconditionally agreed to hold the United
Commercial Bank harmless and indemnified for all consequences of non-acceptance
and/or non-payment of bills due to the discrepancies in the documents. The goods
despatched, were not accepted by B. The United Commercial Bank, therefore, made a
demand upon the Bank of India, to refund the amounts paid under reserve. Thereupon G
approached the High Court for interim injunction restraining Bank of India from making
payment. The single Judge of the High Court made absolute the temporary injunction
granted earlier, until the disposal of the suit on the ground that the United Commercial
Bank, in terms of the credit, could not unilaterally impose the condition of payment
'under reserve' or refuse to pay a gainst the documents tendered by G merely because of
alleged discrepancies.
The matter on further appeals finally reached the Supreme Court. After considering the
case law on the subject, the Supreme Court allowed the appeal for the following reasons:
(a) A letter of credit constitutes the sole contract with the banker and the bank
issuing the letter of
credit has no concern with any question that may arise between the seller and the
purchaser of
goods. The judicial authority lays down the necessity of strict compliance both by the
seller with
the letter of credit and by the banker with his customer's instructions.
(b) As pointed out by Halsbury's Laws of England, the documents must be those
called for, and not
documents which are almost the same or which will do just as well.
(c) The banker is not called upon to know or interpret trade customs and terms.
(d) In Paget's Law of Banking, 8th Edn. p. 648, it has been stated thus - Unless
documents tendered
under a credit are in accordance with those for which the credit calls and which are
embodied
the promiseinof the issuing banker, the beneficiary cannot claim against him and it is the
banker's
duty to refuse payment.
(e) The well established rule is that a bank issuing or confirming a letter of credit is
not concerned with
the underlying contract between the buyer and seller. Duties of a bank under a letter of
credit are
created by the documents itself, but in any case, it has the power and is subject to the
limitations
which are given or imposed by it, in absence of the appropriate provisions in the letter of
credit.
(f) The Courts usually refrain from granting injunction to restrain the performance
of a contractual
obligation arising out of a letter of credit or a bank guarantee between one bank and
another. The
whole banking system would fail if the banker making payment under reserve were
restrained by
injunction from recalling the amount.
(g) Buyer-customer cannot instruct the banker not to pay in view of banker's
obligations to pay under
irrevocable letter of credit. Confirmed letter of credit imposes an absolute obligation to
the banker
to pay.
- CAIIB DISCUSSION
128
(h) A bank giving a performance guarantee must honour that guarantee according to its
terms.
(i) It is in exceptional cases that the Court would interfere with the machinery of
irrevocable obligations
assumed by the banks, such as, clear cases of fraud of which the banks have notice, (j)
The payments were made 'under reserve' and against the indemnity or guarantee of Bank
of India.
Therefore, when the bills of exchange were dishonoured, on being presented, the amount
became
immediately, payable on demand.
10.8 LET US SUM UP
A letter of credit (LC) otherwise called a banker's commercial credit is a device used for
effecting payment by bankers for goods supplied or services provided between two
parties and is mostly used in foreign trade. It is similar to a bank guarantee, inasmuch as
the bank, issuing the LC, guarantees payment to the seller, in case the terms as required
under the LC are complied with. There are various parties to a letter of credit transaction.
The opener of the letter of credit otherwise called the Buyer or Importer. The bank,
which issues the LC called the Issuing Bank or the Opening Bank or Importer's Bank.
The person in whose favour the LC is issued - the Beneficiary, also called the Exporter
or Seller. The Advising Bank that advises the LC to the beneficiary, also called the
Notifying Bank. The Negotiating Bank,.i.e. the bank that makes payment on the bills
drawn by the seller also called the Nominated Bank or Paying Bank. The Confirming
Bank, which is the advising bank when it also confirms the credit. The Reimbursing
Bank, which reimburses, the negotiating/paying/confirming bank. Letter of credit are
classified based on the various terms and conditions they contain. Main among them, are
the following Acceptance Credit, where the payment is made after a certain period;
Revocable Credit, where the credit terms can be unilaterally altered or cancelled by the
issuing bank in contrast to an Irrevocable Credit where any alteration of terms or
cancellation
advising bank requires
adds itsthe concurrence
own of beneficiary;
confirmation to the creditConfirmed Credit,
while advising thewhere the
beneficiary;
With Recourse Credits - where the beneficiary is liable on a bill drawn by him under an
LC in contrast to a Without Recourse, where the beneficiary is not liable; Transferable
Credits, where rights under an LC can be transferred to third parties; Back-to-Back
Credits, where on the basis of LC in favour of the beneficiary, his bank opens another
LC in favour of the beneficiary's supplier. Red Clause Credits, where the beneficiary is
entitled to advance payment before production of documents; Green Clause Credits
wherein addition to advance, the beneficiary is entitled to payment of
storage/warehousing charges; Revolving Credits, where the amount is fixed but can be
utilised repeatedly as and when the earlier bills drawn are paid. There are two basic
principles that underline every LC transaction the first one being that in every
transaction strict compliance of terms is required and the other being the independent
nature of LC transaction. As such, it is necessary to ensure strict compliance of the
documents required under an LC. The documents include bill of exchange (drafts, bills),
invoice, transport documents, insurance documents are primary for most transactions.
Over and above these documents the credit terms, which may require various certificates
and/or other documents. The rights and liabilities of all parties to an LC have been laid
down in the UCP 600 a document published by the International Chamber of Commerce.
The UCP 600 though not enforceable as law, is incorporated as a part of the credit terms
and as such is enforceable as a contractual term.
A letter of credit being similar to a bank guarantee, the liability to make payment by a
bank under an LC is primary and the Supreme Court has endorsed this view in various
decisions.
- CAIIB DISCUSSION
10.9 KEYWORDS
Acceptance Credit; Advising Bank; Airway Bill; Applicant; Back-to-Back Credit;
Bankers Commercial
129
Credit; Beneficiary; Bill of Exchange; Bill of Lading; Confirmed Credit; Confirming

Bank; Green Clause Credit; Invoice; Issuing Bank; Negotiating Bank; Red Clause
Credit; Reimbursing Bank; Revocable Credit; Revolving Credit; Transferable Credit;
UCP 600; With Recourse Credit; Without Recourse Credit;
(i) A letter of credit is a form of guarantee given by banks on behalf of its customer. (ii)
Letters of credit are bills of exchange drawn by a seller or a buyer, (iii) LCs are
negotiable instruments.
2. Choose the right answer.
(a) The letter of credit is opened on the request of
(ii) Applicant (iv) Confirming bank
(i) Issuing bank (iii) Beneficiary
(b) The LC issuing bank is also called
(i) the importers bank or the opening bank
(ii) the advising bank or the confirming bank (iii) the negotiating bank or the nominated
bank (iv) the reimbursement bank
(c) The right to receive payment under a letter of credit or the right to draw bills on
a letter of
credit is vested in
(i) the opener of the LC (ii) the issuing bank only
(iii) the seller only (iv) all the three parties
(d) The advising bank's responsibility is
(i) to inform the issuing bank as to whom to issue the letter of credit (ii) to advise the
buyer theof
the letter despatch of documents
credit (iv) none of theby the seller (iii) to inform the beneficiary/seller about
above
(e) The advising bank is also called the
(i) Confirming bank (ii) Notifying bank
(iii) Reimbursing bank (iv) None of the above
(f) Negotiating bank is the bank which
(i) negotiates the preliminary contract of sale between the buyer and the seller (ii) makes
payment of the bills drawn by the seller and accepts the documents
(iii) guarantees payment by the issuing bank
(iv) none of the above
(g) When the LC specifies the bank that is to negotiate the bills drawn under the
LC then the
bank is also called
(i) Confirming bank (ii) Reimbursing bank
(iii) Nominated bank (iv) None of the above
(h) The confirming bank is
(i) the issuing bank when it confirms the issue of the LC (ii) the negotiating bank when it
confirms the negotiation of the bills (iii) the advising bank when it confirms the LC (iv)
none of the above
(i) When the confirming bank confirm the credit it (i) does not take any liability
130
(ii) undertakes on its part the liability under the LC
(iii) undertakes to make timely delivery of the documents and bills to the buyer or
- CAIIB DISCUSSION
his bank
(j) Reimbursing bank is the bank
(i) that reimburses the seller
(ii) that reimburses the negotiating/paying or confirmingbank
(iii) that reimburse the buyer on the goods being found defective
3. Fill in the blanks.
(a) Ordinary letters of credit are usually , i.e. the bills drawn hereunder
have to be
paid immediately.
(b) Letter of credit under which usance bills can be drawn is called an .
(c) In a revocable LC the credit can be amended or cancelled by the .
(d) Only letters of credit can be confirmed.
(e) Credit in which the beneficiary is not liable for the bills drawn thereunder is

credit.
(f) A back-to-back credit would involve at least bank, viz., the bank, the

bank and the bank.
(a) All parties to a letter of credit transaction need to comply with the terms only as
far as
practical and not strictly.
(b) In case the documents submitted by seller do not comply with the terms of letter
of credit
then the same can be accepted and sent for confirmation of buyer.
(c) A bill of exchange is a document to title to goods.
(d) A bill of exchange is also called a 'bill' or a 'draft'.
(e) Invoice in a letter of credit transaction is a document similar to a quotation
based on which
the buyer places his order.
(f) A bill of lading on a bona fide transfer confers on the transferee a right to the
goods.
(g) An airway bill is also a document evidencing title to goods.
1. (i) True; (ii) False; (iii) False
2. (a) ii; (b) i; (c) iii; (d) iii; (e) ii; (f) ii; (g) iii; (h) iii; (i)ii;j)ii
3. (a) Sight credits; (b) Acceptance credits; (c) Issuing bank; (d) Irrevocable; (e)
without recourse;
(f) Three; issuing, advising, third
4. (a) False; (b) False; (c) False; (d) True; (e) False; (f) True; (g) False
DEFERRED PAYMENT GUARANTEE
STRUCTURE
11.0 Objectives
11.1 Introduction
11.2 Purpose of Deferred Payment Guarantee
11.3 Method of Payment
11.4 Let Us Sum Up
11.5 Keywords
- CAIIB DISCUSSION
132
11.0 OBJECTIVES
• a deferred payment guarantee,
• purpose of a deferred payment guarantee,
• various methods of payment under a deferred payment guarantee.
11.1 INTRODUCTION
Though we had touched this type of guarantee while studying bank guarantees, we shall
deal with it here in more detail, since this type of a guarantee is regularly issued by
banks. 'Deferred Payment Guarantee' as the name itself suggests, is a guarantee that
indicates that deferred (postponed) payments. Suppose a bank's customer were to import
capital goods on a deferred payment credit where the price is to be paid in instalments
spread over a five year period, the exporter will have to wait for each instalment to
mature until the whole amount is paid. In the meantime, the chances of the importer
going bankrupt or failing to pay may arise. To avoid such a situation the exporter can
request the importer to obtain a guarantee that the payment in instalments will be made.
The importer would therefore, approach his banker to guarantee the payments in
instalments. This guarantee of the bank, assuring the exporter of the timely payment of
the instalments, is in short, called 'Deferred Payment Guarantee' in brevity referred to as
DPG.
11.2 PURPOSE OF DEFERRED PAYMENT GUARANTEE
When import or export of raw materials or consumer goods are made the payment is
done either immediately or within 360 days. This period is called short term. However,
in the case of capital goods the amount involved being quite substantial, short-term
credit would not be of much help to the buyer, unless he has made arrangements to get a
term loan. Added to this, the requirement of substantial amount of foreign exchange,
may place the buyer at a great disadvantage. To overcome this payment problem, since
the fifties the concept of deferred payment was introduced in India. As stated earlier, in a
deferred payment
payment arrangement,
of the goods theinstead
at one time, buyer/importer
the price is
ofnot
therequired
goods isto make
paid the entire
in instalments
over a period of time as per terms mutually agreed to with the seller.
In a deferred payment guarantee, a third party, mostly banks and financial institutions,
guarantee the payment of the instalments. This guarantee ensures timely payment of the
instalments to the seller/ exporter, failing which, the guarantee can be invoked and
payment received. To understand better the deferred payment guarantee, it is necessary
to understand how a payment is made in a deferred payment contract and how the same
is guaranteed by a bank.
11.3 METHOD OF PAYMENT
In a contract for import of goods on deferred payment terms, the importer is required to
make payments in instalments over a period of time which may range from one to seven
years, in a normal deferred payment contract. The payment, is usually done on the
following terms:
1. Advance payment of ten per cent to fifteen per cent of the price of the goods is made
by the buyer. 3. Another ten per cent to fifteen per cent on receipt of documents under
letter of credit. 3. The balance amount, is paid in instalments spread over a period of
one to seven years, which is secured by a 'Deferred Payment Guarantee'.
In a deferred payment guarantee, which as stated earlier, issued by banks and financial
institutions,
iED PAYMENT GUA
133
- CAIIB DISCUSSION
what is guaranteed, is the timely payment of instalments and interest if provided. This is
done by issuing a deferred payment guarantee in which the following terms are
mandatory:
1. the supply of goods by the seller to the buyer and the seller agreeing to
postpone the payment of the
price, this being the consideration of the guarantee;
2. the payment schedule of both the instalment and the interest;
3. the unconditional and irrevocable assurance of the bank that it would make
payments on the
invocation of the guarantee.
As regards the supply of goods by the seller, it is to be remembered, that banks do not
take the respon¬sibility to ensure that the goods shipped are what is required by the
buyer/importer. Since the guarantee, is mostly given prior to shipment of the goods, if
the documents are, as required under the letter of credit, and are valid, then the guarantee
of the bank subsists and the buyer cannot after receipt of the goods, request the bank to
stop payment on a deferred payment guarantee on the grounds of defective goods.
As regards the payment schedule, it is to be noted that the payment schedule is usually
incorporated in the main contract between the buyer/importer and the seller/exporter and
the bank guarantees the payment as stipulated in the schedule. Some banks as a matter of
abundant caution or to have better clarity of the payment schedule incorporate the same
in the guarantee issued by them, though it is, for all purpose a verbatim reproduction of
the payment schedule from the main contract. In certain cases the seller/exporter would
draw bills on the buyer/importer for the amounts of the deferred instalments including
interest, which are usance bills (being payable on a particular date and not immediately)
and payment of these bills are guaranteed by the bank. The advantage of this method is
that the seller/ exporter can discount these bills with his banker and get immediate
finance.
In a deferred payment guarantee, like all other bank guarantees, the banks undertake to
make payment without any demur or protest, since as per the guarantee, the bank has
given an unconditional
assurance and irrevocable
that the seller/exporter assurance
has sold to the
the goods. It isseller/exporter. It is on
therefore, of prime such
importance
that the bank honours its commitment. We have studied earlier while dealing with the
bank guarantees, that the bank's liability in a bank guarantee is primary and independent
of the underlying contract between the buyer/importer and the seller/exporter. These
principles apply in toto to a DPG also.
11.4 LET US SUM UP
A deferred payment guarantee (DPG) is an unconditional and irrevocable guarantee
given by a bank to a seller/exporter that on his supplying goods to the buyer/importer
(who is the bank's customer) on instalment basis the bank would ensure payment on the
due dates. DPGs are usually insisted upon, when capital goods are imported and the
seller/exporter requires an additional assurance that the instalment payment allowed by
him to the buyer/importer is met. In a DPG the bank guarantees either the payment of the
instalments and the interest on the due dates or the payment of the bills drawn on various
dates by the seller/exporter. A DPG being a guarantee given by a bank, its commitment
to honour the same is absolute unless there exists a case of fraud.
11.5 KEYWORDS
Deferred Payment; Deferred Payment Guarantee.
1. Say whether true or false.
(i) In a deferred payment guarantee, the guarantee is to ensure delivery of eoods.
134
(ii) A deferred payment guarantee is mostly based on a primary contract between the
- CAIIB DISCUSSION
buyer and
the seller, (iii) A deferred payment guarantee differs from other kinds of guarantee
issued by banks as
regards payment liability of the bank on invocation, (iv) In a deferred payment guarantee
the banks liability comes into existence only if all the
instalments are not paid and not on the non-payment of any one instalment by the
customer.
11.7 ANSWERS TO CHECK YOUR PROGRESS
1. (i) False; (ii) True; (iii) False; (iv) False.
er and nks as
ill the tomer.
LAWS RELATING TO BILL FINANCE
STRUCTURE
12.0 Objectives
12.1 Introduction
12.2 Class of Bills and Law Governing Bills
12.3 Classification of Bills
12.4 Various Categories of Bill Finance
12.5 Bill Finance and Legal Position of a Banker
12.6 Let Us Sum Up
136
BEGUL/
12.0 OBJECTIVES
• basic law relating to bill finance;
• legal position of banker in case of bill finance.
12.1 INTRODUCTION
Bill finance is one of the modes of lending by a banker. As compared to other modes of
financing, Bill finance offers a banker an easy mode of lending. From the banker's point
of view, bill finance has many advantages. Bill finance involves discounting or purchase
of commercial bills arising out of sale of goods. Bill finance, as compared to cash credit
and overdraft, has the following advantages:
(a) The underlying transactions are easily identifiable
(b) There is definite date of repayment
(c) The bill will carry more than one signature if it is on usance basis
(d) It represents an easily transferable asset and in case of need the same can be
rediscounted to
improve the liquidity of the bank.
12.2 CLASS OF BILLS AND LAW GOVERNING BILLS
(a) Bills Discounted by banks belong to one of the following categories
(i) Clean bills (ii) Documentary bills
(iii) Bills drawn under credit
(b) Laws Governing Bills: The law on bills deals with the liabilities and rights of
parties to a bill is
governed by the Negotiable Instruments Act, 1881.
- CAIIB DISCUSSION
(i) What is a BUI? The term 'Bill' is the short form of 'Bill of Exchange'. Section 5 of
Negotiable Instruments Act, 1881 defines bill of exchange as 'instruments in writing
containing an unconditional order signed by maker, directing a certain person to pay
certain sum of money only, to or to the order of a certain person or to the bearer of the
instrument.'
(ii) 'Drawer', 'Drawee', 'Payee': Section 7 of the Act provides that amaker of 'Bill of
Exchange' is called 'Drawer' and the person who is directed to pay is called 'Drawee' and
the person entitled to receive payment of amount represented by 'Bill' is called 'Payee',
(iii) Relationship of Parties to a Bill: 'Drawer' of bill is a creditor/seller and the 'Drawee'
of a bill is the debtor/buyer. If the bill is assigned to third parties, then such assignees
will become creditors and drawer would be liable for such assignees in case of default by
drawee.
(c) A Glimpse of some important provisions of Negotiable Instruments Act relating
to Bills: It
will have to be noted that a 'Bill' is a negotiable instrument. Any person to whom the bill
is transferred in accordance with the provisions of the Act, would become entitled to
receive the amounts represented by the bill. We shall now examine certain important
provisions of the Act.
Section 8 'Holder': Section 8 of the Negotiable Instruments Act defines the word
'Holder'. A Holder of bill of exchange means a person entitled in his own name to
possess the bill and recover the amount represented by bill.
Section 9 'Holder in Due Course': 'Holder in due course' means any person who for
consideration became the possessor of the bill (that is a person to whom the bill is
transferred).
Section 10 'Payment in Due Course': 'Payment in due course' means payment in
accordance with
137
the apparent tenor of bill of exchange to the holder or holder in due course in good faith
and without negligence.
Section
to entitle14 'Negotiation':
him to claim theWhen a bill
amount is transferred
represented forthen
by bill, considerations to any
such transfer person so as
is called
'Negotiation'.
Section 15 'Endorsement': If the holder of instrument signs the bill of exchange for the
purpose of transferring it, such signing is called 'Endorsement'.
Section 30 'Liability of Drawer': The drawer of a bill of exchange or cheque is bound in
the case of dishonour (failure to pay) by the drawee or acceptor thereof, to compensate
the holder, provided due notice of dishonour has been given to, or received by, the
drawer.
Section 32 'Liability of Acceptor/Drawee of Bill': An acceptor of bill of exchange is
bound to pay the amount thereof at maturity according to apparent tenor of the
acceptance.
Section 35 'Liability of Endorser': In the absence of contract to the contrary, whoever
endorses and delivers a negotiable instrument is bound thereby to every subsequent
holder in the case of dishonour unless his liability is excluded.
Section 79 'Interest rate Specified': When interest at a specified rate is expressly made
payable on a bill of exchange, then interest shall be calculated at such rates specified and
payable.
Section 80 'Interest when no rate is specified': When no rate of interest is specified in the
instrument, interest due thereon shall be calculated at the rate of eighteen per cent p.a.
12.3 CLASSIFICATION OF BILLS
'Bills' used under bill finance can be classified depending upon the place where drawn,
period and their nature as under:
- CAIIB DISCUSSION
Place
Inland bills
Period
3. Demand bills
4. Usance bills
Nature
1.
5. Clean bills
2. Foreign bills 4. Usance bills 6. Documentary bills
1. Inland Bills: Bills drawn or made in India and made payable in or drawn upon
any person resident
in India are inland bills. The necessary requisites of inland bills are:
(a) it must be drawn and made payable in India; (or)
(b) it must be drawn in India upon some person resident in India, though it may be
made
payable in a foreign country.
Inland instruments are defined in Section 11 of Negotiable Instruments Act, as under -
Inland Instrument:
"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."
2. Foreign Bills: As per Section 12 of the Negotiable Instruments Act, Foreign
Bills are:
(a) Bills, drawn outside India and made payable in or drawn upon any person,
resident in any
country outside India;
(b) Bills drawn outside India and made payable in or drawn upon any person,
resident in India.
3.
Bill': It isDemand Bills: Section 19 of the Negotiable Instruments Act, defines 'Demand
an instrument
payable on demand and no time for payment is specified therein. 'Demand Bill' is
otherwise called
'sight bill'. In these bills, the payee is entitled to the value of the bill on demand and on
presentation.
4. Usance Bills: A usance bill is a bill payable otherwise than on demand. It
specifies nnrmaiiv <. *;~~
138
li
for payment of the value it represents. 'Usance Bills' are otherwise called 'Bills payable
after sight'. In these kinds of bills, the drawer draws a bill of exchange and specifies a
time within which the payment shall be made and presents the same to drawee for
acceptance. Once the drawee accepts the bill, the drawer at the time or date specified on
bill for payment can present the same to drawee and demand payment. The date
specified for payment is otherwise called 'maturity/due date'.
5. Clean Bills: A clean bill is a bill of exchange drawn as per the requirements of
the Negotiable
Instruments Act and is not supported by documents of title to goods. Clean bills are
drawn normally
to effect discharge of a debt or claim. Clean bills also arise when the goods covered by
- CAIIB DISCUSSION
the bill are

directly sent to the buyer due to mutual consent e.g. local bills and supply bills.
6. Documentary Bills: A bill of exchange accompanying documents of title to
goods, is called
'Documentary Bill'. These bills, are drawn to claim price of goods supplied.
(i) Bills drawn with an instruction to deliver against payment: (or) D.P. Bills: In a
transaction for supply of goods, a seller draws a bill on the buyer and sends the same to
his banker along with document of title to goods like bill of lading, or railway receipt or
lorry receipt. The seller instructs the banker to deliver the bill and documents of title to
goods only when the buyer pays the price of goods. These types of bills are D.P. bills in
other words 'Delivery against Payment Bills'.
(ii) Bills drawn with instruction to deliver against acceptance or DA. Bills: An usance
bill supported by documents of title to goods bearing an instruction that the documents
can be delivered, if the buyer accepts the bill of exchange drawn on him. These are
called D.A. Bills or 'Delivery against Acceptance Bills'.
Besides the above, when the government department is supplied goods or raw materials
a bill is drawn on them for the price of goods supplied. These are called supply bills.
They do not squarely fall within the ambit of Negotiable Instruments Act. However,
principle underlying to bills is also applied to 'Supply Bills'.
12.4 VARIOUS TYPES OF BILL FINANCE
Basically, a banker offers following types of bill finance.
1. Bill Purchase (B.P.) 2. Bill Discount (B.D.)
3. Advance against Bills for Collection (A.B.C.)
1. Bills Purchased: When the bank negotiates bills payable on demand, whether
clean or documentary,
the facility is known as bill purchase. The face value of the bill, is immediately paid to
the holder.
The bank, after purchasing the bill, becomes the holder in due course of the bill and
acquires all the
rights of ownership over the instrument. Bill purchase facility is extended generally in
the case
bills of on demand. However, in the case of usance bills also this is extended when
payable
the due
date of the bill is not readily known at the time of extending this facility. Such a situation
arises
when the bill is drawn payable after some days after sight. The due date of such a bill is
known
when the bill is presented to the drawee and the period of usance commences from the
date of
presentation.
2. Bills Discounting: This facility is extended by banker when the bills of
exchange are payable after
a particular period, that is bills payable otherwise on demand. For example, 'A' draws a
bill on 'B'
payable after three months and 'B' on presentation accepts the same and agrees to pay
after three
months. Such a bill is called a bill payable, otherwise on demand or usance bill. In this
type of
facility a banker pays the face value of the bill less discount, becomes holder in due
course, and
acquires all the rights under the bill.
139
3. Advance Against Bills for Collection: When the bank advances against the bills,
- CAIIB DISCUSSION
which are in course of collection, the facility is known as advance against bills for
collection. Under this facility, a prescribed margin is kept by the bank and the amount, in
consideration of this is allowed to the customer. The bill thereafter is sent for collection.
In all these cases, the legal effect is that the banker, who lends money, becomes holder in
due course for the bill.
12.5 BILL FINANCE AND LEGAL POSITION OF A BANKER
Bill Discounting and Rights of a Banker: In the case of bills discounting or bills
purchase the bill of exchange drawn by the borrower on third parties is presented to
banker. Then the banker pays the value of the bill of exchange to the borrower after
charging a commission or after a discount and gets the bill transferred to his name. By
such transfer, which is made by endorsement by the borrower, the banker becomes the
'Holder in due course' and would be entitled to receive the amounts from the acceptor of
the bill. Hence, it is imperative that a banker acquaints himself with the legal aspects of
lending through 'Bills discounting'.
Legal Relationship in the Case of Bills Discounting: In 'Bills discounting' transactions a
banker becomes a lawful holder of the bill by taking a proper endorsement of the bill in
his favour. The banker becomes 'payee' of the bill and is entitled to recover the amount
represented by the bill. We will study some cases in respect of bills discounting facilities
that have been decided by courts.
(i) Irinjalakuda Bank Ltd. vs Pourthussery Panchayat (1970) 40 Compo Cases. 767: In
this case a document in the form of cheque issued by a Panchayat on a Government
treasury payable to 'self or order' was discounted by a bank. It was dishonoured by the
treasury, since Panchayat Inspector countermanded the payment. The Court held that the
banker is a holder in due course and hence can recover the amount from the Panchayat.
(ii) Shambumal Gangaram and Another vs State Bank of Mysore (AIR 1971 Mys. 156):
In this case, legal action was initiated by the bank for the recovery of dues from the
customer because of the bill discounting facility granted to the customer. The bank was
providing 'Local Bill Discounting' (LBD) facility to its customer by discounting the bills
drawn by customer and endorsed by the customer in bank's favour. The drawees of the
bills generally paid the amounts of bills. However, several bills remained unpaid and
bank
shouldfiled
havea filed
suit for
suitrecovery
against from the customer.
the drawees The
of bill of customerThe
exchange. contended that bank
Court rejected the
argument of the customer and directed him to pay the amount to bank holding that
customer being drawee is liable to bank who are holders in due course.
Discounting of Documentary Bills
A banker provides discounting of 'Documentary Bills', as a credit facility to his
customer.
What is a Documentary Bill?
'Documentary Bill' is a bill which is supported or accompanied by a document of title to
goods.
A lorry receipt or railway receipt, warehouse receipt, bill of lading, etc., are some of the
examples of documents of title to goods.
Law relating to Documents of Title to Goods
Sale of Goods Act and Bill of Lading Act: Government documents of title to goods.
Under these Acts, 'documents of title to goods' is one in which ownership in goods can
be transferred by endorsement and delivery. Therefore, a banker as an endorsee of a
lorry receipt, railway receipt or bill of lading becomes the owner of goods on transfer of
said documents in his name.
140
In the case of Morvi Merchantile Bank Ltd. vs Union of India (1965) 35 Compo Cases
629, a Bombay firm, sent by rail (to self) six boxes stated to contain menthol crystals
from Thana to Okhla. The railway receipts were endorsed by the firm to a bank against
an advance of Rs. 20,000. The boxes were not delivered at Okhla and the bank sued the
- CAIIB DISCUSSION
railway claiming damages amounting to Rs. 35,000 which was stated to be the value of
the consignments. The Trial Court dismissed the suit. On appeal by the bank, the
Bombay High Court held that the bank as an endorsee of railway receipts was entitled to
receive the amount. The Supreme Court confirmed the order of High Court.
Drawee Bills Acceptance and Bill Co-acceptance Facilities
In 'Drawee Bills Acceptance Facility', the bank agrees to pay the drawer the amount of
bills drawn on the borrower on presentation and recovers from the drawee on the
respective due dates. This credit facility is normally extended to borrowers who have
been granted working capital facilities. This is an alternative to cash credit or overdraft.
The amounts of bills accepted by the bank are debited to 'drawee bills' discounting
account and the borrower reimburses the bank the amounts paid by bank with interest on
the respective due dates. These advances, are also governed by the principles of law
under the Negotiable Instruments Act. The bank would be entitled to sue the borrower
and recover from him the amount due on bills. The bank will have also an additional
advantage of suing the drawer in event of dishonour of bill.
In the case of 'Bills Co-acceptance Facility', the banker accepts the bills along with the
borrower. Under this facility banker undertakes a joint liability along with the borrower
and enters into agreement with the borrower for reimbursement.
12.6 LET US SUM UP
1. Law relating to bills is provided in the Negotiable Act, 1881.
2. Categories of bills financed by banker are:
(i) Clean bills (ii) Documentary bills
(iii) Bills drawn under credit
3. Maker of bill of exchange is called drawer.
4. Drawee of a bill of exchange is a person who is directed to pay the value of bill,
and in the case
of usance bill of exchange, the drawee is called acceptor.
5. In the case of bills relationships between the parties are:
(i) The drawer of the bill is creditor, (ii) The drawee of a bill is the debtor.
6. Holder in due course means any person who for consideration became the
possessor of the
and is entitled to bill
all the rights of holder of the bill.
7. Payment in due course means payment in accordance the tenor of bill to the
holder in due course
or to the holder of the bill, in due course and in good faith and without negligence.
8. Endorsement means signing the bill of exchange for the purpose of transfer.
9. Depending upon the place where the bills are made, they can be classified into
(i) Inland Bills (ii) Foreign Bills
10. Documentary bill means a bill accompanying documents of title to goods.
1. Bill of exchange means a unconditional direction to the drawer to pay the
moneys. (True/False)
2. The maker of the bill is called .
-^ rtrr? ATIM.
3. Bill purchase facility is granted in the case of demand bills. (True /False)
4. facility is granted in the case of usance bills.
5. of the bill is bound in case of dishonour of bill.
6. Ownership of goods can be transferred by endorsement and delivery of .

7. In bills co-acceptance facility the banker becomes a surety for the value of bill.
(True/False)
/
- CAIIB DISCUSSION
1. True; 2. Drawer; 3. True; 4. Bill Discounting; 5. Drawer; 6. Document of title to

goods; 7. True.
VARIOUS TYPES OF SECURITIES
STRUCTURE
13.0 Objectives
13.1 Introduction
13.2 Various Kinds of Securities
13.3 Let Us Sum Up
13.4 Keywords
144
13.0 OBJECTIVES
• various kinds of securities;
• advantages and disadvantages of the various securities.
13.1 INTRODUCTION
An advance made by a banker may be secured by a collateral security. The effectiveness
of a security would largely depend on the nature of the security. The effectiveness of the
securities can be broadly classified on two aspects, the first being the economic aspect,
that is the marketability, valuation and other economic factors that has a bearing on the
value of the security. The other the legal aspect is the validity and enforceability of the
security. The requisites of a good and acceptable security are as follows:
1. The borrower should have a good title to the security.
2. It should be easily and freely transferable.
3. It should not have any encumbrance or liability for, e.g., partly paid shares.
4.
5. It
It should be easily
should not marketable.
be liable to wide price fluctuations.
6. Its value should be easily ascertainable.
7. Its storing should not be difficult.
8. It should be durable.
9. It should be easily transportable.
We shall now study the various kinds of securities in the light of above requisites and
understand their advantages and disadvantages.
13.2 VARIOUS KINDS OF SECURITIES
1. Land/Real Estate: Bankers in the olden days were very much averse to accept land and
building as a security, but this prejudice has over a period of time changed and land and
building as a security has become an acceptable collateral in most advances, more
particularly to corporate customers. The advantages and disadvantages of this form of
security cannot be universally applied to all lands and it depends on the nature of the
land offered. We shall now discuss both the advantages and disadvantages.
Advantages
(i) The advantage that land has over other types of securities is that its value generally
increases with time. With every fall in the value of money, the value of land goes up and
due to its scarce availability in developing areas its value is bound to increase.
(ii) It cannot be shifted, a fact which sometimes is also a disadvantage.
Disadvantages
(i) Valuation is at-times difficult: The value of a building depends on several factors
such as location, size of property, state of repair, amenities, etc., and in the case of
factories and industrial buildings, the machinery, nature of industry, etc. This makes the
- CAIIB DISCUSSION
valuation very difficult. Buildings and the materials used in the buildings are not alike.
In fact, buildings must be valued on a conservative basis because of limited market in the
event of sale.
(ii) Ascertaining the title of the owner: The banker cannot obtain a proper title unless the
borrower himself has title to the property to be mortgaged. In India, the laws of
succession
145
a security >e broadly lation and >ect is the ty are as

d their
ngas :urity ners. ands and
ises its
as id
particularly those relating to Hindus and Muslims being very complicated, it is difficult
to ascertain whether a person has a perfect title to the property or not. The banker would
therefore have to consult solicitors and obtain their opinion before accepting it as a
security, which in many cases delays lending. Title verification, must also be done to
know whether the property was encumbered. This has to be done by verifying record
with the Registrar's office, which involves expense and time. In the case of agricultural
land, with the introduction of land ceiling legislation, legislation protecting the tenants'
rights, absence of up-to-date and proper land records, it has become less valuable as a
security. Added to this there have been a number of legislations in different states giving
debt relief to the farmers and prohibiting transfer of land to persons other than
agriculturists.
(iii) Difficult to realise the security: Land is not easily and quickly realisable due to lack
of ready market. It may take months to sell and some times if the market is not
favourable, it may fetch a lower price than what was anticipated.
(iv) Creating a charge is costly: The security can be charged either by way of legal
mortgage or by way
a simple deposit of an
of title equitable
deeds mortgage.
with or without aAn equitable mortgage
memorandum. Although may be created by
equitable
mortgage is less expensive, a banker always prefers legal mortgage to an equitable
mortgage, since the remedies under a legal mortgage are better than those under an
equitable mortgage. However, completing a legal mortgage involves expenses including
stamp duty and lot of formalities.
(v) Difficulty on account of Rent Control Act: In the case of buildings, which come
within the purview of the Rent Control Act, it would be difficult to sell the building,
particularly when a tenant has been occupying it for a long time. This reduces the
marketability and value.
Precautions to be taken by the banker
(i) Financial soundness of borrower: The banker should place more reliance on the
financial soundness of the borrower.
(ii) Borrower's title: The banker should get a solicitor to verify the title to the property
and the right of the borrower to mortgage.
(iii) Enquiry regarding prior charges: The borrower should produce a certificate from the
Registrar's office listing the charges over the property over a period of time (generally 30
years) that the property is free from encumbrances. This is commonly understood as
non-encumbrance certificate. If any prior charges exist the banker's right will be subject
to such prior charges.
(iv) Freehold or leasehold: A freeholder is the absolute owner of his land and is able to
deal with it as he likes. A leasehold property is one which is taken on lease for a period
and a leaseholder derives a legal status for a term of years from the freeholder and is free
to deal with the land when acting within the terms of the lease and within the law during
- CAIIB DISCUSSION
that period. When the lease expires, the land reverts to the freeholder. In the case of
leasehold property, the unexpired period of the lease is an important consideration. The
longer the unexpired period of the lease, greater is the value of the security. The bank
should also ensure by verifying a copy of lease deed that there are no onerous covenants
such as the necessity of taking the freeholder's consent before mortgaging the property.
The banker should also obtain the last ground receipt to ensure that the lease is active.
(v) Valuation of the property: Valuation can be done in anyone of the following ways:
(a) By utilising the services of recognised valuers who would be engineers or
architects.
(b) Making enquiries with local real estate agents.
(c) By local authorities.
146
(d) Latest sale transaction of neighbouring properties.
(e) Calculations based on the annual rental value.
(vi) Registration: Where the principal money secured is Rs. 100 or more, a mortgage
charge
is required to be registered unless the charge is an equitable mortgage, (vii)
Documentations: The mortgage deed must be drafted carefully considering all the legal
stipulations. It should be witnessed by at least two persons. In case of simple mortgage it
attracts ad-valorum stamp duty, (viii) Verification of Tax Receipts: The banker should
request the borrower to produce latest
property tax receipts since any arrears of tax constitute a preferential charge on property,
(ix) Insurance of the property: To avoid loss of security by fire, natural calamities, it is
prudent
that in case of buildings the banker insist on insurance of the property for its full value at
the
borrower's expense.
2. Stocks and Shares
Shares: These may be classified into preference shares (which enjoy preference both
with
sharesregards
whichthe
arepayment of dividend
not preference shares.and repayment
Banks accept of capital)
only quotedand equity
shares as shares, i.e.,
security.
Advantages
(i) Value of the security can be ascertained without any difficulty.
(ii) In normal times, stocks and shares enjoy stability of value and are not subject to wide
fluctuations.
(iii) Stocks and shares require very little formalities for taking them as security, (iv) It is
easier compared to real estate to ascertain the title, more so with the advent of
depositories. (v) Creating a charge of this is less expensive than real estate, (vi) They
yield intermittent income by way of dividends, which can be appropriated towards the
loan account.
(vii) Being a tangible form of securities they are more reliable, (viii) The release of such
securities involves very little expense and formality.
Disadvantages
(i) Being easy to realise, they are fraud prone and as such they must be properly secured,
(ii) In the case of partly paid shares, the following demerits are there:
(a) The banker may have to pay the calls.
(b) Partly paid shares are subject to violent price fluctuations.
(c) They are not easily realisable because of the restricted market for such shares.
Precautions while taking stocks and shares as security: Banker must take the following
precautions while advancing against stocks and shares:
(i) In the case of partly paid shares (a) the banker should never register them in his name.
(b) He must ensure that pending calls are paid.
(c) Sufficient margin should be taken to avoid any future loss or change in the
- CAIIB DISCUSSION
value of
the security.
(d) The banker should verify share certificate and ensure that the calls are paid
properly
and entered in the space provided for the same.
Other precautions
(i) Update the list of shares which the particular bank is willing to lend against on a
regular basis.
147
(ii) Updating the amount that can be lent against a particular share which is called the
card limit
at regular intervals, (iii) Yearly review of the portfolio or more frequent review
depending upon the volatility in the
capital market.
3. Debentures: Debenture is a document issued by a company acknowledging its
indebtedness to the bearer or a r egistered holder. A fixed rate of interest is payable at
stated periods on such debentures. In the case of mortgage debentures, a charge is
created on the assets of the company issuing such debentures in favour of a trustee who
is responsible to take care of the interest of individual investors.
Advantages
(i) Easy to sell.
(ii) Not subject to violent price fluctuations.
(iii) They can be transferred at minimum cost.
(iv) Bearer debentures are fully negotiable.
(v) They rank in priority to shares and mostly secured by a charge on the
company's property.
Disadvantages
(i) If interest is not paid regularly on the debentures, it would affect its price and
marketability, (ii) If the charge on property of company is not registered, the subsequent
charges will get a
priority, (iii) Debentures may be issued by companies having no power to borrow
money.
Precautions to be taken while taking debentures as security
(i) The nature of the debentures must be ascertained, i.e., whether they are unsecured or
secured, the later being preferred, (ii) The borrowing powers of the company issuing the
debentures must be ascertained and to
verify that the same has not been exceeded.
(iii) Deposit of the debentures plus a memorandum of deposit is necessary, (iv) The
nature and value of the assets charged must be examined frequently. (v) The banker must
find out whether there are any uncancelled redeemed debentures.
4. Goods: Though, earlier, bankers were not forthcoming to advance against goods or
documents of title to goods, now more and more secured advances of the scheduled
banks in India are against goods.
Merits of this Security
(i) Goods have a ready market and as such can be easily sold unlike other kinds of
security.
(ii) Valuation of the goods can be easily done.
(iii) The banker gets a tangible form of security compared to unsecured advances, which
in
case of default by the borrower, can be realised by sale of pledged goods, (iv) Advances
- CAIIB DISCUSSION
against goods are normally given for short periods and therefore the risk of the
banker is considerably reduced, (v) Barring a few states where the stamp duty is heavy,
creating a charge on the security is less
costly and involves minimum formalities, (vi) Banker acquires a good title to the goods
when dealing with customers of repute and
standing.
Demerits of this Security
(i) Certain goods are liable to perish or deteriorate in quality over a period of time, thus
resulting in reduction of the value of the banker's security.
148
(ii) There are possible risks of fraud or dishonesty on the part of the borrower. For
example, when 10,000 tins of cashew nuts are shown in the godown as security for an
advance, it is not possible for the banker to verify the quality and quantity in every tin. It
is not even possible to verify whether all the 10,000 tins contain cashew nuts. A
fraudulent borrower may not store the full stocks as declared in the godown.
(iii) The value of the security in certain cases more particularly electronic consumer
goods are subject to wide fluctuations. Therefore, the valuation of such goods is difficult.
Even in the case of necessaries, there being several varieties, unless the banker has
expert knowledge, the valuation may be misleading. Disposing of large quantities of
goods within a short time may be difficult and may not fetch the expected / declared
price.
(iv) The banker may find it difficult to store the goods.
(v) Transporting the goods from the borrower's premises to the banker's premises and
thereafter to the market in case of sale is a considerably costly and time-consuming
affair.
(vi) When the banker releases goods for sale on the execution of trust receipts, the
money realised by the sale of such goods may not be deposited with the banker and the
borrowers may default to the bankers.
(vii) If the goods are warehoused, the warehouse keeper enjoys a lien over the goods for
any
dulyunpaid
paid. charges. The banker therefore, has to ensure periodically that all charges are
Valuation of Goods
(i) Advances are given based on the stocks and their value declared in monthly
stock/statements.
The stock/goods are to be inspected at regular intervals and prices verified and tallied
with
purchase invoices.
(ii) By visiting factory/godown by officials and valuers like cost accountants, (iii)
Follow up of account ensuring payment to creditors for stock and collection of debtors
thus avoiding diversion/misuse of funds.
Precautions to be taken
(i) Advances against goods should be restricted to genuine traders and not to speculators,
(ii) Loans must be given for short periods, since the quality and thereby the value of the
security
is likely to diminish, (iii) The banker must have a working knowledge and gather
information of the different types
of goods regarding their character, price movements, storage value, etc. (iv) The banker
should confirm the state of goods, (v) The goods should be insured against loss by theft
or fire, (vi) The banker should verify and confirm the title of the borrower to the goods
by inspecting
the invoices or cash memos. (vii) The banker as a Pawnee is liable, if reasonable care is
not taken of the goods pledged. He
should therefore, take proper care for their storage and also take reasonable steps to
- CAIIB DISCUSSION
protect
them from damage and pilferage.
(viii) The price of the goods must be accurately ascertained, (ix) Necessary margin must
be taken by the banker to protect him against fluctuations in the
price of goods.
(x) The banker must obtain absolute or constructive possession of the goods, (xi) In the
case of hypothecated goods, the bank should obtain from the borrower a written
undertaking that the goods are not charged to any bank or creditor and will not be so
charged as long as the borrower is indebted to the bank. The banker should obtain at
regular
149
periods certificates regarding the quantity and valuation of the goods, which should be
physically verified by the banker.
Documents of Title to Goods: What are Documents of Title to Goods?
As per the Section 2(4) of the Sale of Goods Act, 1930, a document of title to goods is 'a
document used in the ordinary course of business as a proof of possession or control of
goods authorising or purporting to authorise either, by endorsement or delivery, the
possessor of the documents to transfer or receive the goods thereby represented.' Thus,
the essential requisites of a document of title to goods are:
(i) The mere possession of the documents creates a right either by virtue of law or trade
usage,
to possess the goods represented by the documents, (ii) Goods represented by the
documents can be transferred by endorsement and/or delivery of
the documents.
(iii) The transferee of the documents can take delivery of the goods in his own right, (iv)
Although they appear to be negotiable instruments, documents of title to goods are not
negotiable instruments. The title of bona fide transferee for value can be affected by
defects in the title of transferor. They may be called quasi-negotiable instruments.
Examples of documents of title to goods are bills of lading, dock warrant, warehouse-
keeper's certificate, railway

must be distinguished from receipts, delivery like
other documents orders,
the etc. Documents of title
warehouse-keeper's non-to goods
transferable receipts, which are mere acknowledgement of the goods. Documents of title
to goods are preferred by bankers because under Section 52(2)(e) of the Presidency
Towns Insolvency Act, 1909, and Section 28(3) of the Provincial Insolvency Act, 1920,
possession of goods represented by such instruments duly endorsed in his favour are
taken out of the order and disposition of the insolvent. The significance of this is that in
case the borrower becomes insolvent, the Official Receiver or Official Assignee as the
case may be, cannot include such goods in the assets of the insolvent.
Merits of this Security
(i) By mere pledge of the instruments the goods are pledged and serve as a good
security, (ii) The person in possession of the document can transfer the goods by
endorsement and/or
delivery. The transferee thereafter is entitled to take delivery of the goods in his own
right, (iii) The documents are easily transferable, and the formalities involved are less
compared to
mortgage or assignment.
Demerits of this Security
(i) Possibility for fraud and dishonesty: Since the bill of lading or a railway receipt or a
warehouse-keeper's certificate does not certify or guarantee the correctness of the
contents of the bags or packages, the banker will have no remedy against the carrier or
warehouse-keeper, if they turn out to be containing worthless goods.
(ii) Forged and altered documents: The documents might be forged ones, or even if
genuine,
- CAIIB DISCUSSION
the quantity may be altered.

(iii) Not Negotiable documents: The document being "Not Negotiable", the transferee of
such documents will not get a better title than that of the transferor. Therefore, if the
person who pledged the documents has a defective title, the banker will not acquire a
better title, (iv) Unpaid vendor's right of stoppage in transit: Under the Sale of Goods
Act, 1930, an unpaid vendor has the 'right of stoppage in transit' and he is entitled to
direct the carrier that the goods need not be delivered, if not already done. If this right is
exercised by the unpaid vendor, the banker cannot obtain the goods and his security is of
no value.
150
(v) In the case of lost documents, delivery of the goods is allowed on the execution of an
indemnity bond, this option may be misused by the borrower by selling the goods to
some other customer who may take delivery of the goods declaring that he had
lost/misplace the document and indemnifying the carrier. To avoid such a contingency,
the banker can give notice to the carrier regarding his interest and the pledge.
(i) The documents must be examined thoroughly to ensure that they are genuine and of
recent origin. In the case of bills of lading, they are prepared generally in triplicate and
as such all the copies must be obtained by the banker. Otherwise, the carrier is released
from his obligation by delivering the goods on the presentation of any one copy
containing ostensibly regular endorsements.
(ii) The banker should ensure that the documents do not contain any onerous clauses or
prejudicial remarks about the condition of goods received.
(iii) Banker should ensure that the goods are adequately covered by insurance for full
value against risks of theft, fire, damage in transit, etc., and in the case of goods shipped
by sea, all the marine risks should be covered.
(iv) Banker should ensure to get consignee copy and banks name being entered as
consignee, so that endorsement/transfer of title is specific.
Trust Receipt
Wheneverbeing
payment the bank releases
made, then a documents of title
'Letter of Trust' to goods
should to theSo
be taken. borrower without
also in the case of
goods hypothecated to the bank. The r easons are as follows:
(i) The borrower on sale of the goods has to hold proceeds in trust for the banker. (ii)
The goods taken under such trust receipts or the sale proceeds thereof, are not available
to the official receiver in case the borrower becomes insolvent.
A Trust letter incorporates the following clauses
(i) Borrower's recognition, of bank's rights in the goods as security and in case of sale,
the
proceeds, thereof.
(ii) Borrower's, undertaking to hold the goods or sale proceeds thereof, in trust for the
banker, (iii) Borrower's undertaking, to ensure proper storage and insurance, at his cost.
(iv) Borrower's undertaking to direct the buyer to pay the monies directly to the banker,
if so
required by the banker, (v) Borrower's undertaking to return unsold goods on banker's
request or dispose of the same
as directed by the banker.
5. Life Policies: Purpose of Life Policy: A life policy is taken for two purposes:
(i) It is a source of income for the dependents of the assured in case of his death, (ii) It is
an ideal form of saving since along with income tax deduction on the premium, paid
loans can be raised on the policies in times of need.
Advantages
(i) Life insurance business being highly regulated and permitted only to companies
having sound financial health, the banker need not doubt the realisation of the policies,
- CAIIB DISCUSSION
which will be done without any difficulty, if the policy and the claim are in order.
(ii) The assignment of the policy in favour of the banker requires very little formalities
and the banker obtains a perfect title.
151
6.
(iii) The longer the period for which the policy has been in force, the greater the
surrender value. It is also useful as an additional security because, in the event of the
borrower's death, the debt is easily liquidated from the proceeds of the policy.
(iv) The security can be realised immediately on the borrower's default of payment by
surrendering the policy to the insurance company.
(v) The policy is a tangible security and is in the custody of the bank. The banker only
has to ensure that regular payment of premiums is made.
Disadvantages
(i) If the premium is not paid regularly, the policy lapses and reviving the policy is
complicated.
(ii) Insurance contracts being contracts of utmost good faith, any misrepresentation or
non¬disclosure of any particulars by the assured would make the policy void and enable
the insurer to avoid the contract.
(iii) The person (proposer) who has obtained the policy must have an insurable interest
in the life of the assured or the contract is void.
(iv) The policy may contain special clauses, which may restrict the liability of the
insurer.
(v) When the banker accepts a policy coming under Married Women Property Act he
must ensure that all the parties sign in the bank's form of assignment.
(vi) There is facility to obtain the duplicate policy if the original is lost. This can be
misused by persons by obtaining duplicate policies. Banker should, therefore, verify that
no duplicate policy has been issued and there are no encumbrances on the policy.
Advantages
(i) The policy must be assigned in favour of the bank and should be sent directly to the
insurance company for registration and ensured that only authorised office of Insurance
Company has noted assignment.
(ii) The bank should see that the age of the assured is admitted.
(iii) The banker should ensure the regular payment of premium.
Book Debts: Borrowers can take advances by assigning book debts in favour of the
bank. Section 130 of the Transfer of Property Act permits assignment of actionable
claim and the procedure to be followed is:
(i) The assignment must be in writing and signed by the transferor or his duly authorised
agent.
(ii) Notice of the assignment in writing must be given to the debtor; and. (iii) The
assignment may be absolute or by way of charge.
Legal implication of assignment
(i) The assignee can sue in his/their own name and can give a valid discharge.
(ii) The debtor can exercise any right of set off against the assignee, which but for such
transfer, he could have exercised against assignor, (iii) As an actionable claim includes
future debts, there can be a valid assignment of future debts
as well.
Precautions to be taken
(i) The value of the security depends on the solvency of the debtor and his right of set
off, if
any. The banker must enquire into both aspects, (ii) The instrument of assignment must
be in writing and duly signed in the presence of the
- CAIIB DISCUSSION
banker, signed by the assignor or his duly authorised agent.
152
(iii) The banker must serve notices of assignment on debtors, who must be asked to
acknowledge its receipt and confirm:
(a) The amount of the debt.
(b) His right of set off, if any, and
(c) Whether he has received notice of prior assignments, if any.
(iv) An undertaking from the borrower should be taken that the amount of debts
collected directly if any by him will be passed on to the banker, towards the loan account
and operations in account be controlled to ensure this compliance.
(v) Where the book debts are as assigned by a joint stock company, the charge must be
registered with the Registrar of Joint Stock Companies.
7. Fixed Deposit: When money deposited by a customer is not repayable on
demand and is payable on
the expiry of a specified period from the date of deposit such a deposit is called a 'Fixed
Deposit'.
The banker evidences a deposit by issuing a receipt known as fixed deposit receipt.
Interest is paid
at regular intervals at a specified rate on such deposits. Banks usually permit depositors
to borrow
against the deposit. This security is certainly the most valuable, as the money
represented by the
receipt is already with the bank and there is no problem of valuation or enquiring the
title, or the
problem of storage and costs associated with storage.
Precautions
(i) The banker should grant the advance only to the person in whose name the money is
deposited. Banker should not advance against fixed deposit receipts of other banks. This
is because the banker who has received the deposit will have a general lien over such
monies. Even
deposit, the if the
latter maylending bank gives
even refuse noticethe
to register to the
lienbank, which
in favour of has
the received the
lending bank.
(ii) If the deposit is in joint names the request for loan must come from all of them.
(iii) When the deposit receipt is taken as security, the banker should ensure that all the
depositors duly discharge it on the back of the instrument after affixing the appropriate
revenue stamp. In addition to this, the banker should obtain a letter of appropriation
which authorises the banker to appropriate the amount of the deposit on maturity or
earlier towards the loan amount.
(iv) After granting the advance, the banker must note his lien in the fixed deposit register
to avoid payment by mistake and the lien, must also be noted on the receipt itself.
(v) Advance should preferably not be made against fixed deposit receipt in the name of a
minor, unless a declaration is taken from guardian, that loan will be utilised for benefit
of the minor.
(vi) Where the money is being advanced against the fixed deposit receipt issued by
another branch, the FDR duly discharged must be sent to the branch where such money
is deposited for the following purposes:
(a) To verify the specimen signature of the depositor
(b) To ensure that no prior lien exists on the fixed deposit receipt
(c) To mark lien on the FDR and the FDR register, in favour of branch advancing
money.
(vii) Sometimes a person may approach for advances by offering the fixed deposit
receipts held by third parties as security. In such a case, the fixed deposit receipt must be
duly discharged by the third party, i.e., FD holder and he should declare in writing the
bank's right to hold the deposit receipt as security, and also to adjust the deposit amount
- CAIIB DISCUSSION
towards the loan account on maturity or on default in repayment of instalment if any.

8. Supply Bills: Supply bills arise in relation to transactions with the Government
and public sector
undertakings. A party might have taken a contract for execution, and he is entitled to
progressive
153
payments based on work done, for which he has to submit bills in accordance with the
terms and conditions of the contract. Similarly, parties who have accepted tenders for
supply of goods over a period are entitled to payments on the supply of goods, for which
they submit bills in accordance with the terms of the contract. These bills are known as
supply bills.
Procedure followed in respect of supply bills
(i) The supplier delivers the goods supported by a delivery challan and produces the
documents. The appropriate authority of the government department inspects these
goods and accepts for payment on due date and the supplier obtains an inspection note.
In the case of contracts, an engineer's certificate regarding work done is obtained.
(ii) The supplier or the contractor as the case may be, prepares the bill for obtaining
payment. Government departments take quite some time to verify the bills and pass them
for payment. Therefore, the supplier or contractor submits these bills together with the
accepted delivery challan and inspection note or the engineer's certificates to the
appropriate Government department through the banker and r equests the banker to
advance against such bills.
These bills do not enjoy the status of negotiable instruments. They are in the nature of
debts and are assigned, in favour of the banker for payment, after affixing a revenue
stamp for having received the amount. The bank should also obtain a letter from the
supplier or contractor, requesting the appropriate department to make the payment
directly to the banker.
Risks involved in advancing against supply bills
(i) Although the advance is self-liquidating in nature, in certain cases it can take quite
some
time before the advance is realised because of administrative and other Governmental
procedures, (ii) It is virtually a clean advance and the bank may not realise the full
amount, because of the
possibility of counter claim or the right of set off by the Government, as the charge is
only
by way of assignment, (iii) Sometimes, the Government may not pass the bills for full
payment because of the
unsatisfactory quality of goods or defective work done by the contractor or delays in the
completion of work.
(i) Advances against supply bills should be made only to borrowers who have sufficient
experience in Government business and Government regulations. (ii) The contract
between the supplier and the Government department should be scrutinised
by the banker, to know the volume of transaction, period of supply, rates agreed upon
and
various other terms and conditions. The Government will not pass the bills unless there
is
faithful adherence to the terms and conditions by the supplier, (iii) The banker should
obtain a power of attorney from the supplier authorising him to receive
the money. The same should be registered with the appropriate Government department,
(iv) The banker should obtain the inspection note or the engineer's certificates along with
the
bills. There should be no adverse remarks in the inspection report regarding the quality
- CAIIB DISCUSSION
and
quantity of goods supplied, (v) There are two types of bills that are submitted by the
suppliers. They are:
(a) Interim bills against which Government pays eighty to eighty-five per cent of
the
amount.
(b) Final Bills for the balance of twenty to fifteen per cent which will be paid only
after
complete verification of goods at the point of destination. Because of the delay involved
154
in the settlement of final bills, banks should prefer the interim bills for advancing and
final bills only for collection. Keep sufficient margin to cover advance with interest
thereon from proceeds to be received.
(vi) Banker must reserve the right of demanding the repayment of advance, if the bills
remain unpaid for a specified period. The banker, in other words, treats the bills as only
items for collection and the advances are r ecovered.
13.3 LET US SUM UP
The effectiveness of a security offered to a banker would largely depend on the nature of
the security, which includes its marketability, valuation and other economic factors and
certain legal aspects, like the borrower's title, existing encumbrance or liability attached
to the security. The various kinds of normally acceptable securities include land/real
estate, stocks and shares, debentures, goods, life policies, book debts, fixed deposit
receipts and supply bills.
The securities depending on their nature have various advantages and disadvantages. The
banker however, has to verify the worth of the security and its readability, before
accepting it. Of all the kinds of security, fixed deposit receipt of the bank is the best and
most reliable compared to other forms of security. The security of goods can be created
either by pledging the goods directly or by pledging the title to goods, which in turn is a
pledge of the goods or by charge by way of hypothecation.
13.4
PreferenceKEYWORDS
Shares; Equity Share; Debenture; Documents of Title to Goods; Life Policy;
Trust Receipt.
(a) If money lent is more than Rs 100 on the security of land, then the mortgaged
(simple)
requires r egistration.
(b) A mortgage deed need not be witnessed.
(c) Permission from Income Tax Authorities under the Section 230 to create
mortgage is required
only if the land belongs to a company.
(d) Arrears of tax constitute a preferential charge on the property.
(e) There are three types of shares - ordinary, equity and preference.
(f) Debenture is a kind of share issued by a company and has no voting rights.
(g) Borrower can create a valid pledge with documents of title to goods.
(h) Bills of lading, dock warrants, warehouse-keeper's certificate, etc., are some
examples of documents of title to goods.
(i) Documents of title to goods are negotiable instruments.
(j) Only Life Insurance Companies can issue life policies, (k) Insurance contracts are
contracts of absolute good faith.
(1) An assignee of a life policy can sue in his/her own name, (m) For a loan against fixed
deposit receipt, the stamp duty is very high, (n) Supply bills are bills of exchange.
- CAIIB DISCUSSION
1. (a) True; (b) False; (c) False; (d) True; (e) False; (f) False; (g) True; (h) True; (i)
False; (j) True; (k) True; (I) True; (m) False; (n) False.
LAW RELATING TO SECURITIES AND MODES OF CHARGING - I
STRUCTURE
14.0 Objectives
14.1 Introduction
14.2 Mortgage
14.3 Let Us Sum Up
156
14.0 OBJECTIVES
• various types of mortgages and law relating thereto;
• essential features of various types of mortgages.
14.1 INTRODUCTION
When land/building is offered as a security, it is charged to the bank by a mortgage.
Mortgages are of six kinds, though as a banker you would be dealing in only three of
them. The law, relating to mortgages is dealt with in the Transfer of Property Act, 1882.
and more particularly in Sections 58 to 99 and 102 to 104. We shall now study these
provisions and see how they affect us, as bankers in our business of lending.
14.2 MORTGAGE
Section 58(a) of the Transfer of Property Act, 1882 defines a mortgage as follows:
'A mortgage is the transfer of interest in specific immoveable property, for the purpose
of securing the payment of money advanced or to be advanced by way of loan, on
existing or future debt or the performance of an engagement which may give rise to a
pecuniary liability.'
The transferor is called the 'mortgagor' and the transferee a 'mortgagee' the principal
money and interest of which payment is secured is called mortgage money and the
instrument by which the transfer is effected is called the 'mortgage deed'.
1. Ingredients of Mortgage: From the above definition of mortgage, the following
are the r equirements
of a mortgage:
(i) There should be transfer of interest in the property by the mortgagor (the owner or
lessor), (ii) The transfer should be to secure the money paid or to be paid by way of loan.
2. Mortgage of Land - Various Types: The Transfer of Property Act contemplates
six different kinds
of mortgages. They are:
(i) Simple mortgage (ii) Mortgage by conditional sale
(iii) Usufructuary mortgage (iv) English mortgage
(v) Mortgage by deposit of title deeds (Equitable mortgage)
(vi) Anomalous mortgage
Simple mortgage
According to Section 58(b) of the Transfer of Property Act, a simple mortgage is a
transaction whereby, '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 mortgaged property to be sold by a decree of the Court in
a suit and the proceeds of the sale to be applied so far as may be necessary in payment of
the mortgage money.'
- CAIIB DISCUSSION
Features of simple mortgage

(i) The mortgagee has no power to sell the property without the intervention of the
Court.
In case there is shortfall in the amount recovered even after sale of the mortgaged
property the
mortgagor continues to be personally liable for the shortfall, (ii) The mortgagee has no
right to get any payments out of the rents and produce of the mortgaged
property.
iOf
02 of
he
he
id
157
(iii) The mortgagee is not put in possession of the property.
(iv) Registration is mandatory if the principal amount secured is Rs. 100 and above.
Mortgage by way of conditional sale
As per Section 58(c) of the Transfer of Property Act, a mortgage by way of a conditional
sale of the property is a transaction whereby the mortgagor ostensibly sells the
mortgaged property on the condition that:
(a) on default of payment of the mortgage money on a certain date, the sale shall
become absolute, or
(b) on such payment being made the sale shall become void; or
(c) on such payment being made, the buyer shall transfer the property to the seller.
No such transaction shall be deemed to be a mortgage of conditional sale, unless the
condition is embodied in the document, which effects or purports to effect the sale.
Essential features
(i) The sale is ostensible and not real.
(ii) If theupon
absolute money
theis not repaid on the agreed date, the ostensible sale will become
mortgagor applying to the Court and getting a decree in his favour. The mortgagor in
such a case
loses his right to redeem his property, (iii) The mortgagee can sue for foreclosure, but
not for sale of the property. Foreclosure, means the
loss of the right possessed by the mortgagor to redeem the mortgaged property, (iv)
There is no personal covenant for repayment of the debt and therefore bankers do not
prefer this
type of mortgage. The mortgagee cannot look to the other properties of the mortgagor in
case the
mortgaged property proves insufficient.
Usufructuary mortgage
According to Section 58(d) of the Transfer of Property Act, 'a Usufructuary mortgage is
a transaction in which
(a) the mortgagor delivers possession expressly, or by implication and binds
himself to deliver
possession of the mortgaged property to the mortgagee; and
(b) authorises the mortgagee 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
- CAIIB DISCUSSION
of interest and partly in payment of the mortgage money.

Essential features
(i) The mortgagee is put in possession of the mortgaged property. Here, by possession it
is meant, the legal possession and not the physical possession. For example, the
mortgagor may continue to enjoy the physical possession as the lessee of the mortgagee
or the mortgagor may be the caretaker of the property directing the tenants to pay rent to
the mortgagee. However, the deed must contain a clause providing for the delivery of the
property to the mortgagee and authorising him to retain such possession.
(ii) The mortgagee has the right to r eceive the rents and profits accruing from the
property. Such rents and profits or part thereof, may be appropriated in lieu, of interest or
in payment of the mortgage money or partly for both.
(iii) Unless there is a personal covenant for the repayment of the mortgage money, there
is no personal liability for the mortgagor. Therefore, the mortgagee cannot sue the
mortgagor for repayment of the mortgage debt; nor can he sue mortgagor for the sale or
foreclosure of the mortgaged property.
(iv) There is no time limit specified and the mortgagee remains in possession of the
property until the debt is repaid. The only remedy for the mortgagee is to remain in
possession of the mortgaged property and pay themselves out of the rents and or profits
of the mortgaged property. If the
158
mortgagor fails to sue for redemption within thirty years, the mortgagee becomes the
absolute owner of the property.
Bankers do not prefer this form of mortgage for the following reasons:
(i) There is no personal covenant to repay the debt.
(ii) As the mortgaged money can be recovered only by the appropriation of rents and/or
profits, it will take a very long time to recover money through this process.
English Mortgage
According to Section 58(e) of the Transfer of Property Act, an 'English Mortgage' is a
transaction in which, the mortgagor binds himself 'to repay the mortgage money on a
certain
subject date
to theand transfers
provision thehe
that mortgaged property
will retransfer it toabsolutely to theupon
the mortgagor mortgagee,
paymentbut
of the
mortgage money as agreed'.
Essential features
(i) It provides for a personal covenant to pay on a specified date notwithstanding the
absolute
transfer of the property to the mortgagee, (ii) There is an absolute transfer of the property
in favour of the mortgagee.
However, such absolute transfer is subject to a provision that the property shall be re-
conveyed to
the mortgagor in the event of the repayment of mortgage money, (iii) The mortgagee can
sue the mortgagor for the recovery of the money and can obtain a decree for
sale.
Equitable mortgage or mortgage by deposit of title deeds
According to Section 58(f) of the Transfer of Property Act, 'Where a person in any of the
following towns - namely, the towns of Kolkata, Chennai and Mumbai and in 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
immoveable property, with intent to create a security thereon, the transaction is called a
mortgage by deposit of title deeds.'
Documents of title
Documents of title or title deed in case of mortgage by deposit of title deeds, shall be
documents or instruments which relate to ownership of the mortgagor over the property.
In other words, by virtue of a document or instrument, if a person has a right to peaceful
- CAIIB DISCUSSION
possession and enjoyment of the immoveable property, then such a document or

instrument is called the title deed. In the case of Syndicate Bank vs Modern Tile and
City Works (1980 KL T 550); it was explained by the learned Judges that documents of
title or deed means the legal instrument which proves the right of a person in a particular
property.
Essential features
(i) Such a mortgage can be affected only in the towns notified by the State Government.
However, the territorial restriction refers to the place where the title deeds are delivered
and not to the situation of the property mortgaged.
(ii) To create this mortgage, there must be three ingredients i.e. a debt, a deposit of title
deeds and an intention that the deeds shall be act as security for the debt.
Anomalous mortgage
According to Section 58(g) of the Transfer of Property Act, 'a mortgage which is not a
simple mortgage, a mortgage by conditional sale and usufructuary mortgage and English
mortgage or a mortgage by deposit of title deeds within the meaning of this Section, is
called an 'Anomalous Mortgage.'
Essential features
(i) It must be a mortgage as defined by Section 58 of the Transfer of Property Act. (ii) It
is negatively defined and should not be anyone of the mortgages listed above.
159
(iii) Anomalous mortgages are usually a combination of two mortgages. Examples of
such mortgages are:
(a) a simple and usufructuary mortgage, and
(b) an usufructuary mortgage accompanied by conditional sale. There may be other
forms,
moulded by custom and local usage.
3. Merits and Demerits of an Equitable Mortgage
Merits
(i) The borrower saves the stamp duty on the mortgage deed and the r egistration charges.
It
involves minimum formalities, (ii) It involves less time and can be conveniently created.
It can be done without much publicity and therefore, the customer's position is not
exposed to public gaze.
Demerits
(i) In case of default, the remedy is to obtain a decree for sale of the property. Since, this
involves going to the Court, it is expensive and time consuming. This shortcoming, can
be overcome by inserting a covenant by which the mortgagee is given the power of sale.
In that case, the mortgage deed must be properly stamped and registered and the
mortgage loses the advantage of being simple in procedure and less expensive.
(ii) Where the borrower is holding the title deeds in his capacity as a trustee and
equitable mortgage of the same is effected, the claim of the beneficiary, under trust will
prevail over any equitable mortgage. Therefore, the banker has to make a proper scrutiny
of the title deeds before accepting them as a security.
(iii) The borrower may create a subsequent legal mortgage in favour of another party.
However, this possibility is not there, if the equitable mortgagee holds the original title
deeds. In India, there is no difference between the two types of mortgages. According to
Section 48 of the Registration Act, 1908, a mortgage by deposit of title deeds prevails
against any subsequent mortgage relating to the same property. Similarly, the title of the
equitable mortgagee, is not defeated by any subsequent sale without notice. However, to
avoid any risk of this type, the equitable mortgage should be accepted only after
obtaining the original title deeds.
The law in England is slightly different. As between equitable mortgage and legal
(simple) mortgage, the latter prevails even though it is effected subsequently. The law,
- CAIIB DISCUSSION
regarding this is, as between law and equity, law prevails. As between the equities, the
prior in time prevails.
4. Difference between Equitable Mortgage and Pledge
Table 14.1: Difference between Equitable Mortgage and Pledge
Pledge Mortgage
Pledgee acquires only a limited interest in the property and ownership remains with the
right of pledger.
The Pawnee has 'special property' in the goods pledged and can sell the same in the
event of default by the pledger of course, after giving reasonable notice. Pawnee has no
right of foreclosure. He can only sell the property to realise his dues. Here the legal
ownership passes to mortgagee, of course, subject to the mortgagor to redeem the
property. The mortgagee as a rule takes decree of a Court of Law before having recourse
against the property mortgaged. In certain cases, the mortgagee can foreclose the
property.
5. Priority of Mortgages: Indian Law of Priorities is provided in Section 48 of the
Transfer of Property Act. The rule is based on maxim 'He has a better title who was first
in point of time.' It lays the
160
general rule regarding priority of rights created by transfer by a person at different times
in or over the same immoveable property and provides that, as between such rights, each
later created right is subject to the rights previously created. We may further see, as how
the rule of priorities operate in respect of different instruments creating mortgages.
(a) Priority among registered instruments: Section 47 of the Registration Act, 1908
provides
that a registered document operates, not from the date of its registration, but from the
time
of its execution. Thus, a document executed earlier, though registered later than another,
has priority over the documents executed later.
(b) Priority between registered and unregistered instruments: Let us now deal with
the exceptions
to the rule that priority is determined by order of time which either have been created by
statute or owe their origin to the ancient rule of Hindu Law, which required delivery of
possession in the case of a security of land. There are also some exceptions recognised in
the Indian system founded upon those general principles of justice and equity, which in
the
absence of any express enactment, Indian judges are bound to administer, and which
have
been mostly borrowed from the English Law.
The first exception is that contained in Section 50 of the Registration Act which under
certain circumstances allows a registered mortgage priority over unregistered mortgage.
However, it may be noted that prior mortgage by deposit of title deeds is not affected by
subsequent registered mort¬gage as the same need not be registered. This is provided in
Section 48 of Indian Registration Act.
6. Limitation Period in Mortgages: Article 62 of the Indian Limitation Act, 1963
provides limitation period for filing of suit for recovery of mortgaged debt and sale of
mortgaged property in the event of non-payment of the mortgaged debt. Article 63(a) of
the said Act provides a limitation period, in case of foreclosure of the mortgaged
property. The limitation period for filing a suit for sale of mortgaged property is
TWELVE YEARS, from the date the mortgage debt becomes due. The limitation period
for filing suit for foreclosure is THIRTY YEARS from the date the money secured by
mortgage becomes due.
Enforcement of Mortgage - Some Important Aspects
- CAIIB DISCUSSION
We will now learn some important aspects as to enforcement of mortgage. It may be

noted that a banker, secures moneys advanced by creating one of the various types of
mortgages mentioned above. Popular types of mortgages obtained by a banker are:
(i) Mortgage by deposit of title deeds (ii) Simple mortgage and in some cases
(iii) English mortgage.
Enforcement of all these types of mortgages is by way of filing a suit for sale of
mortgaged properties. The procedure for filing a suit for a sale is provided for in the
Code of Civil Procedure, 1908. The Section 16(c) of the Civil Procedure provides that a
suit for sale of mortgaged property shall be filed in the Court within whose jurisdiction
the mortgaged property is situated. Order 34 of the Code provides for various things to
be adhered to while filing suit for sale of mortgaged property. When a suit for sale is
filed, the Court after hearing the parties passes a preliminary decree. Through the
preliminary decree it directs the mortgagor to pay the mortgage debt within a certain
period and in the event of his failure to pay the money due under the mortgage, the Court
orders for sale of mortgaged properties by passing a final decree. After passing of the
final decree, the mortgagee with the help of the Court gets the mortgaged property sold
in execution of the mortgage decree.
14.3 LET US SUM UP
1. Mortgage is a transfer of interest in immoveable property to secure an advanced loan,
or an existing debt or a future debt or performance of an obligation.
161
2. Transfer of Property Act, contemplates six types of mortgages, they are:
(a) Simple mortgage (b) Mortgage by conditional sale
(c) Usufructuary mortgage (d) English mortgage
(e) Mortgage by deposit of title deeds (f) Anomalous mortgage
3. In Simple mortgage, the mortgage is by deposit of title deeds and in English
mortgage, the
possession of the mortgaged properties is not given to the mortgagee.
4. In usufructuary mortgage and in mortgage by conditional sale, possession of
mortgaged
is normallyproperties
given to the mortgagee.
5. In the case of simple mortgage and mortgage by deposit of title deeds, the
mortgagee has a right
to proceed against the property mortgaged and also personally against the mortgagor.
6. Mortgage is to be created by way of deed and requires to be registered under
the Registration Act.
7. Mortgage by deposit of title deeds, is not required to be created by way of a
deed and does not
require registration.
8. The rule of priority in case of successive mortgages is in the order of time they
are created.
9. Limitation period for filing a suit for sale of mortgaged property is twelve years
from the date
mortgage debt becomes due.
10. Limitation period for filing a suit for foreclosure is thirty years from the date
mortgage debt
becomes due.
11. Enforcement of mortgage is governed by the Code of Civil Procedure, 1908.
Suit for sale of
mortgaged properties are to be filed in the Court, within whose jurisdiction the mortgage
property
is situated.
- CAIIB DISCUSSION
12. In a suit for sale, of mortgaged properties, the Court first passes a preliminary
decree and thereafter
a final decree.
1. Mortgage is
in the immoveable property.
2. Simple mortgage is created by an instrument in writing. (True/False)
3. Mortgage by deposit of title deeds is required to be registered. (True/False)
4. In the case of usufructuary mortgage the possession of the properties is given.
(True/False)
5. In mortgage by way of conditional sale the property is sold with a condition for
re-conveyance.
(True/False)
6. All successive mortgages created will rank equally and no mortgage will have a
greater priority
over the other. (True/False)
7. To decide as to which mortgage will have priority over the other in the case of
two or more
mortgages on the same immoveable property, the date of mortgage is pertinent.
8. Limitation period for filing a suit for sale of mortgaged properties is years
from the
date the mortgage debt becomes due.
9. Mortgage suits are filed in the Court within whose jurisdiction the mortgagee
resides. (True/
False)
!• transfer of interest; 2. True; 3. False; 4. True; 5. True; 6. False; 7. execution of; 8.
twelve; 9. False
LAW RELATING TO SECURITIES AND MODES OF CHARGING - II
STRUCTURE
15.0 Objectives
15.1 Introduction
15.2 Pledge
15.3 Hypothecation
15.4 Let Us Sum Up
164
15.0 OBJECTIVES
• the law relating to security of pledge and hypothecation;
• basic features of pledge and hypothecation.
15.1 INTRODUCTION
A banker, in his business of lending takes security of pledge and hypothecation of
moveable goods to secure cash credit and overdraft. These are popular securities
obtained by a banker. In this unit, we will learn about the law relating to security of
pledge and hypothecation.
15.2 PLEDGE
- CAIIB DISCUSSION
'Pledge means bailment of goods for purpose of providing security for payment of debt
or performance of promise' (as per the Section 172 of Contract Act 1872).
As per the above definition to constitute a valid pledge, three requirements are to be
satisfied:
1. There must be bailment of goods (bailment means delivery of goods);
2. The bailment must be, by or on behalf of the debtor; and
3. The bailment, must be for the purpose of providing security for the payment of
a debt or performance
of promise.
The person, whose goods are bailed is called the Pawnor, the person who takes the goods
as security is called the Pawnee.
1. Legal Implications of a Pledge: The following are the legal implications of a pledge:
(a) The ownership of the property is retained by the pawnor, which is subject only
to the
qualified interest which passes to the pawnee by the bailment.
(b) One of the main and most essential requirements of a pledge is the actual or
constructive
delivery of the goods to the pawnee. By constructive delivery, it is meant that there need
be
no physical transfer of goods from the custody of the pledger/pawnor to the pawnee. All
that is required is, that the goods, must be placed in the possession of the pawnee or of
any
person authorised to hold them on his behalf.
Goods, may be delivered by one of the following ways (as mentioned in the Sale of
Goods Act):
(i) By handing over the key of the godown in which the goods are kept.
(ii) By attornment, i.e. if goods are in public warehouse, the warehouseman
acknowledges to the pawnee that he will hold the goods thereafter on behalf of the
pawnee.
(iii) Handing over the document of title to goods, such as railway receipt, bill of lading,
warehouse
(iv) Even ifreceipts,
the goodsetc.
are in possession of the pawnor, he may acknowledge that he
holds them thereafter for and on behalf of the pawnee. This is again similar to
attornment. Thus, delivery may be physical, when goods are physically transferred or
symbolic as in the case of handing over the key to the godown, where the goods are
stored so as to be out of the control of the pawnor or constructive as in the case of an
attornment.
In the case of Co-operative Hindustan Bank Ltd. vs Surendar Nath Dey AIR 1932 Cal
524, it was observed that it is essential in a transaction of pledge that there must be a
delivery of goods to the pawnee and he must keep the goods. The delivery need not be
simultaneous with lending of money. It may be actual delivery or symbolic delivery, e.g.
by delivery of
165
key of the warehouse where the goods are stored or something may be done which is
equivalent to delivery that is keeping of goods without any actual delivery, as if the
pawnee has the possession or effect of possession.
(c) Pledge can be created only in the case of existing goods which are in the
possession of the
pawnor himself. There can be no pledge of future goods or goods which the pawnor is
likely to get into his possession subsequently. Since delivery is involved, goods must be
specific and identified.
(d) Possession of goods is the most important characteristic of pledge and
therefore, pledge is
- CAIIB DISCUSSION
lost when possession of the goods is lost.

However, the pawnee may release the goods after obtaining a letter of trust from the
pawnor. Such a letter of trust is known as the trust receipt. It is an instrument by which
the borrower receives the goods or documents of title to goods and undertakes to hold
them or the proceeds thereof, in trust for the lender. Because of the trust receipt, the
bankers, rights as a pawnee remains unaffected. Even if the borrower becomes insolvent,
the Official Receiver cannot claim the goods.
(e) An agreement of pledge may be implied from the nature of the transaction or
the
circumstances of the case. However, an agreement in writing clearly laying down the
terms
and conditions leaves no ambiguity.
2. Who can create a Pledge?
The following persons can make a valid pledge:
(a) Owner of the goods
(b) A mercantile agent, provided the following conditions are satisfied
(i) He should be in possession of the goods, or the documents of title to goods with the
consent of the owner.
(ii) The goods must have been entrusted to him in his capacity as a mercantile agent, (iii)
The mercantile agent should create the pledge in the ordinary course of his business
as such agent, (iv) The pawnee acts in good faith and has no notice at the time of pledge
that the pawnor
has no authority to pledge (as per Section 178 of Contract Act).
(c) Persons in possession of goods under a voidable contract, provided the contract,
has not
been rescinded at the time of pledge
(d) Seller of the goods, who continues to be in possession of the goods even after
sale, can create
a valid pledge. The pawnee must act in good faith and without notice of the previous
sale.
A pawnee
goods. Whencanthe
repledge thepawnor
original goods,repays
but it is
thevalid
debtonly to first
to the the extent of his
pawnee, interest
he is into
entitled such
the
return of the goods although they may be in the hands of the second pawnee to whom the
first pawnee has not repaid the debt.
3. Rights of Pawnee
(a) Right of retainer: As per Section 173 of the Contract Act, the pawnee can keep
the goods
pledged not only for the non-payment of the debt or non-performance of the promise, but
also for the interest on the debt and for all expenses properly and necessarily incurred for
the preservation of the goods pledged. This is similar to the rights of the bailee.
(b) Right to claim extraordinary expenses: In respect of such expenditure incurred
for
taking care of the pledged goods, he cannot claim lien over the goods but can only sue to
recover the goods.
166
4.
(c) No right to retain in respect of the other debts: In the absence of a contract to
the
contrary, the pawnee cannot retain the goods for a debt or a promise, other than the
promise
- CAIIB DISCUSSION
or debt for which they are pledged. However, in the case of subsequent advances made,
such a contract is presumed, in the absence of anything, to the contrary.
(d) Rights against third parties: A pawnee has the same remedies against third
persons, as
the owner himself would have, if he is deprived of his goods. (Morvi Mercantile Bank
Ltd.
vs Union of India AIR 1965 Supreme Court 1954.)
(e) Pawnee's right where Pawnor makes default in payment: In case where the
pawnor
makes default, the pawnee has three rights:
(i) He may sue the pawnor upon the debt or promise; (ii) He may retain the pawned
goods as collateral security; or (iii) He may sell it after giving the pawnor reasonable
notice of the sale.
The right to retain the pawn(pawned goods) and the right to sell it are alternative and not
concurrent rights. While the pawnor retains, he does not sell and when he sells he does
not retain. However, 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 the pawn does
not exclude this right of suit, since the pawn is a collateral security only.
In Nanak Chand Ramkrishandas vs Lalchand Ganeshilal AIR 1958 Punj. 222, it was
held that a pawnee may keep the goods as security for the debt due to him from the
pawnor and although he has got the right to sell after notice to the pawnor, he is not
bound to sell at any particular time. The mere fact that the pawnee gave a notice that he
would sell the goods cannot possibly be a compelling factor for sale to be effected. If the
goods are sold, by the pawnee without a notice, as provided by this Section, they will be
deemed to have been converted and an action for conversion of the same would lie
against the pawnee; but damages would be assessed, by taking into consideration the
market rate of the goods in question as on the date of conversion, which ordinarily,
would be the date on which the goods were wrongfully sold. In case of an improper sale,
the pawnee is liable for conversion, but the sale cannot be set aside.
Whether two notices must be given
It was held
notice in an
is only A. intimation
Srinivasaluofvsthe
Gajaraj Mehta
proposed &by
sale Sons
the1990
pawnee(II)and
MLJR
it is188, that a sale
not necessary
that such notice must be pr oceeded by another notice informing the pawnor that on his
not making payment the goods would be sold. The sale notice also need not be signed by
the pawnee or the amount due be mentioned.
If the goods are sold by the pawnee after giving reasonable notice, the pawnor is entitled
to receive from him any surplus over and above the debt amount.
The pawnor has a right to redeem the goods even though the time stipulated for payment
is over, provided the goods have not been sold by the pawnee.
Duties of Pawnor:
(a) He must disclose to the pawnee any material faults or extra ordinary risks in the
goods to
which the pawnee may be exposed. Failure to disclose makes him responsible for
damages
for any loss caused to the pawnee.
(b) The pawnor must reimburse the pawnee for any expenses incurred for the
preservation of
the goods.
(c) In the case of forced sale, if the amount realised is less than the debt due from
the pawnor,
he is liable to make good the balance.
- CAIIB DISCUSSION
167
5.
6.
(d) When the goods ar e pledged, there is the implied condition that the pawnor has title
to the goods pledged. However, in practice the banker obtains the pawnor's signature to a
document known as an agreement of pledge. The following are the important points
usually covered in the document:
(i) The pledge is in respect of all the goods delivered and upon all documents of title to
goods deposited by the pawnor (ii) A declaration that the securities deposited would
cover the existing and future debt,
interest and expenses (iii) The letter stipulates that it will be a continuing security
without the operation of the
rule in Clayton's case, (iv) Pawnors title to the security is clear, that the goods will be
insured adequately at his
expense and that sufficient margin will be maintained as agreed upon, (v) A promise to
pay all the money secured by the pledge on demand, and in the case of
default in repayment, the bank to have the right of sale, (vi) Where the pawnor fails to
insure the goods, the banker reserves the right to effect
such insurance and debit the premium and other charges to the account of the customer,
(vii) A declaration by the pawnor not to hold the bank responsible for the default of any
broker employed to sell the goods. The pawnor undertakes to pay the rent and other
charges incidental to warehousing, (viii) The banker reserves the right of general lien
and nothing in the agreement, shall be
construed as excluding such right, (ix) The pawnor undertakes to submit periodical
statements of stocks and to allow inspection
of the goods and records by the bank, all at his cost.
Advantages of Pledge:
(a) The goods are in the custody of the pawnee and, therefore, it is easy to sell in
case of If the banker takes proper precautions, through periodical inspections, it will not
default.
be
possible for the pawnor to create subsequent charges against the same goods.
(b) Because of close supervision, it will not be possible for the pawnor to
manipulate the
stocks.
(c) Even if the goods are lost, the banker can recover the amount under the
insurance policy.
(d) The formalities connected with the pledge are simpler than in the case of
mortgage.
Precautions to be taken:
(a) To ensure that the pawnor has the title to goods.
(b) To ensure that the contract of pledge is complete in all respects and
incorporates the already
referred to usual clauses.
(c) To exercise full and effective control over all the goods pledged.
(d) To put up a signboard at the godown prominently displaying, that the goods are
pledged to
the banker.
(e) To take reasonable care of the goods as a man of ordinary prudence would
under similar
circumstances take of his own goods of the same bulk quantity and value of the goods
pledged. Any loss arising to the goods due to failure to take such care must is to be
- CAIIB DISCUSSION
compensated to the pawnor. In his own interest also, the banker must take such care so
that
the value of security is not eroded.
(f) Banker must make periodical inspections to verify the quality, quantity, value,
etc., of the goods
and ensure the maintenance of reasonable margin throughout the period until the debt is
repaid.
168
7. Cases Relating to Pledge
(a) Morvi Mercantile Bank Ltd. vs Union of India AIR 1965 SC 1954. In this case
M/s Harshadrai
Mohanlal & Co., a firm, entrusted on 4 Octobe, 1949 to GIP Railway, 4 boxes of
menthol
crystals belonging to the firm for transport from Thane to Okhla near Delhi. Further, on
11
October 1949 the firm sent two more boxes to Okhla from Thane through the railways.
The
firm was issued railway receipts. The firm endorsed the railway receipts in favour of
Morvi
Mercantile Bank. On failure of railways to deliver the goods, the bank, claiming as an
endorsee
of the railway receipts for valuable consideration, filed a suit against railways for
recovery of
the value of the goods.
The Supreme Court delivering a judgement in appeal, decided that the bank was entitled
to recover the value of goods for the following reasons:
(i) Valid pledge can be created by endorsement of railway receipts.
(ii) For a valid pledge, actual delivery is not necessary and constructive delivery is
sufficient, (iii) By endorsing the railway receipts, the firm created a valid pledge in
bank's favour,of(iv)
all the rights Pledge being the bailment of goods, the bank as a pledgor will have
owner
of goods, (v) Hence, the bank is entitled to recover value of goods from the railway as a
pledge.
(b) Lallan Prasad vs Rahmat Ali and Another AIR 1967 SC 1322. The question
decided in this
case was whether a pawnee can file a suit for recovery of debt due to him if the pawnee
lost
the goods pledged to him. In this case, on 10 January 1946, Lallan Prasad gave a loan of
Rs
20,000 to Rahmat Ali. Lallan Prasad also obtained a pledge of 147 tonnes of aero-scraps
from
Rahmat Ali. On failure to repay the loan, Lallan Prasad filed a suit against Rahmat Ali
for
recovery. Rahmat Ali argued that Lallan Prasad is not in a position to deliver the goods
pledged and he should not be granted a decree for recovery of money.
Supreme Court after analysing the facts of the case rendered a judgement that a pawnee
under the Contract Act is entitled to retain the goods pledged and file a suit for recovery
of the money. However, this right of pawnee can be countenanced only when pawnee is
in a position to return the goods pledged, when pawnor repays the debt. A pawnee
cannot be allowed to have a decree for recovery, if he is not willing to return the goods
pledged.
(c) Bank of Bihar vs State of Bihar AIR 1971 SC 1210. In this case the rights of
pawnee came up
- CAIIB DISCUSSION
for consideration of the Court. In this case, Bank of Bihar lent moneys and took security
by
way of pledge of different varieties of sugar. Government of Bihar seized the bags of
sugar
from the borrower and sold them to recover Government dues. The bank filed a suit for
recovery of moneys due to it against Government of India.
The Supreme Court deciding the case, held that right of bank as a pawnee cannot be
taken away by government and hence, the Government of Bihar shall pay the amount
due to the bank.
(d) Standard Chartered Bank vs Custodian AIR 2000 SC 1488. In this case, the
Supreme Court
held that, if during the pledge there is an increase in value of the goods pledged, the
pawnee
is entitled to the increase, as an integral part of his security. In this case, the shares and
debentures were pledged with the bank and these shares and debentures were entitled to
bonus, dividend and interest. The Supreme Court held, that these accretions formed part
of
the pledged property and as such the pawnee is required to return the same only when
the
pledged goods were returned and in case of pawnor's default in payment of debt, the
pawnee
has the right to sell the pledged property along with the accretions after giving
reasonable
notice to the borrower.
169
15.3 HYPOTHECATION
Until recently there was no legislative definition of the term 'hypothecation'. This term
came to be defined in the S ARFAESI Act, 2002. As per the definition contained in the
Act, the term 'Hypothecation' means a charge in or upon any moveable property, existing
or future, created
possession of the by a borrower
moveable in favour
property of acreditor,
to such securedas
creditor, without
a security delivery of
for financial
assistance and includes floating charge and crystallisation of such charge into fixed
charge on moveable property.
The mortgage of moveable property is called 'Hypothecation'. It may be described as 'a
transaction whereby money is borrowed by the debtor (owner of the goods) on the
security of the moveable property without transferring either the property or the
possession to the creditor'. Hart describes hypothecation as 'a charge against property for
an amount of debt where neither ownership nor possession is passed to the creditor'.
Hypothecation differs from pledge because goods remain in the possession of the
borrower and are equitably charged in favour of the creditor under documents signed by
the borrower. However, the document provides for a covenant, whereby the borrower
agrees to give possession of the goods when called upon to do so by the creditor. Once
the possession is given up, the charge becomes transformed into pledge.
Hypothecation differs from mortgage in two respects. Firstly, mortgage relates to
immoveable property whereas hypothecation relates to moveables. Secondly, in a
mortgage, there is transfer of interest in the property to the creditor but in hypothecation
there is only obligation to repay money and no transfer of interest.
Facility limited to respectable customers
Law permits hypothecation of assets as a security by sole proprietorships, partnerships,
joint stock companies and even individuals. However, the charge being only equitable
without possession, the facility is normally granted to customers of undoubted integrity.
There is less risk when such a facility is granted to a joint stock company because of the
registration of such a charge with the Registrar of Companies. Such a registration
- CAIIB DISCUSSION
constitutes a constructive notice to the world at large, but such a facility is not available
in the case of other forms of business.
Hypothecation is resorted to in the following cases:
(a) When loan is to be raised against work-in-progress, the only way of creating a
charge is
hypothecation.
(b) It is also done in respect of goods which require constant handling in a factory,
e.g. rice mills, oil
expellers, etc.
(c) This charge is also convenient, where lending is to be done against goods in a
shop or showroom
which are required in day-to-day business.
1. Drawbacks of Hypothecation
(a) The fundamental difficulty about this charge is that goods remain in the
possession of the
borrower and therefore the creditor's control over such goods is almost nil. This may
give
rise to fraudulent dealings in such goods by the borrower.
(b) The borrower may realise stocks hypothecated and pay to other creditors. He
may even sell
marketable stocks and keep only obsolete and slow moving stocks for the banker to
realise.
Thus erosion of security can take place.
(c) The borrower may hypothecate the same stock with more than one banker or
having
previously hypothecated, the goods may subsequently be pledged to another creditor.
(d) The realisation of the assets in case of default of payment is a difficult,
prolonged and costly
affair. As stated earlier, the banker may find only obsolete and slow-moving items.
170
(e) According to Section 534 of the Companies Act, 1956, any floating charge on the
undertaking or property of the company created within a period of twelve months
preceding the commencement of the winding up, becomes invalid under certain
circumstances.
2. Precautions to be taken in the case of Hypothecation: Although these disadvantages
seriously limit the value of hypothecation as a security, the banker can take certain
precautions and avoid at least some of the disadvantages. The following precautions
usually are taken by banks:
(a) Banks ensure that the borrower is not enjoying hypothecation facilities from
other banks and is
confining his borrowings to only one bank. An undertaking to this effect is obtained
from the
borrower in writing. Banks also ensure that boards are prominently displayed on the
premises
where the goods are stored stating that the goods are hypothecated to the bank.
(b) In the case the borrower is a company registered under the Companies Act, the
charge by
way of hypothecation must be registered within a period of thirty days of its creation or a
further period of thirty days on payment of fine. If this is not done, the charge would be
void against the liquidator or any other creditor of the company.
(c) The banker must obtain periodical statements of stocks with a declaration
regarding the
borrower's clear title to the goods and the correctness of the quality, quantity and
- CAIIB DISCUSSION
valuation.
Banks should not merely be content with the receipt of the stock statements, but should
also
effectively supervise the goods hypothecated and the financial position of the borrower
from
time to time. Banks should verify in such an inspection that there is no depreciation in
the value
of the security or any adverse change in the borrower's financial position. If an
inspection
discloses such a state of affairs, the banker should take appropriate action immediately.
Deed of Hypothecation: While lending against hypothecation of goods, bankers obtain a
letter of hypothecation which serves as the hypothecation agreement and contains
several clauses to protect the banker's interest under all contingencies. It is a very
comprehensive document and contains the following important clauses:
(a) The request made by the borrower for the grant of accommodation in the form
of loan or
cash credit on the hypothecation of goods, resulting in the agreement.
(b) The description of the goods in a separate statement giving the particulars,
quality, rate,
quantity, market value and an undertaking that the particulars are true and that the
borrowers
are the absolute owners of the property and with authority to hypothecate. The statement
also declares that the goods are not subject to any lien, claim or charge of any sort.
(c) An undertaking that no further charge or encumbrance will be created on the
goods and that
all money realised by way of sale proceeds or realisation of insurance claims, will be
held
exclusively as the bank's property and such money will be paid in, to the satisfaction of
the
balance due and owing on the account kept by the bank in respect of such
accommodation.
(d) The borrower, whenever required by the bank, must give full particulars of all
his assets
and of the hypothecated goods. He must, at all times allow the bank or its authorised
agent
to inspect the hypothecated goods and all records of the borrower. All costs, charges and
expenses incurred by the bank in respect of such an inspection are to be paid to the bank
on
demand, failing which, the amount and interest thereof will be a charge upon the
hypothecated
goods.
(e) The borrower undertakes to insure the goods against risks specified by the
banker at his
cost. The policy so taken is to be endorsed and assigned in favour of the bank.
(f) The borrower undertakes to maintain the agreed,margin of security at all times
during the
continuance of the security.
(g) The borrower undertakes to pay all rents, taxes, payments and outgoings in
respect of the
immoveable property, in which the hypothecated goods are kept.
171
(h) The bank reserves the right to call upon the borrower to pay to the bank the loan
amount together with interest and other charges at any time. In the event of default, the
- CAIIB DISCUSSION
bank reserves the right to dispose the hypothecated stocks and apply the proceeds in
satisfaction of the loan amount. If the proceeds are insufficient, it reserves the right to
recover the balance from the borrower.
(i) The borrower undertakes not to dispute the correctness of any sum due to the banker
as stated in the demand made by the banker under the hypothecation agreement.
(j) A clause stating that the security shall be a continuing security for the balance due to
the bank from time to time. Where by any chance, the cash credit results in a credit
balance, it is not to be considered to be closed for the purpose of the security. In other
words, the security is not treated as exhausted simply because the cash credit showed a
credit balance at any time.
15.4 LET US SUM UP
1. Pledge means bailment of goods for the purpose of securing a payment of debt
or an obligation.
2. Pawnee has special property rights in the goods pledged.
3. A valid pledge can be created by owner of goods or a mercantile agent.
4. A constructive pledge involves only delivery of keys of the warehouse.
5. Under the contract of pledge, the pawnee can sell the goods pledged after notice
or retain the
goods and file a suit for recovery of debt.
6. Mortgage of moveable property is called Hypothecation.
1. Pledge means of goods for purpose of securing a payment of debt or
performance
of promise, (fill with appropriate words)
2. The most important characteristic of pledge is of goods, (fill with
appropriate words)
3. Owner of goods cannot make a pledge. (True/False)
4. Hypothecation is an implied pledge in cases where constructive possession of
goods is given.
(True/False)
5.
default. Hypothecation letter gives a banker right to possession of goods in the event of
(True/False)
1. bailment; 2. possession; 3. False; 4. True; 5. True.
DIFFERENT TYPES OF BORROWERS
STRUCTURE
16.0 Objectives
16.1 Introduction
16.2 T^pes of Borrowers
16.3 Let Us Sum Up
16.4 Keywords
174
16.0 OBJECTIVES
- CAIIB DISCUSSION
• the legal aspects pertaining to different borrowers;

• the laws governing various types of borrowers.
16.1 INTRODUCTION
One of the prime functions of a banker is lending money. In its business of lending
money, a banker shall acquaint himself with various laws governing different types of
borrowers. The borrowers of a bank may be Individuals, partnership firms, Hindu
Undivided Family, Companies' and other Corporate entities. This unit deals with various
laws that banker should acquaint himself in his business of lending.
16.2 TYPES OF BORROWERS
Types of borrowers, for the convenience of our study, can be classified as follows:
1. Individual 2. Partnership Firm
3. Hindu Undivided Family 4. Companies
5. Statutory Corporations 6. Trusts and Co-operative Societies
1. Individual: An Individual borrower is one of the constituents of a bank in its business
of lending. When a banker lends to an individual, he should verify certain facts, so that
the bank's lending is not affected.
One of the essential elements of a contract is the capacity of the parties to contract. The
bank, while lending to an individual should ensure that he is competent to enter into
contract. Money lent to an individual who is not competent to contract cannot be
recovered in the following circumstances:
(i) If an individual is a. minor: A person who has not attained the age of eighteen years
under Indian Majority Act and twenty-one years if he is a ward, under the Guardians and
Wards Act, is considered a 'Minor' in the eyes of law. Under the law a 'minor' is not
competent to contract. Therefore, if a banker lends money to a minor, then the same,
cannot be recovered, if the minor fails to r epay.
Exceptions:
The only exception recognised in a contract with a minor is of supply of necessities to
him. If a bank lends money to a minor to meet the expenses for purchasing necessities of
life, then bank can recover the money from the estate of the minor.
(ii) If an individual is not of sound mind: If a person is not of a sound mind, then he is
incompetent
considered notto of
enter intomind
sound a contract. The
if, at the Contract
time Actmakes
when he says that
the acontract,
person will
he isbe
not
capable of understanding it and of forming a rational judgement as to its effect upon his
interests.
Notice that a contract entered, would be invalid if proof is shown that the borrower at the
time of entering into contract was not in sound state of mind and could not understand
what he was doing and could not understand the implications of entering into contract.
(iii) Disqualified persons: There may be statutory disqualifications imposed on certain
persons in respect of their capacity to contract. For example, a person, declared as
insolvent under the Insolvency Law. As long as the person continues to be a non-
discharged insolvent, he cannot enter into contract. The contracts entered into by such a
person are not enforceable.
175
In our country there are various businesses and economic activities conducted by a
single person which are called sole proprietary concerns. In the eyes of the law there is
no distinction between the assets and liabilities of the person and the business conducted
in the name of the sole proprietor.
2. Partnership Firm: 'Partnership Firm' is another entity with which a banker deals within
the course of his business. The Indian Partnership Act, 1932 governs the 'Partnership
Firm'. Section 4 of the Act says, that a partnership is the relation between persons who
have agreed to share the profits of a business, carried on by all or any of them acting for
all. The relationship between the partners is governed by partnership deed.
Legal position of a partnership
- CAIIB DISCUSSION
A partnership is not distinct from its partners. Under the law, the name of a partnership
firm, is regarded as an abbreviation of the names of partners. The Indian Partnership Act,
1932, provides for registration of a partnership and it is necessary that a banker dealing
with a partnership firm should verify as to whether the firm is registered or not. This
would help him know all the names of partners and their relationship.
Authority of the partners
Section 19 of the Indian Partnership Act, 1932 deals with the implied authority of a
partner as an agent of the firm and Section 22 deals with the mode of doing acts to bind
the firm. In view of the provisions of Sections 19 and 22, it should be noted that the acts
of a partner shall be binding on the firm if they are done:
1. in the usual business of the partnership,
2. in the usual way of the business, and
3. as a partner, i.e. on behalf of the firm and not solely on his own behalf.
Business of partnership firm; How is it done?
In the case of a partnership firm, rights and duties of the partners are determined by the
deed of partnership. It provides for opening of bank accounts, borrowing powers, signing
of cheques, etc. Generally, there may be a managing partner who conducts the business
on behalf of the other partners. A banker dealing with a partnership firm, should ensure
that the business is conducted as per the partnership deed. If the managing partner does
not have the powers to conduct certain transactions then, it should be ensured, that
consent of all partners are obtained.
Partnership firm and transactions in immoveable property
Section 19 of the Indian Partnership Act, 1932 states that a partner cannot affect the
transfer of immoveable property of the firm unless expressly authorised. A banker taking
a mortgage security of firm's immoveable property should ensure that the partner who is
creating the mortgage is expressly authorised to create the mortgage. If the partner, has
no authority to create the mortgage, then the banker should ensure that all the partners
jointly create the mortgage.
Insolvency of the firm
The banker, on receiving notice of insolvency of the firm, must immediately stop any
further
debit. Intransactions in athe
case there is account
credit irrespective
balance, and the of the fact
banker doesthat
notthe account
intend is off
to set in credit or
the same
against the dues in any other account, then the balance has to be handed over to the
official receiver appointed by the Court or as directed by the Court. In case the account
is in debit then the banker would be required to prove his debt before the Court and
thereafter will be entitled to receive the same from the Official Receiver either in full or
as per the dividend declared by the Courts.
176
Insolvency of the partner
If at the time of insolvency of one of the partners, the firm's account is in credit then the
other partners can operate the same, but the banker should obtain a fresh mandate and all
previous cheques issued by the insolvent partner may be paid provided the other partners
confirm the same. In case, the account is in debit then further transactions in the account
should be stopped so that the rule in Clayton's case does not apply.
Death of a partner
In case of death, the principles as stated in Insolvency of a partner applies. Since the
death of a partner dissolves the partnership firm, upon receipt of such information, banks
are required to stop the transactions of the firm in a running credit facility like cash
credit, overdraft to crystllise the liability of the deceased partner and make his/her estate
liable for its dues. Banks allow the transactions in a separate account so that the business
of the firm is not adversely affected.
3. Hindu Undivided Family: 'Hindu Undivided Family' otherwise known as 'Joint Hindu
Family' is a creature of Customary Law among Hindus and is governed by personal
- CAIIB DISCUSSION
laws. In Bengal and other parts of erstwhile Bengal province, a Hindu Undivided Family
is governed by Dayabhag Law. In other parts of India, it is governed by Mitakshara Law.
Constitution of a Joint Hindu Family
A joint Hindu Family consists of male members descended lineally from a common
male ancestor, together with their mothers, wives or widows and unmarried daughters
bound together by the fundamental principle of family relationship which is the essence
and distinguishing feature of institution. The Joint Hindu Family, is purely a creature of
law and cannot be created by an act of parties.
Law governing Joint Hindu Family
Joint Hindu Family is governed basically by two schools of thought. They are Dayabhag
and Mitakshara schools.
The law governing Joint Hindu Family is codified under Hindu Code and now,
succession among Hindus is governed by the Hindu Succession Act, 1956. Though
Hindu Code changed the law applicable to Hindus substantially, the spirit of joint family
concept is retained; Women are also made members of the Family as its male members.
It is to be noted that a woman member also inherits properties at par with a male member
and is treated as co-parceners.
Management of business of a Joint Hindu Family
In a Joint Hindu Family, for as long as members remain undivided, the senior most male
member of the family is entitled to manage the family properties. He is called 'Manager'
or 'Karta' of the joint family.
In a Hindu Family, the 'Karta' or Manager, occupies a position superior to that of the
other members insofar as he manages the family property or business or looks after the
family interests on behalf of the other members. The managership of the joint family
property comes to a person by birth and he does not owe his position as manager on the
consent of other co-parceners. The liability of the 'Karta' is unlirftited, whereas the
liability of the co-parceners is limited to their shares in the joint family estate.
Powers and duties of the manager
A manager or 'Karta' of a joint family has the following powers and duties:
177
Powers
(a) Right to possession and management of the joint family property
(b) Right to income from the joint family property
(c) Right to represent the joint family
(d) Right to sell the joint family property for family purpose.
Duties
(a) Duty to run the family business and manage the property for the benefit of the
family
(b) Duty to account for the income from the joint family business and property.
Banker and his dealings with joint family
(a) A banker dealing with a Hindu Undivided Family, should know the 'Karta' of
the family.
(b) Banker should ensure that 'Karta' of the joint family deals with the bank and
borrows only for
the benefit of joint family business.
(c) The application to open an account must be signed by all the members and all
adult members
should be made jointly and severally liable for any borrowings or if the account gets
overdrawn.
- CAIIB DISCUSSION
4. Companies: A company is another type of borrower, which a banker deals with in his
business of lending. A company is a juristic person created by law, having a perpetual
succession and Common seal distinct from its members. A company, depending upon its
constitution is governed by various laws.
Basic laws governing company
In India, companies are governed by the Companies Act, 1956. Companies as per the
Companies Act, 1956 are required to be registered under the Act. Section 11 of the
Companies Act provides that an association or partnership consisting of more than ten in
the case of banking business and more than twenty in the case of other business, shall be
registered under the Companies Act. If not registered, the said association or partnership
will be illegal.
Incorporation of company
Section 12 of the Companies Act, 1956 provides that any seven or more persons or
where a company formed is a private company, any two or more persons can form a
company, by subscribing their names to the Memorandum of Association.
Requirements of forming a company
The business and objects of a company and the rules and regulations governing its
management are known by two important documents called 'Memorandum of
Association' and 'Articles of Association'. Therefore, for the formation of a company
these documents are essential. What is Memorandum of Association?
The memorandum of association is the charter of the company. Its purpose is to enable
the shareholders, creditors and those dealing with the company to know its permitted
range of business.
Memorandum of Association of a company contains the following details among others:
(a) Name of the company
(b) State in which the registered office of the company is to be situated
(c) Objects of the company
(d) Liability of the members and
(e) Share capital and its division.
What is Articles of Association?
Articles of Association are rules and regulations governing the internal management of
the company.
178
They define the powers of the officers of the company. Articles of Association are
subordinate to Memorandum of Association and it contains the following details among
other things:
(a) Number of directors of the company
(b) Procedure for conducting meetings of the shareholders, board of directors, etc.
(c) Procedure for transfer and transmission of shares
(d) Borrowing powers of the company
(e) Officers of the company and other details.
Types of companies
(a) Private company: According to the Section 3(1) (iii) a private company is one
which contains
following provisions in its Articles of Association:
(i) Restrictions on the right to transfer its shares
(ii) Limitation on number of members to fifty, excluding the people, who are employees
and ex-employees of the company (iii) Prohibition as to participation by general public
in its capital requirements.
(b) Public company: A public company is one, which is not a private company.
That is, a
public company does not have any restrictions of the private company and its main
features
- CAIIB DISCUSSION
are as follows:
(i) Shares are freely transferable
(ii) No restriction on number of members
(iii) Public at large can participate in its share capital.
The public companies can be further classified as:
(i) Limited liability company (ii) Unlimited liability company (iii) Limited by
guarantee.
It can be seen from the classification itself that in a limited liability company, liability of
the members is limited to their contribution of capital. In the case of unlimited liability
company, the liability of the members is unlimited. In the case of guarantee companies,
the liability of members is not limited to the extent of the amount guaranteed by them.
(c) Government company: A company in which Central Government or State
Government or
both has not less than fifty-one per cent of the share capital, is called Government
Company.
(d) Other companies: Besides the above, Companies Act, 1956 classifies
companies on the
basis of time, place of incorporation and nature of working of share capital into the
following
categories:
(i) Existing company (ii) Foreign company
(iii) Holding company (iv) Subsidiary company, etc.
(i) Existing Company: A company, already existing before the coming into force of the
Companies Act, 1956.
(ii) Foreign Company: A company registered in a foreign country, (iii) Holding
Company: A company owning more than fifty per cent of share capital in
another company or a company, which can appoint the majority of directors in another
company, (iv) Subsidiary Company: It can be seen that when there is a holding
company, the other
company is called a subsidiary company.
We will study
precautions in detail
a banker in other
should chapters
take about incorporation
while lending to a company.of companies and the
179
ite to
tains
yees
is, a ures
the iny, yof
tor iny. the
ing
the
in
her
her
'
5. Statutory Corporations: Besides companies registered under the Companies

Act, 1956, there may
be corporations established by an Act of Parliament. These are called 'Statutory
Corporations'. For
example State Bank of India is established under State Bank of India Act, 1955.
- CAIIB DISCUSSION
Nationalised banks
are established under the Banking Companies (Acquisition and Transfer of
Undertakings) Act,
1970.
These statutory corporations are governed by the Acts under which they were
established. These Acts provide for making rules and regulations by the Government for
the corporation. The Act, rules and regulations define the scope, objects and range of
business of the corporations.
6. Trusts and Co-operative Societies, etc.
(i) Clubs, societies, schools and other non-trading associations: Such bodies, if not
incorporated under the laws governing them, cannot enter into any transactions. These
bodies are usually governed by the Companies Act or the Co-operative Societies Act and
function within the ambit of those laws. For example clubs can be registered either under
the Companies Act, 1956 or under the Societies Registration Act or the Co-operative
Societies Act. In the case of lending to these bodies, a banker should study the bye-laws,
rules and regulations applicable to them and ascertain the legality of lending to them, (ii)
Trusts: These are governed by the Indian Trusts Act, 1882, if they are private trusts and
by Public Trusts Act if they are public trust, or Religious and Charitable Endowments
Act, if they are trusts of Hindus and in the case of Muslims they are governed by Wakf
Act. A banker dealing with trusts should acquaint himself with the respective laws
applicable to them and should ensure that his lending is within the ambit of those laws,
(iii) Trustee: Trustees manage trusts. The powers and duties of the trustees are provided
in trust deed and are also regulated by the respective laws applicable to such trusts. For
example, in the case of public trusts, Charity commissioners, or commissioner of
endowments appointed by the Government, have the power to supervise the activities of
the trusts. The trustee of the Muslim Wakf is called Mutawali and his conduct and
functions are regulated by the Wakf Board. Therefore, a banker dealing with a trust
should ensure that all the permission required for taking a loan is obtained from
respective Government authorities.
16.3 LET US SUM UP
As a banker,
applicable it iswith
along necessary to be aware
the precautions to of
be the various
taken whiletypes of borrowers
dealing with them.and the laws
Borrowers
can be broadly classified in the following categories: individuals, partnership firms,
Hindu Undivided Family, companies, statutory corporations, trusts and co-operative
societies. The laws applicable to all these different kinds of borrowers are different.
Individuals are governed by the Indian Contract Act, partnership firms by the Indian
Partnership Act, Hindu Undivided Family by the customary law pertaining to Hindus,
companies by the Companies Act, statutory corporations by the Acts that created them,
trusts by the Indian Trusts Act, Public Trusts Act, Religious and Charitable Endowments
Act, Wakf Act and co-operative societies by the Co-operative Societies Act or the
Societies Registration Act. .
16.4 KEYWORDS
Memorandum of Association; Articles of Association; Company; Hindu Undivided
Family (HUF); Partnership; Trustee.
ms
L.R.A.B-13
180
1. Fill in the blanks.
- CAIIB DISCUSSION
(a) (b) (c) (d)

(e) (f) (g) (h)
(i)
Individual borrowers are governed by the Act.

In a Hindu undivided family the business of the family is managed by
A company is and from its members.
number of members and a maximum
A Private Limited Company has minimum
of numbers of members.
transferable.
A Public Limited Company shares are
Statutory corporations are established by Acts of
Private trusts are governed by the Act.
Act. Act.
Trusts of Hindus are governed by the _ Trusts of Muslims are governed by the

1. (a) Indian Contract; (b) Karta; (c) separate and distinct; (d) 2, 50; (e) freely; (f)
Parliament; (g) Indian Trusts Act; (h) Religious and Charitable Endowments Act; (i)
Wakf.
um
TYPES OF CREDIT FACILITIES
:nt;
STRUCTURE
17.0 Objectives
17.1 Introduction
17.2 Types of Credit Facilities
17.3 Cash Credit and Overdraft
17.4 Term/Demand Loans
17.5 Bill Finance
17.6 Let Us Sum Up
182
17.0 OBJECTIVES
• various types of credit facilities and the laws governing them;
• laws affecting credit facilities granted by the bank.
17.1 INTRODUCTION
Lending is a principal activity of a bank. The advances portfolio of a bank indicates its
dynamic perso¬nality. A banker to grow in the business of banking should have a
thorough knowledge of the requirements of his customer and should be in a position to
cater to the needs of the customer. It is common know¬ledge that a bank's existence
depends on its customer's need to borrow. A banker should be in a posi¬tion to identify
- CAIIB DISCUSSION
the needs of the customer for funds and mould the lending tool, according to the
requirements of the customer conforming to the laws of the land. Therefore, a banker for
his success as a lender is required to acquaint himself with various types of credit
facilities that are presently in vogue in business of lending and shall understand the legal
relationship existing under different credit facilities. In this unit, we will study different
types of credit facilities and their legal aspects.
17.2 TYPES OF CREDIT FACILITIES
We have seen earlier that the primary business of a bank is lending. The business of
lending is carried on by the bank by offering various credit facilities to its customers. We
can classify the credit facilities into 'Fund' based credit facilities and 'Non-Fund' based
credit facilities and customised credit facilities in the case of special constituents. We
know that Nationalisation of Banks ushered in a new concept in bank's lending and
added a dimension of social banking to business of lending by banks. Basically various
credit facilities offered by banks are generally repayable on demand. That being the case,
a banker, to ensure proper recovery of funds lent by him, should acquaint himself with
the nature of legal remedies open to him and law affecting the credit facilities provided
by him.
Credit facilities are broadly classified into two types based on funds outflow; they are:
1. Fund based credit facilities
2. Non-fund based credit facilities
1. Fund Based Credit Facilities: Fund based credit facilities involve the outflow of
funds meaning
thereby, the money of the banker is lent to the customer. They can be generally of
following types:
(a) Cash credits/overdrafts (b) Term loans/Demand loans
(c) Bill finance
2. Non-Fund Based Credit Facilities: In this type of credit facility the bank's funds
are not directly
lent to the customer and they include:
(a) Bank guarantee (b) Letter of credit facility
(c) Acceptance
These facility
have already been dealt with elaborately in other units and hence, are only
outlined here.
17.3 CASH CREDIT AND OVERDRAFT
A cash credit or overdraft is an arrangement by which a banker allows his customer to
borrow money up to a certain limit. This is the most popular mode of borrowing by the
large commercial and industrial concerns in India, on account of the inherent advantage.
A customer need not borrow at once, the
183
whole of the amount up to the limit as the same may not required from day one, but can
draw such amounts as and when required.
Cash credit/overdraft is a contract of a loan between a bank and its borrower. The
contract of cash credit or overdraft can be express or implied.
In the case of Bank of Maharashtra vs United Construction Co. & Others (1986),[ 60
Compo Cases 163 (Bom).] a customer overdrew his account. There was no written
contract for an overdraft. The bank demanded repayment of the moneys overdrawn with
interest. The customer refused to pay interest. The bank therefore, filed a suit for
recovery of the monies overdrawn with interest. The Bombay High Court held that there
is no need for express contract for an overdraft and directed the borrower to repay the
moneys with interest as there is an implied contract of an overdraft.
Rule in Clayton's Case
The credit facility, given in the form of a cash credit/overdraft is operated normally,
through a running account opened and kept by the customer. Whenever a customer
- CAIIB DISCUSSION
withdraws money, the account being debited for the amount and whenever the customer
pays, the account being credited. Under the law, each item of debit forms a separate loan
and each credit as a repayment of the earliest debits. This aspect of discharge of the debit
items by subsequent credits was first enunciated in a case, called the Clayton's case. In
that case, the Courts held that the first sum of money paid into the account, is deemed to
repay the first item recorded on the debit side of the account. For example, if there are
two items on the debit side of the customer's current account. A debit of Rs. 1,000 on 3
March and Rs 500 on 6 March, in a year and the borrower pays Rs. 750 on 12 March;
the sum will be appropriated first, by reducing the earlier debit of Rs. 1,000 rather than
discreating a charge the later debt of Rs. 500. This creates problems for recovery for the
bank. Hence, the bankers, to avoid the rule in the Clayton's case agree on the method of
appropriation and treat all debits as one debt.
Bank not to Terminate Overdraft Facility without Notice
Once a bank grants an overdraft facility, then there is a contract between the bank and
the customer that is not be cancellable unilaterally. The Gujarat High Court vs Indian
Overseas Bank considered this in M/s Narain Prasad Govindlal Patel (AIR 1980 Guj
158). In this case, a firm was enjoying temporary overdraft facility to a limit of Rs. 5,000
with the bank, for a period of four years. No document was executed nor was any
security furnished. The bank unilaterally, without notice, terminated the facility with the
result that a cheque drawn by the firm was dishonoured by the bank on the ground that
there was insufficient balance in the account. The firm claimed damages for wrongful
dishonour of the cheque. Both the Trial Court and the Appellate Court allowed the claim
of the firm. A further appeal by the bank to the High Court was dismissed, in which the
High Court observed:
The bank grants overdraft facility in order to earn interest. Its constituents enjoy the
overdraft facility in order to develop their business. Therefore, both are deeply interested
in such an arrangement. Such an arrangement - euphemistically called by Mr Chhatrapati
as a facility - is nothing but a contract. The contract, if it is well settled, can be inferred
from the conduct of the parties. The enjoyment of overdraft facility for a period of four
years unfailingly points to the conduct of the bank.
A temporary
sweet will of overdraft facility giving
the bank without is not one, which can be
its constituent terminated
a notice unilaterally
thereof. at the
It is temporary
because, it is not intended to be a permanent and everlasting arrangement. Sometimes, a
constituent is required to square up his account at the end of every half financial year -
30 June and 31 December. Merely because, the overdraft is called temporary overdraft, it
does not militate against the plaintiff drawing a cheque upon the bank in favour of its
constituent and in getting it honoured by the bank.
184
11
17.4 TERM/DEMAND LOANS

Term/Demand loans are granted to customers generally for meeting the capital
expenditure needs of the business. Term loans are granted in one lump sum and are
allowed to be repaid over a period in instalments the schedule of which is specified in
the agreement itself. Demand loans are those which are repayable on demand through a
repayment schedule is agreed upon by the bank. Term loans on the basis of period of
repayment are further classified into:
(i) Short-term Loans, (ii) Medium-term Loans, (iii) Long-term Loans.
Short-term loans are loans that are repayable within one year, medium-term loans within
two to seven years and long-term loans above seven years periods. Banks normally grant
the short-term and medium-term loans. The development financial institutions usually
grant long-term loans. Banks in certain cases like housing loans sanction long-term loans
- CAIIB DISCUSSION
which are repayable over longer period of 20-25 years.

Law relating to term loans
Term loans are governed by the agreement entered into between the parties. The loan
agreement provides for various eventualities and contains details of the loan, repayment
or amortisation schedule and other obligations of the borrower like payment of interests,
costs and expenses, etc. We will now consider a case decided by High Court in respect
of term loans.
(i) Acceleration of Repayment: P.K. Achuthan vs State Bank of Travancore 1974 K.L.T.
806
(FB): A question that came for a decision in this case was, whether a provision in the
hypothecation bond to the effect that on a default of the borrower in paying any of the
instalments, the lender would be entitled to recover the whole of the debt due, inclusive
of the future instalments in one lump sum is legal. The Kerala High Court held that
where the contract provides for repayment of money in instalments and also contains a
stipulation that on a default being committed in paying any of the instalments, the whole
sum shall become payable, then the lender would be entitled to recover the whole sum
inclusive of future instalments.
(ii) Time within which a suit for recovery shall be filed: We have seen earlier that in the
case of term loans, periodical repayment in instalments is allowed. In the event of a
default in payment of instalments, the bank can institute a suit for recovery of the unpaid
instalment. Besides, the bank is entitled to wait until the due date of the last instalment
and then institute a suit for recovery of whole amount. The limitation period for filing a
suit in the case of term loans is three years from the date of default of a
particular/specific instalment. However, if by doing so the time limit gets over in case of
some earlier defaulted instalments, bank looses its right against such unpaid instalments.
In the case of a demand loan the time limit is three years from the date of default.
17.5 BILL FINANCE
Bill finance is also one of the important facets of lending by banks. Generally, the bill
finance is conducted through discounting of bills of exchange drawn by the borrower or
third persons on the customers of borrower. The methods of bill finance, depending upon
payment obligationsand
(i) Bill discounting incurred by the bank, can
bills purchase; (ii)beDrawee
classified
billinto:
acceptance;
(iii) Bills co-acceptance.
In all these cases, the banker undertakes an obligation and depending on the nature of
bill finance, the first two are fund-based facilities and the last is a non-fund based
facility.
This subject has been dealt with in more detail in the chapter of 'Law Relating to Bill
Finance'.
185
Non-Fund Based Facilities
In the business of lending, a banker also extends non-fund based facilities. Non-fund
based facilities do not involve an immediate outflow of funds. The banker undertakes a
risk to pay the amounts on happening of a contingency. Non-fund based facilities can be
of following types among other:
(a) Guarantee facility; (b) Letter of credit facility;
(c) Underwriting and credit guarantee.
(a) Guarantee facility: The banker in his business of lending extends various
facilities to its constituents.
Under this facility, the bank undertakes to discharge the liability of the borrower to third
parties.
The nature of guarantees includes; performance guarantees, deferred payment
guarantees, advance
payment guarantees, guarantees to Government departments, etc.
- CAIIB DISCUSSION
(b) Letter of credit facility: Letter of credit or documentary credit facility is another
non-fund based
facility extended by the bankers to their constituents. Under this facility the banker
undertakes to
pay on presentation of documents of title to goods. The banks generally adopt the
Uniform
Customs and Practices relating to Documentary Credits 600 (UCPDC 600) framed by
International
Chamber of Commerce which defines the obligations and rights of the parties w.e.f. 1
July 2007.
(c) Underwriting and credit guarantee: Besides the above non-fund based facilities,
some banks also
do underwriting and credit guarantee business. The risk under this activity involves the
obligation
of the banker to provide funds or pay, in the event of the failure of the borrower to raise
moneys,
or to repay moneys. After the advent of merchant banking, this type of lending by
commercial
banks is on the decline.
(d) Derivative products: In addition to the above traditional non-fund facilities,
banks are now
increasingly offering the derivative products to their clients to enable them to hedge their
currency
and interest rate risks.
Other credit facilities
A banker besides extending fund based and non-fund based credit facilities, also extends
various other miscellaneous credit facilities depending upon the constitution of the
borrower. For example, in the case of individual borrowers, many of the banks are
extending, personal loans for purchase of a house, car, and other consumer durables.
This type of lending, otherwise called 'Consumer Credit' has become very popular these
days and contributes

17.6 LET US SUM UP significantly to the profitability of the bank's business.
1. Credit facilities are mainly classified into:
(i) Fund based facilities (ii) Non-fund based facilities
2. Fund based facilities, among other things, include:
(i) Cash credits/Overdrafts (ii) Term loans
(iii) Bill finance
3. Non-fund based facilities, among other things, include:
(i) Bank guarantee (ii) Letter of credit facility
4. Under customary law of bankers, interest can be charged on the temporary
overdrafts granted.
5. As per rule, in the Clayton's case each credit discharges the earliest of the debit
entries.
6. Term loans based on period of repayment are classified into:
(i) Short-term loan (ii) Medium-term loan
(iii) Long-term loan
186
1. Cash Credit facility is a
2. Bills co-acceptance facility is a .
3. Banker is entitled to charge interest on temporary overdraft under .
4. Limitation period for filing a suit in term loans is years from the date of
default of
- CAIIB DISCUSSION
instalment.
5. Period of repayment in the case of medium-term loan is .
1. Fund based facility; 2. Non-Fund based facility; 3. Banking custom; 4. 3 (Three); 5.
5-7 years.
SECURED AND UNSECURED LOANS, REGISTRATION OF FIRMS,

INCORPORATION OF COMPANIES
STRUCTURE
18.0 Objectives
18.1 Introduction
18.2 What are 'Unsecured Loans' and 'Secured Loans'?
18.3 Why a Secured Loan?
18.4 Registration of Firms
18.5 Consequences of Non-registration of Firm
18.6 Incorporation of a Company
18.7 Let Us Sum Up

188
18.0 OBJECTIVES
• what is a secured and unsecured loan;
• the law governing bankers' securities;
• the procedure for registration of firms and incorporation of companies.
18.1 INTRODUCTION
In thegoverning
laws earlier units,
them.weIn have
thisstudied
unit, weabout
will type of borrowers,
endeavour credit facilities
to understand and the
the securities for
bank's lending business, legal status of a banker in the case of unsecured loans, and more
about law relating to partnership firms and companies, their registration and
incorporation.
18.2 WHAT ARE 'UNSECURED LOANS' AND 'SECURED LOANS'?
Unsecured Loans
Most of the loans granted by banks in India are generally secured by tangible security
being assets purchased out of the bank funds and/or some valuable collateral such as
bonds, shares and merchandise deposited either in the bank's godowns or in the godowns
of the borrowers under agreement of hypothecation, and immoveable property, but
occasionally loans are granted even without any security.
An unsecured loan is one for which the banker has to rely upon the personal integrity of
the borrower. The chief basis of such transactions is the personal credit or credit
worthiness of the customer. In other words, 'creditworthiness' is the confidence of a
banker on the future solvency of a person or his future financial strength, which enables
him to take a loan at present and pay it in future. All unsecured loans, otherwise called
clean loans are dependent on the borrower's financial strength to pay in future.
Secured Loans
Secured loans are the antithesis to unsecured loans. These loans are given by a banker
not merely based on his confidence on the borrower's future financial strength but also
based on his present net worth that he is able to give a banker to rely upon and recover
the moneys lent in the event of his failure to repay the loan in the ordinary course. We
will elaborate it a little further. In the case of secured loans, a banker besides verifying
- CAIIB DISCUSSION
the future solvency of the borrower asks for the charge over property of the borrower so
that in the event of failure by the borrower to repay, the banker can sell the property of
the borrower charged to him and recover the moneys.
18.3 WHY A SECURED LOAN?
We have seen the difference between an unsecured loan and a secured loan. It would be
relevant to know why a 'secured loan' is preferred over 'unsecured loan'. It is common
knowledge that lending by a banker is generally for the economic activity of the
borrower and recovery of loans given by a banker is mostly dependent on the economic
success of the borrower. Success or failure of an economic activity depends on various
macro and micro economic factors. A banker lending to a customer can assess only the
existing macro and micro economic factors and can only predict success or failure of the
borrower's activity in the future reasonably. A banker cannot be absolutely certain about
the recovery of the amounts lent, if he solely relies on the economic success of the
borrower. Therefore, a banker asks for further security in form of a charge on property of
the borrower. The charge created over the property of the borrower acts as cushion to
absorb the shocks of economic failure of the borrower as the banker can safely sell the
properties charged to him and recover the moneys lent. This is the primary reason for
preference of secured loans over unsecured loans.
18.4 REGISTRATION OF FIRMS

We have in an earlier unit, dealt with borrowers who are 'Partnership Firms' and
governed by the Indian Partnership Act, 1932. In this unit, we shall study the law
relating to registration of partnership firms.
Registration
It is in the interest of the partners themselves to have their firms registered under the
Partnership Act. The procedure for the registration of firms and other incidental matters
has been dealt in Sections 56 to 68 of the Unit VII of Indian Partnership Act, 1932.
For registration, an application is to be submitted to the Registrar of Firms of the area in
which any place of business of the firm is conducted, with a statement in the prescribed
form and accompanied by the prescribed fee, stating
(a)
(b) name of principal
place or the firm, place of business of the firm,
(c) names of any other place where the firm carries on business,
(d) date of joining of each of the partners,
(e) names in full and permanent addresses of the partners,
(f) duration of the firm-length of time for which the firm wants/proposes to
conduct the business.
We have to note that the Act contemplates registration of firms, not the registration of
partnership deed. The registration of the firm is optional and not compulsory. So a mere
non-registration would not affect the carrying on business and giving effect to
partnership deed.
When the Registrar is satisfied that the provision of Section 58 has been duly complied
with, he will record an entry of the statement in the register called the Register of Firms.
In addition to making the necessary entries in the Register of Firms, he is required to file
the original of every statement submitted to him. The original statement and all
subsequent statements and notices will be filed together so that all original papers
relating to any firm will be conveniently found together in one file. Note that the
registration of the firm takes place only when the Registrar makes the necessary entries
in the Register of Firms under-Section 59. In other words, a firm is deemed to be
registered only when the certificate of registration is granted.
Alterations
Rules relating to alterations are provided in Section 60 which reads:
1. When alteration is made in the firm's name or in the location of the principal
place of business of a
- CAIIB DISCUSSION
registered firm a statement may be sent to the Registrar accompanied by the prescribed
fee,
specifying the alteration and signed and verified in the manner required under Section
58.
2. When the Registrar is satisfied that the provisions of the sub-Section (1) of the
Section 60 has been
complied with, he shall amend the entry relating to the firm in the Registrar of Firms in
accordance
with the statement and shall file it along with the statement filed under the Section 59.
There is no
time limit fixed as to when notices of alterations have to be given.
Section 61 provides that when a registered firm discontinues business in any place or
begins to carry on business at any place, such a place, not being its principal place of
business, any partner or agent of the firm, may send an intimation thereof 'to the
Registrar', who shall make a note of such an intimation in the entry relating to firms in
the Registrar of Firms and shall file the intimation along with the statement relating to
firm filed under Section 59. Similarly, when any partner in a registered firm, alters his
name or permanent address, an intimation of the alteration may be sent by any partner or
agent or firm to the Registrar, and he shall deal with it in the manner nrnv
;« c —
ib'U
Section 63 provides for the recording of a change in and the dissolution of a firm and
also the recording of withdrawal of a minor.
There is no particular form of notice. If substantial compliance has been made with the
provision that would be sufficient for the purpose of the section.
Rectification of Mistake
The Registrar has power at all times to rectify any mistake so as to bring the entry in the
Register of firms
firm already filedrelating to any firm in conformity with the documents relating to that
with him.
The Registrar may also rectify any mistake on the application made by the parties who
had signed the document. However, this power is n ot a general power, but limited to
rectifying the mistakes to bring the entry in conformity with the document filed by the
partners or their agents. If there is an omission in the mention of one of the places of
business of the firm, the omission is capable of rectification under this provision.
Moreover, this omission does not affect the registration; similarly, if certain persons are
wrongly noted in the Register, this is a mistake which can be rectified under this
provision.
Amendment of Register by Court's Order
Provision is made for a Court deciding any matter relating to a registered firm may direct
the Registrar to make any amendment in the entry in the Register of Firms relating to
such firms which is consequential upon its decision, and the Registrar shall amend the
entry accordingly.
Inspection
The Register of Firms, the statements, notices and intimations filed with the Registrar
are open to inspection by any person on payment of a prescribed fee.
Copies
Similarly, any person can obtain a copy of any entry or portion in the Register of Firms
by making an application to the Registrar and paying prescribed fee.
Evidentiary Value
Section 68(1) provides, any statement, intimation or notice recorded or noted in the
Register of Firms shall, as against any person by whom or on whose behalf such
- CAIIB DISCUSSION
statement, intimation or notice was signed is conclusive proof of any fact stated therein.
Penalty
Section 70 provides that any person who signs any statement, amending statement,
notice or intimation under the Unit VII of the Partnership Act containing any particulars,
which he knows to be false or does not believe to be true or containing particulars which
he knows to be incomplete or does not believe to be complete, shall be punishable with
imprisonment which may extend to three month, or with fine or both.
18.5 CONSEQUENCES OF NON-REGISTRATION OF A FIRM
Section 69 of Indian Partnership Act, 1932 sets out the effect of non-registration of firm
and may be conveniently studied under the following four heads:
(i) suits by partners inter se (ii) suits by a firm against third parties
(iii) exceptions (iv) non-application of provisions to certain suits,
(i) Suits by Partners Inter se: If a firm is not registered under the Indian Partnership Act,
then no suit to enforce a right, arising from a contract or conferred by the Partnership
Act, shall be
)rding n that
ter of i him.
:d the bring ssion ation rtain sion.
strar ntial
n to
;an
ins
vas
ion or lot or
be
10 >e
191
instituted in any Court, by or on behalf of any person suing as a partner in a firm against
the firm
set off ororother
against any othertopartner
proceeding enforceofa the firm.
right Thisfrom
arising prohibition applies to the claim of
a contract.
The Supreme Court in the case of Loon Karan Sethia (AIR 1977 SC 336) has held that
this provision for registration is mandatory in character and its effect is to r ender a suit
by the plaintiff in respect of a right vested in him or required by him under contract,
which he entered into as a partner of a unregistered firm, whether existing, or dissolved
as void. In other words, a partner of an erstwhile un-registered partnership firm cannot
bring a suit to enforce a right arising out of a contract falling within the ambit of Section
69 and simply by making an application for registration before instituting a suit is also
not sufficient.
(ii) Suit by a Firm Against Third Parties: No suit to enforce a right arising from a
contract can be instituted in any Court, by or on behalf of a firm against any third party,
unless the firm is registered and the persons suing or have been shown in the Register of
Firms as partners in the firm. This provision also applies to a claim of set off or other
proceeding to enforce a right arising from a contract.
Before the bar of the Section 69 can be invoked there should be clear evidence that the
plaintiffs were partners as defined in the Section 4 of the Act and the loose use of the
term 'partnership' on a firm would not by itself establish that the plaintiffs were partners
in the true sense of the term. Moreover, the burden of proof would be on the defendant.
The bar under this section applies to rights arising out of a contract only and not in
respect of other rights as the sub-Section (i) above. Some of the illustrations of such
rights are: the right to enforce a contract embodied in a negotiable instrument, right to
eject a landlord, right to determine the liability of the landlord, etc.
- CAIIB DISCUSSION
Section 69(2) requires that the person serving must have been shown in the Register of
Firms as a partner, but the mode of proof of that fact is not in anyway restricted.
(iii) Exceptions: Sub-Section (3) of the Section 69 provides for two exceptions:
(a) The enforcement of right to sue for dissolution of a firm, or for accounts of a
dissolved firm
or any right or power to realise the property of the dissolved firm.
(b) The powers of an official assignee receiver or Court, under the Presidency
Towns Insolvency
Act, 1909 to realise the property of an insolvent partner.
(iv) Non-application of Section 69: Certain Suits: Sub-Section (4) of Section 69 provides
that the Section 69 shall not apply
(a) to firms to which the Act extends or whose places of business in the said
territories are
situated in areas to which, by notification under the Section 56 Unit VII of the
Partnership
Act does not apply; or
(b) to any suit or claim of set off not exceeding Rs. 100 in value which, according
to the
Presidency Towns is not of a kind specified in the Section 19 of the Presidency Small
Cause
Courts Act, 1882, or outside the presidency towns, is not of the kind specified in the
second
Schedule to the Provincial Small Cause Courts Act, 1887, or to any proceedings in
execution
or other proceeding incidental to or arising from any such suit or claim.
The bar does not apply to suits of Small Cause nature, value of which not exceeding Rs.
100. But when a suit or cross-objection is not cognisable either by the Presidency Court
of Small Causes or by the Small Causes Court, the Section 69(4)(b) will not apply even
though the relief for accounts may be value at Rs. 100.
192
18.6 INCORPORATION OF A COMPANY
We have seen in the earlier units that among others 'company' is also one of the
borrowers of a banker. We have also studied briefly the law governing companies. In
this unit, we will study the law relating to companies and their incorporation.
1. Company - Meaning and Characteristics: A company is an artificial person, since it is
created by law. It is clothed with many of the rights, liabilities, powers and duties
prescribed by law. Among the two most important characteristics of a company, one is
its separate individuality and the other is perpetuity within the limits prescribed by law.
It can do all acts as a natural person may do.
A company has a 'Corporate Personality' separate from all the members who have
formed it unlike a partnership firm. Because of this, a company incurs all the liabilities
and possesses all rights of a natural person subject to the regulation of law. The classical
judgement of the House of Lords in Salomon vs. Salomon & Co. Ltd. (1897) AC 22 lays
down the principle of 'corporate personality'.
The facts of this case are that one Mr. Salomon who was individually carrying on the
business of boot and shoe manufacture, incorporated a company named 'Salomon & Co.
Ltd.' which consisted of seven of his family members. This company took over the
personal business assets of Mr. Salomon for 38,782 pounds and in turn Mr. Salomon
took 20,000 shares of one pound each and debentures worth 10,000 pounds, for which
there was a charge on the company's assets and balance in cash.
All his family members took one share of a pound each. The company later went into
liquidation and various unsecured creditors contended that Mr. Salomon could not be
treated as a secured creditor of the company in respect of debentures held by him. The
- CAIIB DISCUSSION
House of Lords after hearing the arguments held that:

The company is by law a different person altogether from its shareholders and though it
may be that after incorporation, the business is precisely the same as it was before and
the same persons are managers and the same hands receive the profits; the company is
not in law the agent of the shareholders or trustees for them. Nor are the shareholders
liable in any shape or form except to extent and the manner provided in the Act.
The Salomon Case for the first time authoritatively and clearly established the fact that a
company has its own existence or personality, which is separate and distinct from its
members and as a r esult a shareholder cannot be held liable for the acts of the company,
even though he holds virtually the entire share capital. The case also recognised and
accepted the concept of limited liability. The legal status and position of a company has
been aptly described by Supreme Court in Tata Engineering and Locomotive Company
Ltd. vs State of Bihar AIR 1965 SC 40 in the following words:
The corporation in law is equal to a natural person and has a legal entity of its own. The
entity of the corporation is entirely separate from that of its shareholders; it bears its own
name and has a seal of its own; its assets are separate and distinct from those of its
members and it can sue and be sued exclusively for its own purpose; its creditors cannot
obtain satisfaction from the asset of its members; the liability of the members or the
shareholder is limited to the capital invested by them. Similarly, the creditors of the
members have no right to the assets of the corporation.
The main characteristics of a company are summed up as under:
(i) Company is a voluntary association of persons who have come together to carry on
some business
for profit, (ii) It has a perpetual existence and though members may come and members
may go, the company
continues forever. Change in its members or in their identity does not affect the legal
existence or
its identity. Only law can dissolve it, since it is a creation of law.
193
(iii) Thelimited
private shares company,
of joint stock
the companies
CompaniesareActfreely transferable
has put and in theon
certain restrictions case
theof a
transferability of shares. Every member who owns fully paid-up shares is free to dispose
of his shares according to his choice but subject to any r egulation of the company. Any
absolute bar or restriction on the right to transfer shares is void.
(iv) The member's/shareholder's liability in a company is limited to the extent of the
nominal value of the shares held by them. Under no circumstance, is a
member/shareholder directed to pay anything more than the unpaid value of his shares.
As regards a company limited by guarantee, the members are liable only to the extent of
the amount guaranteed by them and not beyond and that too only when the company
goes into liquidation.
(v) As a corporate person, a company is entitled to own and hold property in its own
name.
(vi) A company being a body corporate can sue and be sued in its own name.
In brief, the most striking features of a company are its distinct legal personality, the
easy transferability of its shares, and the limited liability of its members.
Incorporation of a Company
We shall now in brief understand the various steps to be taken and as to how a company
comes into existence. It is to be noted that at the time of formation of the company the
promoters have to amongst other things decide the following aspects:
(a) Type of company: Under the Companies Act, 1956 only two types of
companies can be registered,
viz.,
(i) Public companies (ii) Private companies.
- CAIIB DISCUSSION
These companies may further be classified as follows:

(i) Companies limited by shares
(ii) Companies limited by guarantee with or without share capital and (iii) Unlimited
companies with or without share capital.
(b) Name of company: A company is identified by the name under which it is
registered. According
to Section 13 of the Act, the Memorandum of Association of a company should state the
name of
the company. To avoid delay and to afford flexibility to the Registrar to decide the
availability of
names the promoters are required to submit at least three suitable names in the order of
preference.
The name of a company must necessarily end with the word 'limited' in the case of a
public
company and the words 'private limited' in case the company is a private company. In
case of a
Section 25 Company, the inclusion of the word 'limited' can be dispensed with by
obtaining a
licence from the Regional Director. Section 20 prohibits the registration of a company,
the name
of which is undesirable or which is identical with or too nearly resembles the name of an
existing
company. A company will not be permitted to use a name which is prohibited under the
Emblems
and Names (Prevention of Improper Use) Act, 1950.
The Registrar is required by law to make preliminary enquiries so as to ensure that the
name permitted by him will not be misleading or is not intended to deceive with
reference to its objects clause.
(c) Memorandum of Association: The memorandum of association is the
constitution of a company
and amongst other things, defines the area withiirwhich the company can act. It is,
therefore,
necessary to state the object for which the company has been formed, the various
businesses that
it can undertake, the liability of its members, etc. For a banker it is absolutely essential to
verify
the memorandum and ensure that the business undertaken by the company is within its
objects,
if not, any loan made to the company would not be recoverable.
194
(d) Articles of Association: The other important document of a company is the
articles of association,
which contains the rules and regulations relating to the internal management of a
company.
Section 15 of the Companies Act stipulates that every memorandum should be signed by
each
subscriber who should add his address, description and occupation, if any, in the
presence of at
least one witness who shall attest the signature and shall likewise add his address,
description and
occupation, if any. As regards companies having a share capital the subscribers to the
memorandum
should at least take one share each and they have to state clearly the number and nature
- CAIIB DISCUSSION
of the
shares taken by them.
The articles of association should similarly be signed separately by persons subscribing
to the same. The signatures of the subscribers in the Articles of Association are also to
be attested by a witness.
(e) Preparation of other documents: The promoters forming the company are also
required to submit
various other forms and documents prescribed under Companies (Central Governments'
General
Rules and Forms) Act, 1959.
(f) Payment of registration fees: The fee prescribed for registration of a company is
required to be
paid the quantum of which depends on the nominal capital of the company to be
incorporated in
the case of companies having share capital.
(g) Certificate of Incorporation: Once all the formalities as detailed above are
satisfied, the promoters
are entitled to get from the Registrar of Companies the certificate of Incorporation.
Section 33(3)
of the Companies Act states that if the Registrar is satisfied that all the requirements, as
stated
above have been complied with by the company and that it is authorised to be registered
under the
Act, he shall retain and register the memorandum, articles, if any. On the registration of
the
memorandum of a company the Registrar shall certify under his hand that the company
is
incorporated and, in the case of a limited company that the company is limited. From the
date of
incorporation mentioned in the certificate of incorporation, such of the subscribers of the
memorandum
shall be and other persons, as may from time to time be members of the company,
a body corporate by the name contained in the memorandum, capable forthwith of
exercising all
the functions of an incorporated company and having perpetual succession and a
common seal,
but with such liability on the part of the members to contribute to assets of the company
in the
event of its being wound up as mentioned in the Act (Section 34).
Certificate of Incorporation: Conclusive Evidence
Section 35 of the Act states that a certificate of incorporation given by the Registrar in
respect of any association shall be conclusive evidence that all the requirements of the
Act have been complied with in respect of registration and matters precedent and
incidental thereto, and that the association is a company authorised to be registered and
duly registered under the Act. The certificate of incorporation is conclusive evidence that
everything is in order as regards registration and that the company has come into
existence from the earliest moment of the day of incorporation stated therein with rights
and liabilities of a natural person, competent to contracts. Once a certificate of
incorporation has been issued its validity cannot be impeached. In the case of Moosa vs
Ebrahim [ILR (1913)40 Cal.l (PC.)] the memorandum of association of a company was
signed by two adults and by a guardian of the other five members, who happened to be
minors. The Registrar, however, registered the company and issued under his hand a
certificate of incorporation. It was contended that the certificate of incorporation should
be declared to be void. Lord Macnaughten deciding the case said:
- CAIIB DISCUSSION
from the
company and pay for his qualification shares, if any, or sign the memorandum for
shares not being less than his qualification shares (Section 266). In case, a prospectus
is issued in relation to the intended company and proposed directors are named therein,
then the consent and undertaking must be filed before the publication of the prospectus.
(i) Payment of the requisite fee for registration
Procedure for the incorporation of a company limited by guarantee: Though the
procedure involved for the incorporation of a company limited by guarantee is the same
as that of the public
196
company or a private company, as described above, following must however be noted in
this regard:
• In the memorandum of association of such a company, a clause stating the
amount of guarantee
will have to be added in addition to the other necessary clauses to this effect.
• A guarantee company may be a company with the share capital or without the
share capital.
• A company formed with no intention to generate profit is usually formed as a
guarantee
company.
• A company limited by guarantee can either be a private or a public company.
18.7 LET US SUM UP
1. An insecured loan is one for which the banker has to rely upon the personal
security of the
borrower.
2. Secured loans are antithesis to insecured loans.
3. Various methods of securing a loan are pledge, hypothecation, mortgage and
assignment of debts
of the borrower.
4.
is called aIf two or more persons come together and agree to share profits of a business, it
partnership.
5. A partnership firm can be registered under the Section 58 of Partnership Act,
1932.
6. If a firm is not registered, then a partner cannot sue the other partners or third
parties to enforce
contractual rights.
7. A company is an artificial person created by law.
8. There are only two types of companies that are registered under the Companies
Act. They are:
(a) Public Limited Company (b) Private Limited Company
9. Certificate of incorporation is the conclusive evidence of coming into existence
of the company.
10. Certificate of commencement of business is required for a public company to start
business.

loans.
1. Only personal security of the borrower is available in the case of.
2. Secured loans are normally secured by .
3. Pledge is of goods as a security for debt.
4. Hypothecation is treated as pledge.
5. Personal obligation of mortgagor is a distinct feature of
- CAIIB DISCUSSION
6. Section 58 of Partnership Act, 1932 provides for .
7. A partner on behalf of firm cannot institute a suit on contract, if the firm is

registered.
(True/False)
8. Shares of public limited company are freely transferable. (True/False)
9. Certificate of incorporation is a document evidencing existence of company.
(True/False)
10. Certificate of commencement of business is required for private limited company to
start business. (True/False)
1. Insecured; 2. pledge, hypothecation, mortgage or assignment of debts; 3. bailment; 4.
constructive; 5. mortgage by deposit of title deeds; 6. registration of partnership; 7.
False; 8. True; 9. True; 10. False.
REGISTRATION AND SATISFACTION OF CHARGES
STRUCTURE
19.0 Objectives
19.1 Introduction
19.2 What is a Charge?
19.3 Procedure for Registration of Charge
19.4 Effect of Non-registration of Charges
19.5 Provisions of Law Relating to Registration of Charges
19.6 Let Us Sum Up
198
19.0 OBJECTIVES
After studying this unit, you should be able to briefly understand:
• the creation of charge over the properties, registration of charges under different
enactments;
• registration of charges with the various authorities.
19.1 INTRODUCTION
We have seen in earlier units, the types of loans granted by a banker and methods of
securing a loan. In this unit, we will focus on the meaning of 'charge' under the
Companies Act and registration of charges.
19.2 WHAT IS A CHARGE?
1. Before studying the meaning of word 'charge' and provisions relating to the
registration of charges, we will learn the general meaning of the word 'charge'.
It may be noted that the word 'charge' is used to mean any form of security for debt,
unless the word is used otherwise. We have seen in the earlier chapters, that a banker
accepts different types of securities to secure a loan granted to borrowers. Section 125(4)
of the Companies Act, 1956 provides, that for the purpose of registration under the said
Act, it includes all the following charges:
(a) A charge for the purpose of securing debentures
(b) A charge on uncalled capital of the company
(c) A charge on any immoveable property, wherever situated, or any interest
therein
(d) A charge on any book debts of the company
(e) A charge, not being a pledge, on any moveable property of the company
(f) A floating charge on the undertaking or any property of the company including
- CAIIB DISCUSSION
stock-in-
trade
(g) A charge on calls made but not paid
(h) A charge on a ship or any share in a ship
(i) A charge on goodwill, on a patent or a licence under a patent, or a trademark, or on a
copyright or a licence under a copyright
2. Types of Charges: 'Charges' registered under the Companies Act can be classified
into the two types:
(i) Fixed charge (ii) Floating charge
(i) Fixed charge- 'Fixed charge' is also called 'specific charge'. It extends over a specific
property or properties of the company. In other words, when a particular or a specific
property of the company is given as a security for loan, then a 'fixed charge' is said to be
created over the property. It may be noted, that charges specified in Section 125(4)(b) ot
the Companies Act, 1956, created in conformity with the provisions of the said Act over
a specific property gives right to the creditor so secured, to sell the said property and
claim the proceeds towards the dues payable by the company.
(ii) Floating Charge: A 'floating charge' means a 'charge' that is general and not specific.
It can be said to be a charge
(a) that floats over the present and future property of the company subject thereto,
that
means it does not fasten on or attach to any particular or specific property;
(b) that does not restrict the company from assigning the property, subject to
charge to
third persons, whether by way of sale or security;
(c) that on happening of an event or contingency, crystallises as a fixed charge.
199
From the above, it can be noted that when the charge is floating, the company may, in
the ordinary course of business, deal with the property in any manner until the charge
attaches. In other words, a floating charge is an equitable charge which does not fasten
on anysubject
is not specific
toproperty but covers the whole of the company's property whether it is or
fixed charge.
When floating charge becomes fixed or crystallised/attaches
When the debtor company ceases to carry on business or goes into liquidation or the
debenture holder or creditor, in whose favour charge is created, intervenes by getting a
receiver appointed or doing some other act which affects the powers of the company to
dispose the assets charged. A floating charge may also crystallise on the happening of an
event specified in the creating a charge deed.
Effect of floating charge becoming fixed or crystallised
When a floating security upon all the property or assets of the company becomes fixed, it
constitutes a charge upon all the property or assets then belonging to the company. It has
priority over the subsequent equitable charges and over insecured creditors and over
money advanced to the liquidator.
19.3 PROCEDURE FOR REGISTRATION OF CHARGE
Companies Act, 1956 under Section 125(1) provides that all the particulars of a charge
created by the company shall be filed with the Registrar of Companies together with an
instrument, creating charge, for registration within thirty days of the creation of charge.
The time limit of thirty days within which the charge shall be registered can be extended
by Registrar of Companies by further thirty days.
The procedure for registration is provided under the Rule 6 of the Companies (Central
Government's) General Rules and Forms:
(a) It provides that for the registration of charge, the company shall file the
prescribed particulars for
creation, modification or satisfaction of the charge in the Form 8, or Form 13 or Form 17
- CAIIB DISCUSSION
in
triplicate. The forms are prescribed under the rules.
(b) A copy of every instrument evidencing any charge or modification of charge is
required to be filed
with the registrar duly verified and certified.
(c) The fee prescribed for registration shall be paid.
Recently Government of India has introduced electronic filing of returns. This is a
centralized registry and all companies are required to file all returns which they were
filing with ROC earlier are required to file them with this new registry. Even banks and
other charge holders are required to file the particulars of the charges created in their
favour by the companies under this method. This is to ensure reduction in delays and one
point availability of information about any company.
19.4 EFFECT OF NON-REGISTRATION OF CHARGES
Section 125 of the Companies Act provides that the charge created by the company over
the properties, if not registered, would not be valid against the liquidator and any creditor
of the company.
It has been held in various cases by the Courts that non-registration of charge under
Section 125 would not render the security invalid automatically. The only consequence
of non-registration is that the charge would not be valid against the liquidator and other
creditors of the company in the event of winding up.
It must be noted that, as against the company itself, so long as the company does not go
into liquidation, the mortgage or charge is good and maybe enforced.
200
19.5 PROVISIONS OF LAW RELATING TO REGISTRATION OF CHARGES
Sections 124 to 145 of the Companies Act, 1956 provides for the registration of charges.
They can be stated briefly as follows:
Section 124: This Section provides that 'charge' means and includes mortgage over any
or all properties of the company.
Section 125: This Section provides that the charge created over the properties of the
company
creation ofshall be registered
charge. with the
It also provides Registrar
that of Companies
if the charge within thirty
is not registered dayscharge
then the of
created would be invalid as against the liquidator and other creditor of the company in its
winding up.
Section 126: This Section provides that after registration of charge created, any other
person acquiring such property charged or any party thereof, shall be deemed to have
notice of the charge registered and shall take the property subject to such charge.
Section 127: This Section provides that if a company acquires a property charged under
Section 125, then the company shall declare the same by filing the particulars of the
property, so acquired, subject to charge.
Section 128: This Section provides that provision for registration charges is also
applicable for securing debentures issued by the company. The registration of charge for
securing debentures shall be carried out by filing particulars of the amount of debentures,
the date of the resolutions authorising the issue of the series of debentures, general
description of property charged, and the names of the trustees.
Section 129: This Section provides that the particulars filed for creating the charge for
securing deben¬tures shall also contain any commission, allowance or discount paid
directly or indirectly by the company to any person in consideration of his subscribing or
agreeing to subscribe or procuring subscriptions.
Section 130: It is provided under this Section that Registrar of Companies shall keep a
register of charges containing particulars of all charges requiring registration. This
Section further provides that a copy of particulars contained in the register of charges
can be obtained by any person on payment of fee.
Section 131: This Section provides that Registrar of Companies shall maintain an index
- CAIIB DISCUSSION
of register of charges.
Section 132: This Section provides that the Registrar shall give a certificate under his
hand of the registra¬tion of any charge registered, stating the amounts thereby secured;
and the certificate shall be a conclusive evidence of that the requirements of Companies
Act as to registration has been complied with.
Section 133: This Section directs that the company, in the case of secured debentures,
shall cause a copy of every certificate of registration given under Section 132 to be
endorsed on every debenture or certificate of debenture stock.
Section 134: This Section imposes duty on a company to register a charge required to be
registered under the Act. It also provides that any person interested in registration of
charge can also apply for registration.
Section 135: This Section provides that the procedure and law of registration of charges
is equally applicable to modification of charges.
Section 136: This Section requires the company that a copy of an instrument or
document creating the charge shall be kept at the registered office of the company.
Section 137: Under this Section any person appointed as receiver or manager of the
property charged, shall give notice to Registrar of Companies within 30 days of his
appointment.
201
Section 138: Under this Section, the company shall give intimation to the Registrar of
the payment or satisfaction in full, of any charge, relating to the company and requiring
registration under this part, within thirty days from the date of such payment or
satisfaction. Thereafter the Registrar of Companies shall record such satisfaction of
charge.
Section 139: Under this Section, Registrar of Companies that on evidence being given to
his satisfaction with respect to any registered charge:
(a) that the debt for which the charge was given has been paid or satisfied in whole
or in part; or
(b) that part of the property or undertaking charged has been released from the
charge,
to form or has
part ofceased
the company's property or undertaking can record the fact that charge is
satisfied
or property is released.
Section 140: This Section provides that the Registrar after entering memorandum of
satisfaction in whole or in part, in pursuance of Section 138 or 139, he shall furnish the
company with a copy of memorandum.
Section 141: Under this Section the Company Law Board can order for the creation of
charge or modification or satisfaction of the charge, if the company due to inadvertence
or by accident, omitted filing charges under those provisions.
Section 142: This Section empowers Registrar to impose a penalty on the company, if it
fails to comply with the provisions of law relating to registration of charges.
Section 143: This Section enjoins upon a company to keep at its registered office a
register of charges and enter therein all the charges specifically affecting the property of
the company.
Section 144: This Section provides that any creditor or member of company can inspect
the books relating to charges created by the company and it is the duty of the company to
keep the register of charges open to inspection.
19.6 LET US SUM UP
1. The word 'charge' means any form of security for debt, unless the word is used
otherwise.
2. All charges created by a company are required to be registered with Registrar of
Companies
under Section 125 of the Companies Act, 1956.
- CAIIB DISCUSSION
3. Charges can be fixed or floating.

4. Charge will have to be registered within thirty days of creation of the charge.
5. If the charge created is not registered, then the same is invalid against
liquidator and other
creditors on winding up of the company.
6. Sections 124 to 145 of the Companies Act deal with Registration of Charges.

for
(a) Charge means any form of
(b) Charges created by company shall be registered with .
(c) Under Companies Act a charge includes .
(d) Charge, if not registered is not enforceable against company. True/False
(e) Charge shall be registered within days from the date of creation of charge.
(a) Security, debt; (b) Registrar of Companies; (c) Mortgage; (d) False; (e) 30
MODULE -C
BANKING RELATED LAWS
SECURITISATION AND RECONSTRUCTION OF

FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY
INTEREST, 2002 (SARFAESI ACT, 2002)
Unit 20. Introduction to Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest, 2002 (SARFAESI Act, 2002)
Unit 21. Definitions of SARFAESI Act, 2002
Unit 22. Regulation of Securitisation and Reconstruction of Financial Assets of Banks
and Financial Institutions
Unit
Unit 23. Enforcement
24. Central of Security Interest
Registry
Unit 25. Offences and Penalties
Unit 26. Miscellaneous Provisions
THE BANKING OMBUDSMAN SCHEME, 2006
Unit 27. The Banking Ombudsman Scheme, 2006: Purpose, Extent, Definitions,
Establishment and Powers
Unit 28. Procedure for Redressal of Grievance
1993 (DRT ACT)
Unit 29. Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (DRT
Act) Preliminary
Unit 30. Establishment of Tribunal and Appellate Tribunal
Unit 31. Jurisdiction, Powers and Authority of Tribunals
Unit 32. Procedure of Tribunals
Unit 33. Recovery of Debts Determined by Tribunal and Miscellaneous Provisions
THE BANKERS' BOOKS EVIDENCE ACT, 1891 Unit 34. The Bankers' Books
Evidence Act, 1891
THE LEGAL SERVICES AUTHORITIES ACT, 1987 Unit 35. The Legal Services
Authorities Act, 1987: Lok Adalats
204
THE CONSUMER PROTECTION ACT, 1986

- CAIIB DISCUSSION
Unit 36. The Consumer Protection Act, 1986: Preamble, Extent and Definitions Unit 37.
Ponsumer Protection Councils Unit 38. Consumer Disputes Redressal Agencies
THE LAW OF LIMITATION Unit 39. Limitation of Filing Suits, Appeals and
Applications
TAXLAWS Unit 40. Income Tax, Banking Cash, Transaction Tax, Fringe Benefit Tax
and Service Tax
INTRODUCTION TO SECURITISATION AND RECONSTRUCTION OF

FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST, 2002
(SARFAESI ACT, 2002)
STRUCTURE
20.0 Objectives
20.1 Introduction
20.2 Constitutional Validity of the Act
20.3 Let Us Sum Up
20.4 Keywords
20.7 Multiple Choice Terminal Questions
206
20.0 OBJECTIVE
The objective, of this unit is to see why there was a need for the new legislation, viz.,
Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest, 2002 (SARFAESI Act 2002) and why it was enacted. The Act has created a
new legal framework, new concepts about security and new procedures for recovery of
dues
20.1 by banks and financial institutions.
INTRODUCTION
1. Banks and Financial institutions lend money by obtaining security, except for
the category of clean
loans. The security obtained is to act as a protection for the money advanced and in the
case of
need, the money can be realised by the sale of securities.
2. The lender's rights over the securities, both moveable and immoveable, for
realisation of the
amount advanced, were limited and less effective since they were required to take help
of the legal
system which was taking unduly long time to complete prior to the passing of the
SARFAESI Act,
2002. This Act introduced major changes in the legal framework for the recovery of dues
by laying
hands on the securities.
3. The Act is a major step in financial sector reforms. It has brought a legal
framework for the
following important activities in the credit market:
(a) Securitisation of financial assets.

(b) Reconstruction of financial assets.
(c) Recognition of any 'interest' created in the security for due repayment of a loan
as a 'security
- CAIIB DISCUSSION
1. Banks obtain security while lending, so that in the case of need, the money can
be of
securities.
2. The SARFAESI Act is applicable to the housing finance companies whose
names are notified by
the Central Government. (True or False)
3. In Mardia Chemical Case the Supreme Court decided that the condition of
deposit of amount is
fully invalid. (True or False)
4. After Mardia Chemical Case, the amendment made in the SARFAESI Act
stipulates deposit of
amount before preferring the appeal to DRT (Appellate Tribunal).
1. realised by sale; 2. True; 3. True; 4. 50 per cent.
20.7 MULTIPLE CHOICE TERMINAL QUESTIONS
1. Whether moveable securities in possession of the bank can be sold by the bank
without the
intervention of the Court?
(a) Now, a Court order is required to sale the security.
(b) Yes, bank can sell as provided in the Contract Act, 1872.
(c) Yes, as the SARFAESI Act, 2002 has made provisions to that effect.
(d) No, until the account is not declared as NPA by the bank.
2. As per the laws existing today, the mortgaged security cannot be sold without a
Court intervention.
Is this correct?
(a) Yes, Court intervention is required as per the provisions of the Transfer of
Properties Act.
(b) No, SARFAESI Act, 2002 has now made enabling provisions.
(c) Yes, since the Contract Act has made no provisions about any Court
intervention.
(d) No,isdue to the recent amendments in the Transfer of Property Act no Court
intervention
required.
rto-wmxrrseeurifies?
(a) Any moveable or immoveable security charged to the bank or financial institution.
208
(b) To mortgage securities only.
(c) Where the security interests are created for repayment of financial assistance
given by the
bank or a financial institution.
(d) To the properties owned by the defaulter borrower, but those that are not
charged to the
bank.
4. In the Mardia case what did the Supreme Court declared as invalid?
(a) Entire SARFAESI Act, 2002.
(b) Creation of security interest.
(c) Formation of Reconstruction Companies.
(d) Condition to pay seventy-five per cent of the amounts as pre-condition while
preferring
appeal to the DRT.
Ans. I. (b); 2. (b); 3. (c); 4. (d).
UNIT
- CAIIB DISCUSSION
21
DEFINITIONS OF SARFAESI ACT, 2002
STRUCTURE
21.0 Objective
21.1 Introduction
21.2 Preamble
21.3 Appellate Tribunal
21.4 Asset Reconstruction
21.5 Bank
21.6 Board
21.7 Borrower
21.8 Central Registry
21.9 Debt Recovery Tribunal
21.10 Default
21.11 Financial Assistance
21.12 Financial Asset
21.13 Financial Institution
21.14 Hypothecation
21.15 Non-performing Asset
21.16 Originator
21.17 Obligor
21.18 Property
21.19 Qualified Institutional Buyer
21.20 Reconstruction Company
21.21 Scheme
21.22 Securitisation
21.23 Securitisation Company
21.24
21.25 Security Agreement
Secured Asset
21.26 Secured Creditor
21.27 Secured Debt
210
21.28 Security Interest
21.29 Security Receipt
21.30 Sponsor
21.31 Keywords
211
21.0 OBJECTIVE
The objectives of this unit, are to understand:
• The purpose of enacting the Act;
• Important definitions given in the SARFAESI Act, 2002.
21.1 INTRODUCTION
For any Act, different concepts and effects revolve mainly around certain defined words.
- CAIIB DISCUSSION
The Act also takes some definitions from some other Acts, to the extent it is relevant and
applicable. The preamble to the Act gives in a nutshell, the purpose of the enactment.
21.2 PREAMBLE
The preamble indicates the purpose of the enactment. For the SARFAESI Act, the
preamble states 'An Act to regulate securitisation and reconstruction of financial assets
and the enforcement of security interest and for the matters connected therewith or
incidental thereto.'
21.3 APPELLATE TRIBUNAL
Any person aggrieved by the order passed by the 'Debt Recovery Tribunal' can file an
appeal to the authority called as the 'Appellate Tribunal', subject to the maintainability of
the appeal. These tribunals are constituted by the Central Government for the various
States as per the provisions of the Recovery of Debts due to Bank and Financial
Institutions Act, 1993.
21.4 ASSET RECONSTRUCTION
Acquisition of any right or interest, of any bank or financial institution, in any financial
assistance, by any securitisation company or reconstruction company, for the purpose of
realisation of such financial assistance, is called as asset reconstruction. In simple words,
it is the takeover of loans or advances from the bank or financial institution for the
purpose of recovery.
21.5 BANK
All the banking companies, Nationalised banks, the State Bank of India as well as its
subsidiary banks and co-operative banks are within the meaning of the word bank for the
purpose of this Act. This definition has excluded the regional rural banks. So the
SARFAESI Act is not applicable to RRBs.
21.6 BOARD
The word 'Board' is used in the Act to mean the Securities and Exchange Board of India
(SEBI). It is established under the Securities and Exchange Board of India Act, 1992.
21.7 BORROWER
The borrower means,
(i) any person,

institution, who
or (ii) hashas
who been granted
given financial assistance
any guarantee, or by any bank or financial
(iii) who has created any mortgage or pledge as a security for the financial assistance
granted by any bank or financial institution, or
212
(iv) a person who becomes the borrower of a securitisation company or reconstruction
company, consequent upon acquisition by it of any right or interest of any bank or
financial institution, in relation to such financial assistance.
21.8 CENTRAL REGISTRY
Under this Act, 'Central Registry' means the registering office, set up or caused to be set
up by the Central Government. With this proposed set up, all the transactions of asset
securitisation, reconstruction as well as transactions of creation of security interests, will
have to be registered with this authority. The registration system will operate on a
priority of registration basis, i.e., first in time to register gets priority over the person
doing registration at a later time. The registry will also serve the purpose of maintaining
credit information for the lenders.
21.9 DEBT RECOVERY TRIBUNAL
These tribunals were established under the Recovery of Debts Due to Banks and
Financial Institutions Act, 1993, to deal with the cases of recovery of debts above Rs. 10
lakh due to the banks and financial institutions.
21.10 DEFAULT
1. When the borrower does not pay any principal debt or any interest on the
principle debt or any
- CAIIB DISCUSSION
other amount payable to the secured creditor and due to such non-payment the account
of such
a borrower is classified as a non-performing asset (NPA) in the books of accounts of the
secured
creditor, as per the RBI guidelines, it is called default.
2. For getting the right of security enforcement, under this Act, there should be a
default committed
by the borrower. The creditor must also be a secured creditor. Any insecured creditor has
no
right of any nature in this Act.
3. In the Mardia Chemicals case, it was argued before the Supreme Court by the
bank, that bank can
classify the account as NPA as per its decision. The Supreme Court rejected this
argument and
stated that it should be done as per RBI guidelines only.
21.11 FINANCIAL ASSISTANCE
Whenever any bank or financial institution grants a loan or advance or makes
subscription of debenture or bonds or gives guarantee or issues letters of credit or
extends other credit facility, it is called financial assistance.
21.12 FINANCIAL ASSET
Financial asset means debt or receivables and includes:
(i) a claim to any debt or receivables or part thereof whether secured or insecured,
or
(ii) any debt or receivable secured by mortgage of or charge in immoveable
property, or
(iii) a mortgage charge, hypothecation or pledge of moveable property, or
(iv) any right or interest in the security, whether full or part, securing debt, or
(v) any beneficial interest in any moveable or immoveable property or in debt,
receivables, whether
such an interest is existing, future, accruing, conditional or contingent, or
(vi) any financial assistance.

213
21.13 FINANCIAL INSTITUTION
The financial institution means:
(i) A public financial institution within the meaning of the Companies Act, 1956.
(ii) Any institution specified by the Central Government under the Recovery of Debts
due to Bank
and Financial Institutions Act, 1993. (iii) The 'International Finance Corporation',
established under the International Finance Corporation
(Status, Immunities and Privileges) Act, 1958. (iv) Any other institution or non-banking
financial company as defined in the Reserve Bank of India
Act, 1934, which the Central Government may specify as a financial institution for the
purpose
of this Act.
21.14 HYPOTHECATION
1. Hypothecation means:
• a charge in or upon any moveable property
• existing or future
• created by a borrower
• in favour of a secured creditor
• without delivery of possession of the moveable property to such creditor as a
security for
financial assistance and includes floating charge and crystallisation of such charge into
- CAIIB DISCUSSION
fixed
charge on moveable property.
2. Prior to this Act no Indian Law has defined the term hypothecation though
hypothecation is a very
common type of charge on a security for a banks' lending.
21.15 NON-PERFORMING ASSET
It is an asset or account of a borrower classified by a bank or financial institution as sub-
standard, doubtful or a loss asset, in accordance with the directions or under guidelines
relating to asset classification issued by the Reserve Bank. For classification of any
account as NPA it is important that the classification is done as per the RBI directives.
21.16 ORIGINATOR
Originator is the owner of a financial asset that is acquired by a securitisation company
or reconstruction company for the purpose of securitisation or asset reconstruction. In
plain meaning, when the bank or financial institution lends money against security they
are the originator.
21.17 OBLIGOR
Obligor means a person liable,
(i) To pay to the originator, whether under a contract or otherwise, or
(ii) To discharge any obligation in respect of a financial asset, whether existing, future,
conditional
or contingent, or
(iii) and includes a borrower.
214
21.18 PROPERTY
1. Property means:
(i) Immoveable property, (ii) Moveable property,
(iii) Any debt or any

(iv) Receivables, right existing
whether to receive
or payment
future, of money whether secured or insecured,
(v) Intangible assets such as; know-how, patents, copyright, trademarks, licence,
franchise or any other business or commercial right of a similar nature.
2. Definition of property is made much wider by this Act. Prior to this Act,
property has been defined
under various Acts such as Transfer of Property Act, Registration Act, etc. By this Act,
the addition
of properties stated at sub-clauses (iii), (iv) and (v) here above is made. Due to this, now
security
interest can be created against these properties for raising loans from the banks and
financial
institutions.
21.19 QUALIFIED INSTITUTIONAL BUYER
1. Such buyer means a financial institution or an insurance company or a bank or a
state financial
corporation or state industrial development corporation or trustee or any asset
management company,
making an investment on behalf of a mutual fund or provident fund or gratuity fund or
pension
fund or a foreign institutional investor, registered under the SEBI Act, 1992 or any other
body
corporate as may be specified by SEBI.
2. This definition covers several categories of institutional investors but does not
- CAIIB DISCUSSION
include a company
registered under the Companies Act, 1956. If any company wants to become a qualified
institutional
buyer then it will have to get such a registration from SEBI.
21.20 RECONSTRUCTION COMPANY
A company formed for the purpose of asset reconstruction and registered under the
Companies Act, 1956 is called Reconstruction Company.
21.21 SCHEME
The securitisation company or the reconstruction company can raise funds from
qualified institutional buyers by formulating schemes. Funds so raised are required to be
maintained in, separate and distinct accounts scheme-wise,. The scheme invites
subscription to security receipts proposed to be issued by such a company.
21.22 SECURITISATION
1. Securitisation means acquisition of financial asset by the securitisation or
reconstruction company
from the originator. Such an acquisition may be by raising of funds by such a
securitisation or
reconstruction company from the qualified institutional buyers by issue of security
receipts
representing undivided interest in the financial assets or otherwise.
2. The concept and modality of securitisation defined here is new for the Indian
laws as well as for
the markets. This is a process where non-liquidated financial assets are converted into
marketable
securities, i.e., security receipts that can be sold to the investors. It is also a process of
converting
the receivables and other assets into securities, i.e., security receipts that can be placed in
the
market for trading. In Indian laws, there is no provision for transfer of claims that are
secured by
215
any security. Now SARFAESI Act has made the loans secured by mortgage or other
charges transferable.
On acquisition of a financial asset, the securitisation or reconstruction company becomes
the owner of the financial asset and steps into the shoes of the lender bank or financial
institution. This acquisition can also be said to be, as a sale of asset without recourse to
the bank or financial institution. RBI is the regulatory authority for all securitisation or
reconstruction companies.
3. As per present guidelines of 29 March, 2004, the minimum capital requirement for the
securitisation or reconstruction company is Rs. 2.00 crore at the time of registration and
these companies are required to maintain capital adequacy of fifteen per cent of total
asset acquired or Rs. 100 crore whichever is less.
21.23 SECURITISATION COMPANY
It is a company registered under the Companies Act, 1956 for the purpose of
securitisation. The securitisation company also needs a registration from the RBI as per
the SARFAESI Act. The securitisation company can set up separate trusts scheme wise
and act as trustee for such schemes, as provided in the Securitisation Companies and
Reconstruction Companies (Reserve Bank) Guidelines and Directions, 2003. The
investors in the securitisation company are the beneficiaries of such trusts.
21.24 SECURITY AGREEMENT
Security agreement means an agreement, instrument or any other document or
arrangement under which security interest is created in favour of the secured creditor.
This includes creation of mortgage by deposit of title deeds with the secured creditors.
- CAIIB DISCUSSION
21.25 SECURED ASSET

Secured asset means the property on which a security interest is created. The powers
given by SARFAESI Act for the enforcement of securities are against the secured assets
only. If the borrower has any pr operty over which no security interest is created, such a
property is outside the purview of enforcement powers under the SARFAESI Act.
21.26 SECURED CREDITOR
Any bank or financial institution or any consortium or group of banks or financial
institutions in whose favour the security interest is created by the borrower for due
repayment is called a secured creditor. It includes debenture trustee appointed by any
bank or financial institution or securitisation company or reconstruction company. It also
includes, any other trustee holding securities on behalf of a bank or financial institution.
21.27 SECURED DEBT
Secured debt means a debt which is secured by any security interest.
21.28 SECURITY INTEREST
1. Any right, title and interest of any kind whatsoever upon the property created in
favour of any
secured creditor is called as security interest. It includes any mortgage charge,
hypothecation,
assignment other than those specified in Section 31 of the SARFAESI Act.
2. Whenever any lender takes any security from the borrower, the lender pets i
216
The type of interest depends on the nature of charge created over the security. Until now,
such interest of the lender in the security was not defined in any law. SARFAESI Act
has, for the first time defined this. Now, any type of charge or any type of security has
come under one wide scoped definition, called the security interest.
21.29 SECURITY RECEIPT
1. A receipt or another security issued by a securitisation company or
reconstruction company to any
qualified institutional buyer pursuant to a scheme evidencing the purchase or acquisition
by the thereof of an undivided right, title or interest in the financial asset involved in
holder
securitisation
is called the security receipt.
2. The security receipt evidences the purchaser's undivided right, title and interest
in the security.
These receipts are transferable in the market. By this Act, a new type of transaction in
the financial
market has been created for transfer of the security interest.
21.30 SPONSOR
Sponsor is an entity holding not less than ten per cent of the paid-up equity capital of
securitisation or reconstruction company.
21.31 KEYWORDS
Appellate Tribunal; Asset Reconstruction; Central Registry; Debt Recovery Tribunal;
Non-performing Asset; Notification; Obligor; Originator; Qualified Institutional
Borrower; Reconstruction Company; Securitisation; Securitisation Company; Security
Agreement; Secured Asset; Security Interest; Security Receipt; Sponsor.
1. The SARFAESI Act is applicable for pledged securities also. (True or False)
2. For the enforcement of a mortgage security, court intervention is required even
for actions under
the SARFAESI Act. (True or False)
3. Banks and financial institutions can issue notice for enforcement over security
under SARFAESI
- CAIIB DISCUSSION
Act only if these securities are not creditor and only when the account is classified
as .
4. If the borrower does not pay within ' days after notice by the secured
creditor the
creditor can . of the security.
5. After receipt of notice from the secured creditor for repayment of dues by the
borrower, the
borrower is legally prevented from transferring his property in any way. (True or False)
6. On request of the secured creditor the District Magistrate or the Chief Judicial
Magistrate can
take possession of the security for handing over it to the creditor. (True or False)
7. When the management of the company is taken over by the secured creditor,
the directors of
such company are entitled to compensation for loss of office. (True or False)
In this unit we have studied various definitions given in the SARFAESI Act, 2002. Some
definitions are creating new notions. Definitions for asset reconstruction, borrower,
default, financial assistance, hypothecation, property, securitisation, security interest and
security receipt are some of the important definitions to clear the concepts of the Act.
217
1. False; 2. False; 3. in possession, NPA; 4. Sixty, take possession; 5. True; 6. True; 7.
False.
1. When any bank or financial institution obtains a charge against property, with
which authority
will the transaction have to be registered under the SARFAESI Act, 2002?
(a) With the Central Registry.
(b) With the ROC.
(c) With the Registrar of Assurances within whose jurisdiction the property lies.
(d)
2. With
Whenthe canReserve Bank ofofIndia.
the provisions SARFAESI Act, 2002 be invoked for proceeding
against the charged
property?
(a) When the bank feels that it is necessary for the recovery at any time.
(b) When the RBI directs to do so.
(c) When there is default in repayment by the borrower.
(d) When there is default in repayment and the bank declares the account as NPA.
3. Whether existing or future receivables are property?
(a) Yes.
(b) No.
(c) Yes, but if and when charged to the lender.
(d) No, if hypothecated to the lender.
4. From the following which function is of a securitisation company?
(a) Acquisition of loan transaction from the lender.
(b) Help the lender in recovery by sale of charged property.
(c) Take legal steps against the defaulter borrower on behalf of the lender.
(d) Acquisition of financial asset from the originator.
Ans. 1. (a); 2. (d); 3. (a); 4. (d)
REGULATION OF SECURITISATION AND RECONSTRUCTION OF FINANCIAL

ASSETS OF BANKS AND FINANCIAL INSTITUTIONS
- CAIIB DISCUSSION
STRUCTURE
22.0 Objectives
22.1 Introduction
22.2 Registration of Securitisation Company or Reconstruction Company
22.3 Cancellation of Certificate of Registration
22.4 Acquisition of Rights or Interest in Financial Assets
22.5 Notices to Obligor and Discharge of Obligation of Such Obligor
22.6 Issue of Security Receipts and Raising of Funds by Securitisation Company or
Reconstruction Company
22.7 Exemption from Registration of Security Receipt
22.8 Measures of Assets Reconstruction
22.9 Other Functions of Securitisation Company or Reconstruction Company
22.10 Resolution of Dispute
22.11 Power of Reserve Bank to Determine Policy and Issue Directions
22.12 Let Us Sum Up
22.13 Keywords
220
22.0 OBJECTIVE
The objective of this unit is to understand the regulatory framework, in which the
securitisation and reconstruction companies are required to work, how they have to raise
the funds, acquisition of assets and other such functional modalities.
22.1 INTRODUCTION
The SARFAESI Act has streamlined the functions of the securitisation and
reconstruction companies for dealing with financial assets of banks and financial
institutions. For this purpose, procedures as well and regulatory control measures were
required. In this unit we will consider these aspects.
22.2 REGISTRATION COMPANY

OR RECONSTRUCTION OFSECURITISATION COMPANY
1. The securitisation or reconstruction company can commence or carry business,
only after complying
the following two conditions:
(i) It obtains certification of registration from the Reserve Bank of India by applying in
prescribed
format; and (ii) It has the owned funds at the time of registration not less than Rs. 2 crore
or such other
amount not exceeding fifteen per cent of the total financial assets acquired or to be
acquired
as the RBI may specify.
2. As per the SARFAESI Act the securitisation of an asset or reconstruction of an
asset, are treated as
similar activities and the provisions relating to the registration of these companies are
same. Such
registered companies can raise money for their acquisition activities by issue of security
receipts
for formulating schemes. This Act has provided the legal framework for this activity.
3. Depending on the nature of security asset the Reserve Bank of India has the
powers to specify
different amounts of owned funds for different class or classes of securitisation
companies or
reconstruction companies. The Reserve Bank of India may impose such other conditions
- CAIIB DISCUSSION
as it
deems fit on the company.
4. If any securitisation or reconstruction company wants to make any substantial
change in its
management or a change in the registered address or change in the name, then that needs
prior
approval of the Reserve Bank of India.
5. The scheme of the Act and the guidelines published by the Reserve Bank of
India under the Act,
gives a business pattern of the securitisation or reconstruction company as under.
(i) The company can formulate separate schemes for the acquisition of a financial asset.
(ii) Create separate trusts for each scheme and maintain separate and distinct records and
accounts in respect of each scheme and issue security receipts to the investors, (iii) The
securitisation company or reconstruction company can act as trustees for such trusts
and manage the assets held in trust.
(iv) As the assets acquired in trust are scheme-wise, the risk of non-realisation of assets
will be impacting the investors who are the beneficiaries under the trust. As such there
should not be loss to the company. These companies do the activity in such a way that
they make arrangements for realisation of money from the asset acquired. They do not
invest their own funds in the acquisition of asset but utilise the money invested on risk
assessment and act on careful considerations for asset acquisition decision. The risk
factors are required to be assessed, anticipated and also disclosed to the investors.
221
22.3 CANCELLATION OF CERTIFICATE OF REGISTRATION
1. The registration granted to the securitisation or the reconstruction company by
the Reserve Bank
of India is cancellable on following grounds:
(i) The company ceases to carry on the business of securitisation or asset reconstruction,
or (ii) The company ceases to receive or hold any investment from a qualified
institutional buyer, fails to comply with any of the conditions subject to which the
or (iii) The company
certificate of
registration was granted, or (iv) The company fails to,
(a) comply with any of the directions issued by the Reserve Bank, or
(b) maintain accounts in accordance with the requirements of any law or any
direction or
order issued by the Reserve Bank of India, or
(c) submit or offer for inspection its books of accounts or other relevant documents
when so demanded by the Reserve Bank of India, or
(d) obtain prior approval of the Reserve Bank of India for change in management
or
change in registered office or change of name.
2. The Act has provided that the cancellation of registration may be of two
categories. In the first
category the cancellation of registration is without giving any opportunity to the
company if the
company does any of the following:
(i) Ceases to carry on the business of securitisation or reconstruction, or
(ii) Ceases to carry or hold any investment from a qualified institutional buyer, or
(iii) Fails to comply with RBI directions, or
(iv) Fails to maintain accounts in accordance with directions issued by RBI, or
(v) Fails to give accounts and documents to RBI for inspection.
The second category of cancellation is done with an opportunity to comply with the
- CAIIB DISCUSSION
defaults other than the above. However, even in this second category, the RBI has
powers and discretion, to deny opportunity, if the RBI feels that a delay in the
cancellation of registration shall be prejudicial to the public interest or the interests of the
investors of the company. It is required that the order is with reasons recording the
reasons as to why the company has been denied the opportunity.
3. The securitisation or reconstruction company whose registration is cancelled
can prefer an appeal
within thirty days from the date of communication of order, to the Central Government.
The
company is required to be given a hearing before rejecting the appeal.
4. Even if the application for registration is rejected or the already existing
registration is cancelled,
the company shall be deemed as registered, until the company pays the dues of the
investors along
with interest within the period as the RBI may specify.
22.4 ACQUISITION OF RIGHTS OF INTEREST IN FINANCIAL ASSETS
1. The securitisation company or the reconstruction company can acquire the financial
asset of any bank or financial institution by any of the following ways:
(i) By issuing a debenture or bond or any other security in the nature of debenture for the
agreed consideration and agreed terms and conditions between the bank/financial
institution and the securitisation company/reconstruction company as the case may be,
(ii) By entering into an agreement with such bank or financial institution for the transfer
of financial asset to such company on terms and conditions as may be agreed between
them.
222
2. The securitisation or the reconstruction company can acquire financial assets
without execution of
any deed of assignment or transfer in its favour by the concerned bank or the financial
institution.
Assignment
incorporatingis complete on the acquiring company issuing a debenture or bond and
therein the terms and conditions of acquisition. There is no need for execution of any
other
document. The document to be executed requires payment of stamp duty as per the
Indian Stamp
Act, which is an Act of the Union of India. The said document is not required to be
stamped as per
the State Stamp Duty laws.
3. As stated earlier, the securitisation transaction involves two stages. The first is
acquisition of
financial assets and undivided interest therein. The second is issue of security receipts in
favour of
the investors for the purpose of raising money from investors.
4. If the bank or financial institution is a 'lender' in relation to any financial asset
acquired by the
securitisation or a reconstruction company, then such a company is deemed as lender in
context
with the acquired property. Therefore, all the rights of such bank or financial institution
in the
security vest in the company which acquired the assets.
5. The statutory provisions say that acquiring company shall be vested with all the
rights of such
bank or financial institution. The provisions have excluded the liabilities. Thus, if there
- CAIIB DISCUSSION
is any
liability or commitment to be discharged from the side of bank or financial institution, it
will not
pass on to the securitisation or reconstruction company. Even if there is any commitment
to lend
further to the borrower, such commitment will not pass on to the asset acquiring
company. On this
issue, the Reserve Bank of India in the guidance note for securitisation companies and
reconstruction
companies has provided recommendatory guidance as under:
(i) Acquisition of funded assets, should not include takeover of outstanding
commitments, if
any, of any bank or financial institution to lend further, (ii) Terms of acquisition of the
security interest in non-fund-based transactions should provide
for the relative commitments to continue with bank or financial institute until demand
for
further funding arises.
6. In relation to the financial asset all contracts, deeds, bonds, agreements, power
of attorney, grants
of legal representations, permissions, approvals, consents or no objections under any law
or otherwise
to which the bank or financial institution is a party or which are in favour of the bank or
financial
institution are fully enforceable upon in place of bank or financial institution by and in
favour of
securitisation company or reconstruction company.
7. If at the time of acquisition of an asset by the securitisation company or
reconstruction company,
any suit, appeal or other proceeding of whatever nature related to the asset is pending by
or against
the bank or financial institution it does not get discontinued or abated or get in any way
prejudicially
affected because of the acquisition of asset. In such an event the suit, appeal or other
proceeding
can be continued, prosecuted and enforced by or against the securitisation or
reconstruction
company, as the case may be. If a securitisation company or reconstruction company
acquires the
assets of more than one bank or financial institution, where cases before different Debt
Recovery
Tribunals are pending, the securitisation company or reconstruction company can file an
application
to any of the Appellate Tribunal under which, such DRT come for transfer of all
applications to
anyone of the DRT as the Appellate Tribunal may decide.
8. Following documents are involved in a securitisation transaction.
(i) Offer document: The Reserve Bank of India in its guidelines of 2003 has mentioned
details about the form of offer and details to be incorporated therein. By and large the
full details and particulars about the financial asset, loan details of bank, trustees' details,
etc., are included. Some quarterly details are also required to be disclosed. These include
details
223
about profit-loss, prepayments, expenses, defaults, collection, etc., and also any other
- CAIIB DISCUSSION
material thing affecting the securitisation arrangement.

(ii) Debenture: A debenture, for the payment of consideration, is to be paid to the bank
or the financial institution for the acquisition of financial asset from it. As per the extant
guidelines from RBI, the rate of interest offered in the debenture cannot be less than one
and half per cent above the Bank Rate as on the date of issue of the debentures and the
period of redemption of debenture cannot exceed six years.
(iii) An agreement: It is with the originator to continue to service the assets of the
securitisation.
(iv) Security receipt: It is in favour of the investors.
22.5 NOTICES TO OBLIGOR AND DISCHARGE OF
OBLIGATION OF SUCH OBLIGOR
1. When the bank or financial institution decides, that the financial asset be now
acquired by the
securitisation or reconstruction company, a notice may be given about such an
acquisition to the
obligor, i.e., borrower or any other person liable to repay to the bank or financial
institution. Giving
of such notice is optional and not compulsory under the Act. In case, the obligor is a
company and
creation of charge has been registered, then also the giving of notice to the respective
registrar is
optional. Thus, there is no need of modification of charge with the Registrar of
Companies. However,
if the bank or financial institution decides to give notice to the obligor, then notice to the
ROC is
required to be given when the obligor is a company.
2. If notice of acquisition as said above is given to the obligor, it is necessary that
the obligor should
make payments to the concerned securitisation or reconstruction company. Such
payments amount
to a validofdischarge
If notice of liability
acquisition, of the obligor
as said above making
is not given, thethe payment.
money or property received by the
bank or financial institution from the obligor shall be held by such bank or financial
institution in trust and shall be handed over to the concerned securitisation company or
reconstruction company.
22.6 ISSUE OF SECURITY RECEIPTS AND RAISING OF FUNDS BY
SECURITISATION OR RECONSTRUCTION COMPANY
1. The securitisation or reconstruction company raises funds for acquisition of an
asset by issue of
security receipts. Only the qualified institutional buyers can buy these security r eceipts.
The security
receipts are not issued to the public. The investment and financial market in this field is
very
complex and much risk assessment is required to be done by the investor. The individual
investor
does not possess such expertise. Therefore, the Act has debarred individuals from
making an
investment in securitisation or reconstruction company.
2. When the securitisation or reconstruction company decides to raise funds from
qualified institutional
investors following conditions apply:
(i) For each financial asset acquired or to be acquired there should be a separate scheme.
(ii) Scheme-wise and asset-wise separate distinct accounts should be maintained.
(iii) Realisation of the asset is held and applied towards redemption, i.e., repayment of
- CAIIB DISCUSSION
investments as assured while issuing the security receipt.

(iv) In case there is no realisation and repayment as said above, the qualified institutional
buyers, holding not less than seventy-five per cent of the total value of the security
receipts issued are entitled to call a meeting of all qualified institutional buyers making
investments in that scheme and the resolutions passed in such a meeting are binding on
the concerned securitisation or reconstruction company.
(v) When the qualified institutional investors call the meeting, as said above, to decide
the further course of action due to non-realisation of the asset, they have to follow the
same procedure, as nearly as possible as is followed at meetings of the board of directors
of the securitisation company or reconstruction company, as the case may be.
(vi) The funds raised or assets acquired out of the raised funds by the securitisation or
reconstruction company shall be held by such company in trust for the investors.
3. When separate schemes are made and funds are raised by the securitisation or
reconstruction company, the provisions of SARFAESI Act do not directly provide for
setting up of trusts for each scheme. However, in totality the legal effect is that there are
resultant trusts in respect of each scheme. The investors in such schemes become the
beneficiaries under the trust and the company framing the scheme is the trustee,
managing the trust. The Reserve Bank of India guidelines for securitisation also provide
for such an arrangement. Due to such trust arrangement the money held by the company
are held in trust and do not form the assets of the company. Due to this, in the
eventuality of liquidation of such a company the money does not pass on to liquidator
and the beneficiaries get the money on priority and distinctly.
22.7 EXEMPTION FROM REGISTRATION OF SECURITY RECEIPT
1. When the securitisation company or reconstruction company issues security
receipts the holder of
the security receipts is entitled to an undivided interest in the financial assets. In such an
event the
security receipt does not require registration that is otherwise compulsory under the
Registration
Act,
2. 1908. However registration of the security receipt is required in following cases or
eventualities,
(i) There is a transfer of the security receipt.
(ii) If the security receipt is creating, declaring, assigning, limiting or extinguishing any
right, title or interest to or in an immoveable property.
22.8 MEASURES OF ASSET RECONSTRUCTION
1. Asset reconstruction means the acquisition of any right or interest of any bank
of financial institution
in any financial asset for the purpose of realisation. Powers to take various measures for
asset
reconstruction are given without prejudice to the provisions contained in any other law.
Thus, the
powers given under the SARFAESI Act are subject to the provisions of all the other
existing laws.
2. The measures for asset reconstruction are as under :
(i) To change or takeover of the management of the business of the borrower for proper
management of business of the borrower.
Until now, the recovery actions against the defaulting borrowers were taken as a last
stage and as a last resort when the unit is closed and has incurred losses. Such legal
actions at the last stage when unit is unable to function do not give desired recovery.
With these new provisions under SARFAESI Act, a borrowal unit that has been
classified as NPA as per the applicable norms of ninety days default, but is still
functioning, can be treated differently by banks and financial institutions. If the cause of
- CAIIB DISCUSSION
default in such a unit is any mismanagement or lack of expertise on the part of the
existing management, the securitisation company or reconstruction company has the
powers to takeover the management or change the management. This power can be
exercised even when there is no default. On realisation of the secured debt in full the
management of the business can be restored back to the borrower. When the lender lends
money against a security asset and creates charge over the assets, the ownership of the
asset still remains with the borrower who has
225
created the charge. The lender has charge and the only objective is to have a secured
lending and getting repayment by realising the asset, (ii) To sell or lease of a part or
whole of the business of the borrower, (iii) Rescheduling of payment of debts payable by
the borrower.
(iv) Enforcement of security interest in accordance with the provisions of the
SARFAESI Act. (v) Settlement of dues payable by the borrower, (vi) Taking possession
of secured asset in accordance with the provisions of the SARFAESI
Act.
3. In respect of these powers for asset securitisation, the following important operative
points need to be kept in mind.
(i) The power is not linked with any default by the borrower. Even without there being
any
default these powers can be exercised, (ii) The exercise of powers is subject to existing
laws.
(iii) There is no provision for having an overriding effect on the loan agreements
between the bank/financial institution and the borrower.
(iv) There is no civil appeal provided for against any action under this section.
(v) The SARFAESI Act is silent about the grounds or reasons based on which the action
of acquisition can be taken. Therefore, loan agreements between the bank/financial
institution and the borrower are required to be taken into account as provisions of this
section do not have an overriding effect on existing contracts and laws.
(vi)
underThe Act
this does not
section. provideconsidering
However, giving notice to the borrower
a Supreme beforeininitiating
Court ruling any action
the Swadeshi Cotton
Mills vs Union of India AIR 1981 SC 818, a hearing at pre-decisional stage must be
given before resorting to any action. The said ruling is under a different law but on
similar powers of taking over of the undertaking by the Central Government. The same
principle laid down in the said case, will apply to these actions. Therefore, before taking
action, notice to the borrower will be required to be given.
(vii) The provisions contained in the SARFAESI Act for taking forcible possession of
the assets
are applicable to the secured assets only and not to other assets.
(viii) Since the actions can be taken in accordance with the loan agreements, it is
necessary that defaults as contemplated in such agreements have occurred.
(ix) If the contractual power arising out of the loan agreements to takeover or change the
management or to sale or to lease the business of the borrower becomes exercisable, the
same must be exercised under the provisions of the SARFAESI Act.
(x) There are cases that the controlling shares of the promoter directors are pledged with
the bank/financial institution with power to transfer and sale of such shares in case of
default. In such cases, the power to change or takeover the management or sale of
business of the borrower can be done by sale of such shares in accordance with the
powers derived under loan agreements and the provisions of the Indian Contract Act.
Provisions of SARFAESI Act will not apply to such cases because pledge and
enforcement of pledge are kept outside the purview of SARFAESI Act. For such transfer
and sale of shares, compliance of SEBI regulations regarding the takeover code and
other applicable laws and regulations will have to be done.
- CAIIB DISCUSSION
(xi) The acquisition powers under the SARFAESI Act are exercisable subject to
guidelines framed by Reserve Bank of India. This provision is incorporated in the Act
itself.
226
22.9 OTHER FUNCTIONS OF THE SECURITISATION COMPANY
OR RECONSTRUCTION COMPANY
1. Any securitisation company or reconstruction company registered under the
SARFAESI Act may,
(i) Act as an agent for any bank or financial institution for the purpose of recovering
their dues from the borrower on payment of fees or charges as may be mutually agreed
upon between them.
(ii) Act as a manager for the secured assets, of which the possession is taken by any bank
or financial institution for such bank or financial institution on fees as may be mutually
agreed upon between the parties. However, if acting such as manager gives rise to any
pecuniary liability on the securitisation or reconstruction company, then no such acting
as manager can be done.
(iii) Act as receiver if appointed by any Court or Tribunal.
2. The securitisation company or reconstruction company can act as stated above
without the prior
approval of the Reserve Bank of India. For any other acts as well as business other than
securitisation
or asset reconstruction prior approval of the Reserve Bank of India is required.
For the purposes of above said provisions the 'securitisation company' or 'reconstruction
company' does not include its subsidiary.
22.10 RESOLUTION OF DISPUTE
1. Any dispute between the bank or financial institution and the securitisation or
reconstruction company
as well as with or by qualified institutional buyer relating to securitisation or
reconstruction or
non-payment
arbitration of any amount due or interest, is required to be settled by conciliation or
as provided in the Arbitration and Conciliation Act, 1996. The dispute may be amongst
any of the
three parties stated above. The Act provides that settlement of dispute through arbitration
and
conciliation shall be as if the concerned parties have consented in writing for such a
settlement and
the provisions of Arbitration and Conciliation Act, 1996 shall apply.
2. Here it should be noted that only the said three parties are mentioned in the
provision made in the
Act. Obligor or borrower is not mentioned. Therefore, the provisions of mandatory
arbitration and
conciliation are not applicable to the dispute by or against the borrower.
22.11 POWER OF RESERVE BANK TO DETERMINE POLICY
AND ISSUE DIRECTIONS
1. If the Reserve Bank of India is satisfied that it is necessary or expedient so to
do, it may determine
the policy and give directions,
(i) In the public interest, or
(ii) To regulate financial system of the country to its advantage, or
(iii) To prevent the affairs of any securitisation company or reconstruction company
from
being conducted in a manner prejudicial to the interest of such securitisation company or
- CAIIB DISCUSSION
reconstruction company.
2. The Reserve Bank of India directions are given to or policies are framed, in
respect of the
securitisation company or reconstruction company in matters related to,
(i) Income recognition,
(ii) Accounting standards,
(iii) Making provisions for bad and doubtful debts,
227
(iv) Capital adequacy based on risk weights for the assets,
(v) Deployment of funds by the said companies.
Whenever, the Reserve Bank of India decides the policy, and issues directions, the
securitisation company or the reconstruction company is bound to follow the same as it
has a statutory effect.
3. In addition to the above stated powers vested with the RBI for making policy or
giving directions
generally, the RBI has the powers to make policy or issue directions to any particular
securitisation
or reconstruction company or a class of such companies or all such companies. In such
cases, in
addition to the aspects given above, on which the policy can be framed or directions can
be issued,
the RBI may do so on the following aspects also:
(i) The type of financial asset of a bank or financial institution which can be acquired
and procedure for such an acquisition of such assets and valuation thereof.
(ii) The aggregate value of financial asset which may be acquired by any securitisation
company or reconstruction company.
4. Some important points from the guidelines issued until October 2004 by the
RBI are as under:
(i) On the acquisition of a financial asset that has been classified by the bank or financial
institution
company has as atonon-performing
formulate a planasset, the securitisation
for realisation of such company or the twelve
an asset within reconstruction
months.
During such a planning period, the asset can be classified as a Standard Asset, (ii)
Definition of a non-performing asset, has been linked to an overdue period, which is now
ninety days, (iii) Any entity not registered with the Reserve Bank of India under the
SARFAESI Act, may
conduct the business of securitisation or asset reconstruction outside the purview of
SARFAESI Act. (i v) The securitisation company or reconstruction company can
undertake activities and functions
as given in the SARFAESI Act and no other business.
(v) A securitisation company or reconstruction company cannot raise money by way of
deposits, (vi) At the time of enforcing securities as per provisions of the SARFAESI Act,
the securitisation
company or reconstruction company may itself acquire secured assets for use or resale if
such resale is through a public auction, (vii) When the asset is acquired for
reconstruction there is a limit of five years for such
reconstruction, (viii) The securitisation company or reconstruction company is permitted
to set up trusts that
can issue security receipts. Trusteeship of such trusts vests in the concerned
securitisation
or reconstruction company, (ix) While issuing security receipts, detailed disclosures are
required to be made by the concerned
securitisation or reconstruction company, (x) The balance sheet of the asset acquiring
company should disclose names and addresses of
- CAIIB DISCUSSION
the banks/financial institutions from whom the assets are acquired with values thereof,
industry-wise and sponsor-wise dispersion of assets and related party disclosures, (xi)
Maintaining of the capital adequacy of fifteen per cent of total assets acquired or the
capital
of Rs. 100 crore, whichever is less.
5. The RBI has powers to call for statements and information at any time from the
securitisation or
reconstruction company, relating to the business and affairs of these companies as the
RBI may
consider necessary.
L.R.A.D-16
228
22.12 LET US SUM UP
In this unit, we have seen about the functional part of the securitisation and
reconstruction company. It includes the registration of these companies, their functional
freedom and the RBI restrictions thereon. There are some stipulations for capital
requirements and for raising the same. The existing companies require registration.
There are various conditions based on which the registration is considered by the RBI.
We have seen when registration of the company can be cancelled and reasons thereof.
How financial assets are acquired is important and it involves detailed procedure. The
effect of contracts, deeds, suits by or against involving the security asset is also seen.
There are specific documents involved and the procedure for securitisation transaction.
The acquisition of asset involves the proper notice and procedure. There are conditions
for raising funds from the qualified institutional investors. Issuance of security receipts
and conditions/exemptions for the same is also seen. The asset reconstruction company
can take various measures for realisation from the asset. The Act provides for dispute
settlement between the securitisation/reconstruction company and the investor by
arbitration. RBI has powers to issue various guidelines under the Act.
22.13 KEYWORDS
Securitisation Company
Directors; Nominees and Reconstruction
of Sponsor Restrictions;Company; Experienced
No Conviction; Professional
No Controlling Interest;
Prudential Norms; Notice of Acquisition; Contents and Procedure; Funds from
Institutional Investors; Scheme-wise Trust; Security Receipt; Arbitration.
1. A securitisation or reconstruction company needs registration from the RBI for
commencement
of business. (True or False)
2. Right of acquisition of a financial asset by the securitisation or reconstruction
company is subject
to the prior agreements or contracts about the asset. (True or False)
3. Acquisition of a financial asset by the securitisation company or reconstruction
company is with
the liability also over such an asset. (True or False)
4. Which are the four documents involved in the securitisation transaction?
5. For each asset acquired or to be acquired, by the securitisation company or the
reconstruction
company there should be scheme.
6. When the securitisation company or reconstruction company issues security
receipts, the holder
thereof, is entitled to a in the financial asset.
7. The security receipt issued by the securitisation or reconstruction company
requires r egistration.
(True or False)
- CAIIB DISCUSSION
8. Any direction issued by the RBI under the SARFAESI Act has effect
and is
on the parties concerned.
1. True; 2. False; 3. False; 4. offer document, debenture, agreement and security receipt;
5. separate; 6. undivided interest; 7. False; 8. statutory, binding.
1. After application of the SARFAESI Act what have the existing companies to do about
registration with RBI?
229
(a) They are automatically deemed to be registered.
(b) They are required to stop functioning.
(c) Existing companies do not require registration
(d) They have to get registered within six months from the commencement of the
Act.
2. Which, from amongst the following, is a reason for the cancellation of registration of
the securitisation company and reconstruction company without giving a hearing
opportunity?
(a) The company does not keep accounts as per the RBI norms.
(b) The company ceases to carry on the business of securitisation or reconstruction.
(c) The company fails to hold investment from the qualified investor.
(d) The company does not fulfil any of the conditions imposed at the time of
registration.
Ans. 1. (d); 2. (b).
UNIT
23
ENFORCEMENT OF SECURITY INTEREST
STRUCTURE
23.0 Objectives
23.1 Introduction
23.2 Enforcement of Security Interest
23.3 Chief Metropolitan Magistrate or District Magistrate's Assistance for Taking
Possession
of Secured Asset
23.4 Manner and Effect of Take Over of Management
23.5 No Compensation to Directors for Loss of Office
23.6 Right to Prefer Application to DRT
23.7 Appeals to Appellate Authority
23.8 Right of Borrower for Compensation and Costs
23.9 Let Us Sum Up
23.10 Keywords
232
23.0 OBJECTIVES
We know that when immoveable property is obtained as security by way of mortgage for
its sale and realisation of money, Court intervention is required. Similarly, in the case of
moveable property also, except for the pledged security, Court intervention is required
- CAIIB DISCUSSION
for sale of property and realisation of money. Now with the provision of this Act, there
are changes in the procedures for sale of securities. The creditor can also take the help of
the District Magistrate or the Chief Metropolitan Magistrate. We will see all these
provisions in this unit.
23.1 INTRODUCTION
With introduction of NPA norms and its higher levels on one side and delay in
realisation of money by sale of properties through Court intervention on the other side,
giving powers to the lender to enforce security was essential, by the introduction of new
suitable enactment.
The SARFAESI Act empowers banks and financial institutions to enforce securities in
the event of default by the borrower without the intervention of either, the Civil Court or
the Debt Recovery Tribunal. The powers so given by this Act, have an overriding effect
on other laws in this respect. The powers are also over and above other remedies
available for recovery, by filling appropriate proceeding either in a Civil Court or Debt
Recovery Tribunal. The secured creditor has been given the option to decide which
course of action should be adopted in respect of defaulted loans.
From the angle of banks and financial institutions this unit is very important. In this unit,
see about the powers to enforce the securities obtained, while lending money and realise
money therefrom. These powers can be exercised by the creditor, i.e. lender without
intervention of the Court.
23.2 ENFORCEMENT OF SECURITY INTEREST
1. Under the SARFAESI Act a secured creditor can enforce the security interest
created in his favour
without the intervention of the Court or Tribunal. This power given to the secured
creditor, has an
overriding effect over the provisions related to mortgage in the Transfer of Property Act,
1882, as
in that Act Court intervention is required.
2. Section 13(2) of the SARFAESI Act speaks about the notice to be given by the
secured creditors to
the borrower,
classified as who has defaulted in making the r epayment and whose account is
NPA. The precondition to get the right to serve this notice is that the notice should be
given asking
the borrower to discharge in full his liabilities to the secured creditors within the sixty
days from
the date of notice. Failing to do so by the borrower, the secured creditor gets further
rights as
detailed in the Act, that we will see later herein below.
3. The notice referred to above, should give the details of the amount payable by
the borrower and the
secured asset intended to be enforced by the secured creditor in the event of non-
payment of
secured debt by the borrower.
Though the Act contemplates giving of only two particulars, viz., details of amount
payable and details of securities, in the notice said above, it is more proper to give the
details of defaults, overdue period and the date from which the account is classified as
NPA, facility-wise securities provided for the loans and particulars of security
documents executed.by the borrower. The Act or the rules made there under, have not
prescribed any format of notice to be given. However, this notice is a statutory notice
having consequence, that the borrower is prohibited from transferring the property
mentioned in the notice in any way. Any contravention of these legal consequences, if
made, by the borrower is punishable under the SARFAESI Act. So it is advisable that
the notice mentions about the legal consequences and the penal provisions.
- CAIIB DISCUSSION
233
4. The Act does not Contemplate a reply from the borrower to the notice. But the
borrower may reply
or make representation to the notice, so received by him. The Supreme Court in Mardia
Chemicals
Ltd. case, has laid down certain guidelines about what the bank or the financial
institution should
do when the borrower submits any reply or representation to the said notice. These
guidelines
broadly are as under:
(i) The secured creditor must apply his mind to the objection raised by the borrower in
reply or representation to the notice served on him by the secured creditor.
(ii) An internal mechanism must be particularly evolved to consider the reply of the
borrower.
(iii) There may be some meaningful consideration in the objection raised by the
borrower and the rejection of the points raised by the borrower should not be ritually
followed by execution of drastic action under the Act.
(iv) The reasons for overriding the objections of the borrower must be communicated to
him by the secured creditor.
(v) While directing that the reasons for the rejection must be conveyed to the borrower,
the Supreme Court has clarified that the communication to the borrower giving the
reasons for not accepting the objections of the borrower does not give an occasion to
resort to any proceedings, such as a stay application, injunction, any other type of suit to
restrain the creditor's actions.
After this ruling, there has been an amendment to the Act. Now, Section 13(3A) says
that if the borrower on receipt of the notice under Section 13(2) from the secured
creditor makes any representation or raises any objection, the secured creditor has to
consider the representation or the objection and, if it is not tenable or acceptable it has to
be communicated within one week to the borrower. The borrower has to be
communicated
However, such the reasons for non-acceptance
communication of the representation
or reasons mentioned therein by the or the objections.
secured creditor or
the likely action as contemplated does not confer any right upon the borrower to prefer
an appeal to the DRT or to any Civil Court.
5. If the borrower does not pay in full as per the notice such non-payment by the
borrower gives the
secured creditor right to take recourse to one or more of the following measures to
recover his
secured debt:
(i) Take possession of the secured assets of the borrower including the right to transfer
by way of lease, assignment or sale for the realisation of money from the secured asset.
This right can be exercised only when a substantial part of the business of the borrower
is held as security for the debt.
(ii) Takeover the management of the secured asset of the borrower including the right to
transfer by way of lease, assignment or sale and realise the secured asset.
(iii) Appoint any person as manager to manage the security assets the possession of
which has been taken over by the secured creditor.
(iv) Require at any time, by giving a notice in writing, any person who has acquired the
secured asset from the borrower and from whom any money is due or may become due
to the borrower, to pay to the secured creditor. Such demands from the other person will
be to the extent of secured debt. If such other person pays any amount to the secured
creditor the person so paying gets a valid discharge as if he has made payment to the
borrower.
6. Any transfer of secured asset effected by the secured creditor as provided under
- CAIIB DISCUSSION
this Act, shall

vest in the transferee all rights in, or in relation to, the secured asset as if the transfer has
been
made by the owner of such a secured asset.
7. When sale of the secured asset is made the appropriation of sale proceeds
realised are required to
be made in the following order:
234
(i) Firstly, towards costs, charges and expenses incidental towards preservation and
protection of securities, insurance premiums, etc., that are recoverable from the
borrower.
(ii) Secondly, towards the due of the secured creditors.
(iii) Thirdly, if there is any surplus it will be paid to the person entitled thereto, in
accordance with the right and interests.
The above stated order of payment thus gives the right of secured creditors to realise
their securities in preference to all other creditors and even the other preferential
payments like the dues payable to the Government labour, etc.
8. If the borrower pays the entire dues, costs charges and expenses incurred by the
creditor at any
time before the date fixed for sale or transfer, the secured creditor shall not sell or
transfer the
secured asset and no further steps shall be taken for sale or transfer. In cases of joint
finance or
consortium finance by two or more secured creditors no secured creditor can take any
action of
taking possession of secured asset, unless exercise of such right is agreed upon by the
secured
creditors representing not less than three-fourths in value of the outstanding dues on the
record
date. Theby'outstanding
payable the amount' shall include principal, interest and any other dues
borrower to the secured creditors in respect of secured asset as per the books of account
of the
secured creditors. The 'record date' means the date agreed upon by the secured creditors
representing
not less than three-fourths in value, of the amount outstanding on such date. Any
decision taken by
such creditors is then binding on all other remaining creditors.
9. In case the borrower is a company under winding up process, the dues payable
to the workmen
have pari passu charge with the secured creditors as provided in Sections 529 and 529A
of the
Companies Act. This is the exception for the priorities the secured creditor otherwise
gets when he
initiates recovery actions under the SARFAESI Act. The dues of the workmen are
required to be
deposited from the realised amount with the liquidator. In case the dues are not
ascertained or
ascertainable at such a time, then the liquidator has to give an estimated amount to be
deposited.
The liabilities of the secured creditor to payout of the realised amount from the secured
asset is not
finished due to the payment of the estimated amount but the balance amount on
- CAIIB DISCUSSION
finalisation is
required to be paid.
If after the sale of the secured asset the entire dues of the secured creditors are not
recovered and still there is due balance then the secured creditor can file an application
before DRT or a civil suit in a competent Civil Court. Depending on the amount to be
recovered the pecuniary jurisdiction will be decided.
10. Apart from the security assets, many times the secured creditor may be holding
security by way of
pledge of any moveable or guarantee of any person for the due repayment of the loan
amount. In
such cases, secured creditors are entitled to sell the pledged goods or proceed against the
guarantor
to recover the defaulted loan without initiating any actions against the security asset.
Thus, the
right against security under the SARFAESI Act and the one against the pledged security
and
proceeding against guarantor are kept separate and distinct.
11. The SARFAESI Act has given different rights to the secured creditor. The
rights of a secured
creditor under the Act may be exercised by one or more of its officers authorised in this
behalf in
such manner as may be prescribed. As the powers of enforcing securities need to be
exercised
prudently, fairly, and with due care and caution the Rules framed under the SARFAESI
Act provide
that the authorised officer should be of the level equivalent to a Chief Manager of a
public sector
bank or equivalent or any other authorised person exercising powers of superintendence,
direction
,s and control of the business or affairs of the creditors, as the case may be.
235
12. When the borrower receives the notice from the creditor under Section 13(2),
the borrower shall
not transfer by way of sale, lease or otherwise, other than in the ordinary course of
business, any
of his secured assets referred to in the notice without prior written consent of the secured
creditor.
Non-compliance with this provision attracts penal provisions under the SARFAESI Act
that provide
for punishment of imprisonment of one year or fine or both.
13. The provision of Section 13 at different sub-sections gives power to the secured
creditor for
taking the security into possession and then sell the same. This entire process involves
several
factors of fairness and technicalities. Therefore, the Rules framed under the SARFAESI
Act, have
laid down certain procedural aspects in this connection. Some broad procedures and
precautions
as per the Rules are as under:
(i) Inventory of the property taken into possession be made and the property must be
entrusted
to any person authorised or appointed by the secured creditor, (ii) The secured creditor
shall take care of the property under his possession as an owner of
- CAIIB DISCUSSION
ordinary prudence, preserve and protect the secured assets and insure the same if
necessary
until they are sold, (iii) If the property is subject to speedy or natural decay or the
expense of keeping such property
in custody is likely to exceed its value, then the authorised officer can sell it at once, (iv)
For taking of possession and then sale of immoveable property, the secured creditor is
required to serve a possession notice as nearly as possible as given in Appendix IV to the
Rules on the borrower and by affixing the possession notice on the outer door or at a
conspicuous place at the property, (v) The authorised officer is required to obtain a
valuation of the immoveable property before
sale, fix the reserve price after consulting the secured creditor and sell it by methods
permitted
under Rule 8. (vi) The authorised officer is required to publish the possession notice in
two leading newspapers,
one of which should be in the local vernacular language, (vii) Thirty days before sale of
the immoveable property, the borrower should be given a notice
about the sale. If the sale is by public auction or by inviting tenders from the public,
notice
is required to be published in two leading newspapers, one of which should be in the
local
vernacular language, detailing the terms of sale, (viii) If the price for the secured asset is
coming to less than the reserve price, the authorised
officer can sell the asset at a lower price with the consent of the borrower and secured
creditor, (ix) When the offer of sale of property is accepted by the purchaser and the
secured creditor
accepting the offer confirms the sale, the purchaser has to deposit twenty-five per cent of
the offer price, (x) In case of immoveable property, the purchaser has to deposit the
amount required to clear
the encumbrance. The authorised officer then has to pay and remove the encumbrance
after giving notice to the concerned parties.
14. The
certificate authorised officer
is conveyance of is authorised to issue the sale certificate. Such a
immoveable property and requires stamping, as may be required under the relevant State
laws.
23.3 CHIEF METROPOLITAN MAGISTRATE OR DISTRICT MAGISTRATE'S
ASSISTANCE FOR TAKING POSSESSION OF SECURED ASSET
1. When the secured creditor is required to take possession or control of the secured
asset or when the secured asset is required to be sold or transferred under the provisions
of the SARFAESI Act,
236
the secured creditor can take the help of the Chief Metropolitan Magistrate or the District
Magistrate. For seeking such help the secured creditor has to make a request in writing to
the said authority within whose jurisdiction the secured asset or documents related to it
are situated.
2. On such request being made the Chief Metropolitan Magistrate or the District
Magistrate, as the case may be, shall take possession of th e security asset and documents
relating thereto.
For compliance of the provisions of the Act as stated above, the Metropolitan Magistrate
or the District Magistrate may take or cause to be taken such steps and use or cause to be
used such force as may be in his opinion necessary. Any act of the Metropolitan
Magistrate or the District Magistrate for and while taking possession of the security shall
not be called in question in any Court or before any authority.
A very important aspect of these provisions is that the powers of taking possession, or
- CAIIB DISCUSSION
causing the same, are given to the judicial authority, who will take the possession and
hand it over to the secured creditor.
23.4 MANNER AND EFFECT OF TAKE OVER OF MANAGEMENT
1. When the secured creditor takes over the management of business of a
borrower, he may publish
a notice in a newspaper published in the English language and in a newspaper published
in an Indian
language in circulation in the place where the principal office of the borrower is situated,
for
appointment of:
(i) If the borrower is a company as defined in the Companies Act, 1956, to be the
directors of
such company, or (ii) In any other case, to be the administrator of the business of
borrower.
2. On publication of such a notice, the directors of the company, in case the
borrower is a company
and in other cases, the person holding any office having power of superintendence,
direction and
control of the business of the borrower immediately before the publication of the notice,
shall be
deemed to have vacated their offices. As an effect of this, any management contract
between the
borrower and any directors or manager thereof shall be deemed to be terminated.
3. On publication of the above said notice and then after the appointments of
directors or the
administrators as stated above, all the property and effects of the business of borrower
are deemed
to be in the custody of the directors or the administrators so appointed, as the case may
be. All the
directors or the administrators are empowered to take such steps as may be necessary to
take
their into
custody or under their control all the property, effect and actionable claims to
which the
borrower is entitled. Thereafter, the directors or the administrators are alone entitled to
exercise all
the powers of superintendence, direction and control of the business of the borrower.
Such powers
are derived as if from the memorandum or articles of association of the company or from
any
other source whatsoever.
4. Where the management of the business of a borrower which is a company as
defined in the Companies
Act, 1956, is taken ever by the secured creditor, then, notwithstanding anything
contained in the
Companies Act, 1956 or the memorandum or in the articles of association following
effects apply:
(i) The shareholders of the company can lawfully appoint any person to be a director of
the
company, (ii) No resolution passed by the shareholders of the company shall be given
effect to, unless
approved by the secured creditor, (iii) No proceeding for the winding up of such
company or for the appointment of a receiver for
the company shall lie in any Court, except with the consent of the secured creditor.
- CAIIB DISCUSSION
237
5. Where the management of the business of a borrower has been taken over by 'the
secured creditor', on realisation of the debt in full the secured creditor shall restore the
management of the business of the borrower to him.
23.5 NO COMPENSATION TO DIRECTORS FOR LOSS OF OFFICE
No managing director or director or any person in charge of management of the business
of the borrower shall be entitled to any compensation for the loss of office or for
premature termination of any contract of management, entered into by him with the
borrower. This provision has an overriding effect over any other laws or contract.
However, if any director or any other person controlling the management has to recover
any amount from borrower, it can be recovered.
23.6 RIGHT TO PREFER APPLICATION TO DRT
1. Any person, including the borrower, aggrieved by any of the measures taken by
the secured
creditor or his authorised officer for taking possession of the security may make an
application
along with the prescribed fees, to the Debts Recovery Tribunal having jurisdiction within
forty-
five days from the date on which such measures are taken. There can be different
prescribed fees
for the borrower's application and the application from other than the borrower. The
right to file an
application is provided not only to the borrower but also to any person aggrieved by the
action
taken by the secured creditor.
2. The Debts Recovery Tribunal has to dispose of the application, in accordance
with the provisions
of the recovery of debts due to Banks and Financial Institutions Act, 1993 and the Rules
made
thereunder. The application has to be disposed as early as possible, but within sixty days.
If for any
reason it is not possible to so dispose the application, the Tribunal has to record the
reasons for
delay, but such delay should not be beyond four months from the date of filing of the
application.
If any such application is not disposed within four months, the aggrieved party can
prefer an
application to the Appellate Tribunal for seeking directions for the early disposal of the
application.
23.7 APPEAL TO APPELLATE AUTHORITY
Any person aggrieved by any order made by the debts recovery tribunal can prefer an
appeal along with the prescribed fees to the Appellate Tribunal within thirty days from
the date of receipt of the order of debts recovery tribunal. There can be different fees
prescribed for the borrower's appeal and an appeal by anyone other than the borrower.
The amendments to the Act made in November 2004 have now stipulated that no appeal
can lie unless the borrower deposits fifty per cent of the debt claimed by the secured
creditor. The tribunal has powers for reasons to be r ecorded, to reduce this amount to
twenty-five per cent of the claim amount.
23.8 RIGHT OF THE BORROWER FOR COMPENSATION AND COSTS
1. If the debt recovery tribunal or the appellate tribunal, as the case may be
(i) holds that the possession of secured asset by the secured creditor is not in accordance
with
the provisions of the Acts or Rules framed thereunder and (ii) directs the secured creditor
to return the secured asset to the borrower, then such borrower
- CAIIB DISCUSSION
shall be entitled to payment of such compensation and costs as may be determined by the
tribunal or the appellate tribunal.
238
2. No pecuniary limit is fixed by the Act for the appellate jurisdiction. The jurisdiction of
the DRT is Rs. 10 lakh and above under the Recovery of Debts due to Banks and
Financial Institutions Act, 1993. However, the SARFAESI Act does not provide any
pecuniary limit. Therefore, appeal before the DRT against the actions initiated by the
secured creditors in cases even below Rs. 10 lakh would lie.
23.9 LET US SUM UP
In this chapter, we have seen the details about enforcement of securities by banks and
financial institutions and the procedural requirements thereof. We have discussed how,
on default being committed by the borrower, the creditor can enforce the securities as
per provisions of the Act. For this no Court intervention is required as earlier. The
service of notice calling for payment and on failing to pay, the creditor can invoke the
provisions for the take over of the asset/management. After the notice, transfer by the
borrower is prohibited. The reply to the notice needs consideration on lines with
Supreme Court directions as in Mardia case. Creditor can also call for payment due to
the borrower from a third party. For the remaining dues after sale of assets, the remedy at
Civil Court or DRT are open as per jurisdiction. For initiating various actions under the
Act there is need of an authorised person. While taking possession of the asset, various
precautions are required to be taken. For talcing possession, help of the Chief
Metropolitan Magistrate or District Magistrate can be taken. In such an event the
possession is taken by such authorities and handed over to the creditor. Against the
possession notice, appeal can be made but on payment of the amount as prescribed. If
possession is wrongfully taken, the creditor has to pay compensation to the borrower.
For appeal to the tribunal fifty per cent of the debt amount is required to be deposited.
23.10 KEYWORDS
Enforcement of Security; Notice for Default; Contents; Take Over Management;
Payment in Hands of Third Party; Consortium/Joint Finance; Payment of Labour; Pari
Passu; Independent Remedy.

1. Asset reconstruction means
by any securitisation company or reconstruction
company of any right or interest of the creditor in any
2. SARFAESI Act is applicable to the Regional Rural Banks. (True/False)
3. Mortgage or asset backed debt instruments can be issued by the securitisation
company or
reconstruction company to the general public. (True/False)
4. A guarantor to the loan is within the meaning of the word borrower under
SARFAESI Act.
(True/False)
5. SARFAESI Act is applicable only when there is security. (True/False)
6. Has SARFAESI Act defined hypothecation and whether the Act is applicable to
hypothecation
security? (True/False)
1. acquisition, financial assistance; 2. False; 3. False; 4. True; 5. True; 6. True
1. On giving of a default notice by the creditor, the borrower gives a reply to it. What
should the creditor do?
- CAIIB DISCUSSION
239
)RTis
is Act, before )lakh
itions
iy the
:ourt
Y, the
nsfer
lourt
)arty.
tfion.
ision
:hief
aken
lade
pay
ired
(a) Ignore the notice as the law does not provide for any reply option to the bank.
(b) Wait until the borrower initiates any legal action based on his reply.
(c) Give due consideration to the reply as per the guidelines issued in the Mardia
Chemical case
by the Supreme Court and reply to it.
(d) Take the matter before DRT for resolving issues raised in the reply.
2. On sale of the security asset, the sale proceeds are appropriated firstly.
(a) Towards the satisfaction of dues of secured creditor.
(b) Towards the payment of dues of labour.
(c) Towards payment of cost, charges and expenses for the preservation and
protection of
securities, insurance premiums, etc.
(d) Towards payment of legal costs incurred by the creditor for taking possession
and for
effecting sale.
Ans. 1. (c); 2. (c).
s of
ion
or
ct.
on
CENTRAL REGISTRY
STRUCTURE
24.0 Objectives
24.1 Introduction
24.2 Central Registry
24.3 Central Registrar
24.4 Register of Securitisation, Reconstruction and Security Interest Transactions
- CAIIB DISCUSSION
24.5 Filing of Transactions of Securitisation, Reconstruction and Creation of

Security Interest
24.6 Modification of Security Interest Registered
24.7 Satisfaction of Security Interest
24.8 Right to Inspect Particulars of Securitisation, Reconstruction of Security
Interest
Transactions
24.9 Let Us Sum Up
24.10 Keyword
242
24.0 OBJECTIVES
The SARFAESI Act has brought in a new concept of security and the enforcement of
security. For a proper noting and registering of the charges created in favour of the
secured creditors against the properties that would eventually be enforced, the charges
created need to be noted with authority. It is like the charges noted with the Registrar of
Companies in case of charges created against the property of the Company. This unit
deals with the central registry created under the SARFAESI Act.
24.1 INTRODUCTION
The creation of a security interest in property has gained importance and significance
with the provisions of the SARFAESI Act. It has given various powers to the creditor.
The securitisation and reconstruction companies will be carrying on transactions of a
different nature in accordance with the provisions of the Act. Therefore, both of these
need an authentic registration. In this unit, we will see about the central registry with
whom the transactions above and the creation of charges over security will be required to
be registered. In this unit, we will see the provisions about the same.
24.2 CENTRAL REGISTRY
1.
Registry' The Central Government is authorised to set up or cause to be set up a 'Central
by issue
of notification from such date as may be specified in the notification for the purpose of
registration
of following transactions:
(i) Securitisation and reconstruction of financial assets (ii) Creation of security interest
under the SARFAESI Act.
Maintaining the records of the 'Registry' on computers is permissible under the Act. The
Government can also establish branch offices at other places. The Government has the
authority to decide the territorial jurisdiction of these offices for the purpose of
registration.
2. There are some other Acts which require registration of certain things and
charges. These Acts are:
(i) Registration Act, 1908 (ii) Companies Act, 1956
(iii) Merchant Shipping Act, 1958 (iv) Patents Act, 1970
(v) Designs Act, 2000 (vi) Motor Vehicles Act, 1988
The registration contemplated before the central registry is in addition to the respective
registrations contemplated under the above stated six Acts or any other Act. Thus, the
registration under SARFAESI Act is not in substitution of the other registrations
required under different laws. This is obvious because the purpose and effect and
consequence of registration are different under different respective Acts. The registration
under different laws will have priority of charge depending on the provisions of
respective registration laws.
24.3 CENTRAL REGISTRAR
- CAIIB DISCUSSION
The Central Government has to appoint by notification a person as central registrar for
the purpose of r egistration contemplated under the Act. The Central Government is also
empowered to appoint such other officers with such designations as it thinks fit for the
purpose of discharging various duties for registrations under the Act.
24.4 REGISTER OF SECURITISATION, RECONSTRUCTION AND
SECURITY INTEREST TRANSACTIONS
A record shall be maintained at the central registrar at the head office of the central
registrar in which transactions relating to
243
(i) Securitisation of financial assets,
(ii) Reconstruction of financial assets,
(iii) Creation of security interests shall be maintained.
The record of central registrar can be kept fully or partly on computer, floppies,
diskettes, or any other electronic form. Any entry made with the central registrar shall be
a reference to any such transaction. The central registrar shall have the control and
management of the central register.
24.5 FILING OF TRANSACTIONS OF SECURITISATIQN,
RECONSTRUCTION AND CREATION OF SECURITY INTEREST
Under the SARFAESI Act, now filing of details of transactions of securitisation,
reconstruction and the creation of security interest is required to be filed with the central
registrar. The period of filing such details in proper form as may be prescribed, is thirty
days after the date of transaction or the creation of security. The central registrar has to
prescribe fees for such filing. The particulars are required to be filed as stated above by
the securitisation company or the reconstruction company or the secured creditor, as the
case may be. The delay in filing the said particulars can be condoned by the central
registrar for a period of next thirty days after the first thirty days prescribed, on payment
of fees not more than ten times of the prescribed fees.
24.6 MODIFICATION OF SECURITY INTEREST REGISTERED
Whenever any security interest is registered with the central registrar is modified, the
modification
securitisation is
orrequired to be filed company
the reconstruction before central
or theregistrar.
secured It is the duty
creditor ofthe
to file the
modification. For filing the modification same provisions as are made for registration of
charge apply. This means, modification will have to be filed within thirty days in the
prescribed forms with prescribed fees. Delay condonation will be for a period of next
thirty days on payment of fees not more than ten times of the prescribed fees.
24.7 SATISFACTION OF SECURITY INTEREST
1. The security interest registered with the central registrar is required to be
satisfied on the payment
of full amount by the borrower. The duty to report satisfaction is on the securitisation or
reconstruction company or the secured creditor, as the case may be. The reporting is
required to
be done within thirty days of payment in full or satisfaction of the charge.
2. On receipt of the satisfaction of the charge the central registrar is required to
cause a notice to be issued
to the securitisation or reconstruction company or the secured creditor, calling upon to
show cause
within a time not exceeding fourteen days as to why the payment or satisfaction should
not be recorded
as intimated. If no cause is shown then the central registrar has to order that a
memorandum of
satisfaction shall be entered in the central register. If any cause is shown the central
registrar shall record
a note to that effect in the central register and shall inform to the borrower about it.
- CAIIB DISCUSSION
24.8 RIGHT TO INSPECT PARTICULARS OF SECURITISATION,

RECONSTRUCTION OF SECURITY INTEREST TRANSACTIONS
The particulars of securitisation or reconstruction or security interest entered in the
central register are open for inspection by any person during office hours on payment of
fees as may be prescribed. Same is applicable if the data is kept in the electronic form at
the office of the central registrar.
L.K.A.B-17
244
24.9 LET US SUM UP
Central Government has to set up or cause to set up central registry for registration of
securitisation and reconstruction transaction and creation of security interest.
Registration under other applicable laws will continue. All transactions and creation of
security interest needs to be noted. Modification and satisfaction also needs noting in
prescribed form with payment of fees.
24.10 KEYWORD
Central Registry.
1. After coming into operation, the provisions relating to central registry the banks
and financial
institutes will have to register all security interests created in the asset. (True/False)
2. The period stipulated in the Act for filing details of security interest is days.
3. Duty to report satisfaction of charge to the central registrar is on creditor or on
the borrower?
1. True; 2. 30; 3. Creditor.
1. Besides the SARFAESI Act, some other laws require some registration of charge
created in the property. Is such double registration avoidable?
(a) Yes, the creditor can choose under which law he needs registration.
(b)
will haveNo, registration under the SARFAESI Act as well as any other applicable law
to be
made as the SARFAESI Act is not substitution of any other law.
(c) Yes, if one charge noting is by a registered document.
(d) No, as the Civil Courts and DRT still have jurisdiction against the properties
both registrations
are required.
Ans. 1. (b)
tion ible and
OFFENCES AND PENALTIES
rial
the
)be
STRUCTURE
25.0 Objectives
25.1 Introduction
25.2 Penalties
- CAIIB DISCUSSION
25.3 Penalties for Non-compliance of Directions of Reserve Bank of India

25.4 Offences
25.5 Cognisance of Offences
25.6 Let Us Sum Up
25.7 Keyword
ons
246
25.0 OBJECTIVE
The objective of this unit is to know the penal provision of the Act. For effective
implementation of the law and as a deterrent step to prevent improper actions by parties
concerned penal provisions are kept in laws.
25.1 INTRODUCTION
The Act has given many statutory obligations. If anything said in the law is not acted
upon or is not followed there is a breach of the legal provisions. So there are penalties
provided in the Act. In this chapter, we will see about the offences and penalties. It also
gives details about which Court should be dealt with for imposition of penalty for breach
of provisions of the Act.
25.2 PENALTIES
Section 23 of the Act provides for filing of the particulars of charge created. Section 24
has provides for modification of the charge filed and the Section 25 has provides that the
satisfaction of the charge has to be intimated to the central registrar. If the securitisation
or reconstruction company or the secured creditor fails to perform any of the duties as
stated above, the company and the officers concerned for the default, as per provisions of
this section, are punishable with a fine that may extend to five thousand rupees for each
day during which the default continues.
25.3
DIRECTIONSPENALTIES FOR NON-COMPLIANCE
OF RESERVE BANK OF INDIA OF
Under the Section 12 of the SARFAESI Act, the Reserve Bank of India is statutorily
empowered to issue directions to the securitisation or reconstruction company. If any
such company fails to comply with any of the directions issued by the Reserve Bank of
India, then such company is punishable with a fine not exceeding Rs. 5 lakh for the
default. In case of further continuation of the offence, an additional fine up to Rs. 10,000
per day of the default can be imposed.
25.4 OFFENCES
If any person:
1. contravenes, or
2. attempts to contravene, or
3. abets the contravention of the provisions of the SARFAESI Act or rules made
thereunder, he shall
be punishable with imprisonment for a term, which may extend to one year or with a fine
or both.
The Act has made various provisions where duties are cast on the borrower, the secured
creditor, the securitisation and the r econstruction company. Any contravention of these
provisions is punishable as stated above under the provisions of this section.
25.5 COGNISANCE OF OFFENCES
Section 30 provides that cognisance of the offence under the SARFAESI Act shall be
taken by the Metropolitan Magistrate or the Judicial Magistrate of First Class only. No
Court below rank than this can take cognisance of such offences.
- CAIIB DISCUSSION
25.6 LET US SUM UP

If the charges created, modified and satisfied are not intimated to the central registrar it
is an offence. The securitisation company or the reconstruction company is required to
perform various duties under the Act. Breach thereof is also an offence. The
punishments are up to Rs. 5,000 for each day of default. Breach of RBI directives is also
punishable by a fine up to Rs. 5 lakh and Rs. 10,000 for continuation per day. Any
general infringement of provisions of SARFAESI Act is punishable with imprisonment
for one year or fine or both.
25.7 KEYWORDS
Offences for Breach.
1. Is there any punishment provided in the Act for not following RBI directions?
(Yes/No)
2. Can the Honorary Magistrate take cognisance of offence under the SARFAESI
Act?
1. Yes; 2. No
1. Whether breach of RBI directives is punishable offence and to what extent?
(a) Yes, a fine up to Rs. 5 lakh and for continuation of offence a fine of up to Rs.
10,000 per
day.
(b) Yes, by cancellation of licences of the company.
(c) No, these are the administrative directions.
(d) No, the Act has not provided for any punishment in specific.
Ans. 1. (a)
MISCELLANEOUS PROVISIONS
STRUCTURE
26.0 Objective
26.1 Introduction
26.2 Non-Applicability of the Provisions of the SARFAESI Act in Certain Cases
26.3 Protection of Action Taken in Good Faith
26.4 Offences by Companies
26.5 Civil Court not to have Jurisdiction
26.6 Overriding Effect on Other Laws
26.7 Limitation
26.8 Power of the Central Government to Make Rules
26.9 Certain Provisions of the Act to Apply after Central Registry is Set Up or Cause
to be Set Up
26.10 Amendments to Certain Other Enactments
26.11 Let Us Sum Up
250
26.0 OBJECTIVE
The objective of this unit is to understand the exceptions of securities to which this Act
is not applicable. At the same time, the person or the organisation utilising the provisions
and powers given under this Act should know about the legal protections the Act has
given when it is implemented properly and in good faith. At the same time, if any of the
- CAIIB DISCUSSION
provisions are not followed, then it has penal provisions also.

26.1 INTRODUCTION
In this unit, we will see some miscellaneous provisions about implementation of the Act.
Section 31 gives some exclusions of securities to which the Act is not applicable. For
creditor it is important to note these exclusions. The Act has given many strict powers to
take possession of security, change of management, etc. These require some hard steps
to be taken. So the person exercising the rights under the Act needs a legal protection.
Section 32 gives such protection for action taken in good faith under the Act. Similarly,
to curb the tendency of the borrowers to go to Civil Court or any other authority and
bring injunctions, stay, orders for status quo, etc., the Act has barred the jurisdiction of
Civil Court as well as other authorities for the matters covered by this Act. The unit also
deals with offences, limitation period for actions, overriding effect on other laws, Central
Government powers to make rules and some such provisions for effective
implementation of the Act.
26.2 NON-APPLICABILITY OF THE PROVISIONS OF
THE SARFAESI ACT IN CERTAIN CASES
The object of the SARFAESI Act is to give powers to the banks and financial
institutions to enforce the securities given to the loans and advances by the borrowers
without the intervention of the Court. It should be noted that the securities not in
possession of the bank or financial institution are only covered by this Act. The
securities in possession of the secured creditors are not covered by this Act and
provisions of the Act are not applicable to them.
Therefore, the Section 31 gives the exclusions for securities that can be taken possession
of and to some other specific securities to which the Act is not applicable. These
exclusions, to which the provisions of the Act are not applicable, are
(i) A lien, on any goods, money or security given by or under the Indian Contract Act,
1872 or the
Sale of Goods Act, 1930 or any other law for the time being in force.
(ii) A pledge of movable, within the meaning of Section 172 of the Indian Contract Act,
1872. (iii) Creation of security interest in any vessel as defined within the meaning of
Section
Merchant 3(55) of theAct, 1958.
Shipping
(iv) Creation of security in any aircraft as defined in Section 2 of Aircraft Act 1934. (v)
Any conditional sale, hire-purchase or lease or any other contract in which no security
interest
has been created.
(vi) Any rights of unpaid seller under Section 47 of the Sale of Goods Act, 1930. (vii)
Any properties not liable for attachment or sale under the first proviso to Section 60(1)
of the
Civil Procedure Code, 1908.
(viii) Any security interest for securing repayment of any financial asset not exceeding
one lakh rupees, (ix) Any security interest created in agricultural land, (x) Any case, in
which the amount due is less than twenty per cent of the principal amount and
interest thereunder.
26.3 PROTECTION OF ACTION TAKEN IN GOOD FAITH
The secured creditors and their officers are protected for actions taken in good faith by
the provisions made in the Act. For initiating actions under the Act no suit, prosecution
or any other legal proceeding
251
can be taken against the secured creditor or his officers. This protection is given so that
actions contemplated and authorised under SARFAESI Act, can be taken without fear of
counteraction from the borrower or any other person having interest in the property.
26.4 OFFENCES BY COMPANIES
- CAIIB DISCUSSION
1. If a company and its officers commit any offence under the provisions of the
SARFAESI Act the
same is punishable. There are provisions in the Act that cast some statutory obligations.
If these
statutory obligations are not observed then there is contravention of the Act which
amounts to
offence. If any offence is committed under the provisions of this Act by a company, such
company,
as well as any person who is in charge of the business of the company, are deemed to be
guilty of
the offence and they are liable to be prosecuted and punished. It is permissible for a
person acting
for the company to prove that the offence was committed without his knowledge or that
he had
exercised due diligence to prevent the commission of such offence. In such cases and on
proving
his stand the person concerned shall not be punishable. If such offence is committed with
the
consent or connivance of any director or officer of the company, such director or officer
shall be
deemed to be guilty for the offences along with the company.
2. The penal provisions are applicable to all categories of borrowers such as
individuals, partnership
firms, companies incorporated under the Companies Act or any other association of
individuals.
The Act has clarified, that company includes a partnership firm or other association of
individuals
and the expression director includes a partner of a firm.
26.5 CIVIL COURT NOT TO HAVE JURISDICTION
1. The SARFAESI Act has conferred jurisdiction on many matters to the debts recovery
tribunal or the appellate

and jurisdiction is to the tribunal. Therefore,
debts recovery for any
tribunal such
or the matterstribunal,
appellate where empowerment
no Civil Court
shall have jurisdiction to entertain any suit or proceedings. Similarly, any Court or
authority cannot grant injunction in such matters and actions taken, or to be taken, under
this Act as well as under Recovery of Debts Due to Banks and Financial Institutions Act,
1993. Due to such provisions the implementation of the Act becomes effective.
26.6 OVERRIDING EFFECT ON OTHER LAWS
The provision of this Act has overriding effect on any other laws if the provisions in the
other law are inconsistence with this Act. If for any particular point, the provisions of
this Act and in some other Act are inconsistent with each other, a question will come as
to which provisions are to be followed, when both such Acts are applicable to that
particular point. The Act, therefore, provides that the provisions of the SARFAESI Act
will have overriding effect on the other Act. Mainly, such inconsistencies are in the
Transfer of Property Act and the Registration Act. The provisions the SARFAESI Act
will apply, overriding the provisions in those Acts.
26.7 LIMITATION
The actions that secured creditor can take against the security under the SARFAESI Act
are required to be taken within the limitation as per Section 36 of the Limitation Act.
That means, the action has to be taken within three years from the date on which the
cause of action arose.
Due to the provisions of this section, all secured creditors are required to take measures
such as taking possession of the securities, provided their claim is within the period of
limitation. It will be necessary
- CAIIB DISCUSSION
252
for the banks and financial institutions to comply with the limitation aspect. If after sale
of securities the claim is not fully satisfied and still there are any dues to be recovered
from the borrower, the creditor is required to file civil suit before the Civil Court or a
claim before the debt recovery tribunal within the limitation period. Therefore, the
secured creditor will have to make an assessment, before taking possession of the
security, whether it would be possible to sell the security and make an eventual claim for
shortfall within the limitation period.
26.8 POWER OF CENTRAL GOVERNMENT TO MAKE RULES
1. For carrying out the provisions of this Act, the Central Government can frame
rules and notify
them in the Official Gazette. The Act also allows the Government to notify the rules in
the Electronic
Gazette as defined in the Information Technology Act, 2000, i.e. on the website of the
Government.
2. Whenever the Government makes a rule under the Act, the rule is so required to
be kept before
each House of Parliament, while in session for a total period of thirty days. Both the
Houses should
agree to the rules as framed and they can make modifications therein or decide not to
make the
rules. The rule gets the validity in the manner as decided by both the Houses. If already
made rules
are modified or cancelled, then any act done under the then existing rule does not get
vitiated or
modified in any way.
26.9 CERTAIN PROVISIONS OF THE ACT TO APPLY AFTER
CENTRAL REGISTRY IS SET UP OR CAUSE TO BE SET UP
The provisions contained in sub-Sections (2) to (4) of Sections 20 and 21 to 27 that
provide for registration of the security interest created, satisfaction of charge, etc., are
applicable
Government. only after the central registry is set up or caused to be set up by the Central
26.10 AMENDMENTS TO CERTAIN OTHER ENACTMENTS
For effective purpose of this Act, it has amended some related provisions of the
Companies Act, 1956, The Securities Contracts (Regulation) Act, 1956 and The Sick
Industrial Companies (Special Provisions) Act, 1985.
The amendments are as under:
1. Section 4A of the Companies Act, 1956 is amended for the purpose of declaring
any securitisation
company or reconstruction company registered with the Reserve Bank of India as a
Public Financial
Institution within the meaning of Section 4A of the Companies Act, 1956.
2. The Securities Contracts (Regulation) Act, 1956 is amended at Clause (h) of
Section (2 )for
including security receipt as defined in Clause (zg) of Section 2 of the SARFAESI Act.
3. Amendment to The Sick Industrial Companies (Special Provisions) Act, 1985 is
made to provide
that
(i) no reference to the Board for Industrial and Financial Reconstruction (BIFR) shall lie,
where financial assets are acquired by any securitisation company or reconstruction
company under sub-Section 5 of the SARFAESI Act, and
(ii) for the purpose of providing that a reference pending before BIFR shall abate if the
secured creditors, representing not less than three-fourths in value of the amount
outstanding, take any measures to recover their secured debt under sub-Section (4) of
- CAIIB DISCUSSION
STRUCTURE
27.0 Objective
27.1 Introduction
27.2 Object of Scheme and Extent
27.3 Definitions
27.4 Appointment and tenure
27.5 Territorial Jurisdiction and Location of Office
27.6 Secretariat
27.7 General Powers of Banking Ombudsman
27.8 LetUsSumUp
27.9 Keywords
256
27.0 OBJECTIVE
The objective of this unit is to understand the purpose of introduction of the scheme,
viz., 'The Banking Ombudsman Scheme 2006, various words and the terms used in the
scheme and how the appointment of banking ombudsman is done, its establishment and
powers.
27.1 INTRODUCTION
In this unit, we will see the definitions of the words used in the scheme. The definitions
are important, as they have an assigned meaning in the scheme and these words are used
in the scheme in the context of definitions. If the definitions are well mastered, it is easy
to understand the scheme. We will also see the provisions relating to establishment of
office of banking ombudsman. The RBI decides his appointment and other terms of
office, his secretariat, his powers, etc. The RBI also decides the territorial jurisdiction of
the banking ombudsman. The scheme has come in force with effect from 1 January
2006.
27.2 OBJECT OF SCHEME AND EXTENT
1. The scheme was introduced with the following objectives:
(i) To resolve complaints relating to banking services and to facilitate the satisfaction or
settlement
of such complaints, (ii) Resolve disputes between a bank and its constituents as well as
amongst banks, through the
process of conciliation, meditation and arbitration.
2. The scheme extends to the whole of India. It is applicable to the banks in India.
The Reserve Bank
has the authority to suspend the operation of the scheme fully or partly for such period as
may be
specified in the order. Such suspension, may be general or in relation to any specified
bank. The
period of suspension can be extended if deemed fit by the Reserve Bank.
27.3 DEFINITIONS
1. 'Award' means an award passed by the banking ombudsman in accordance with
this scheme.
2. 'Appellate Authority' means the Deputy Governor in charge of the department
of the RBI
implementing the scheme.
3. 'Authorised Representative' means a person duly appointed and authorised by a
complainant to
act on his behalf and represent him before a banking ombudsman, for consideration of
- CAIIB DISCUSSION
his complaint.
4. 'Banking Ombudsman' means any person appointed under Clause No. 4 of the
scheme.
5. 'Bank' means,
• a banking company,
• and includes a corresponding new bank,
• a Regional Rural Bank,
• State Bank of India and its Subsidiary banks as defined in Part I of the Banking
Regulation Act,
1949,
• and also includes a scheduled primary co-operative bank and included in the
second Schedule
to the RBI Act, 1934 having a place of business in India.
6. 'Complaint' means a representation in writing or through ELECTRONIC

MEANS containing a
grievance, alleging deficiency in banking service.
7. 'Settlement' means an agreement reached by the parties either by conciliation or
mediation under
the Scheme.
257
27.4 APPOINTMENT AND TENURE
The Reserve Bank may appoint one or more of its officers in the rank of Chief General
Manager or General Manager to be known as the banking ombudsmen to carry out the
functions entrusted to them by or under the scheme. This appointment may be made for a
period not exceeding three years at a time.
27.5 TERRITORIAL JURISDICTION AND LOCATION OF OFFICE
1. The Reserve Bank shall specify the territorial limits to which the authority of
each of the banking

ombudsman shall extend.
2. The office of the banking ombudsman will be located at such places as may be
specified by the
Reserve Bank.
3. The banking ombudsman may hold sittings at such places within his area of
jurisdiction as may be
considered necessary and proper by him, in respect of a complaint or reference before
him.
27.6 SECRETARIAT
(i) The Reserve Bank shall depute such number of its officers and other staff to the office
of the banking ombudsman as considered necessary to function as the secretariat of the
banking ombudsman.
(ii) The cost of the secretariat will be borne by the Reserve Bank.
27.7 GENERAL POWERS OF BANKING OMBUDSMAN
The banking ombudsman shall have the following powers and duties:
(a) to receive complaints relating to banking services
(b) to consider such complaints relating to the deficiencies in the banking and other
services and
facilitate their satisfaction or settlement by agreement through conciliation and
mediation between
the bank and the aggrieved parties or by passing an award in accordance with the
scheme.
27.8 LET US SUM UP
- CAIIB DISCUSSION
The object of the scheme makes clear the purpose behind introduction of the scheme.
We have seen the definitions of different words used in the scheme. The definition of
words have importance as they are used in a particular context in the scheme. We have
seen the provisions about appointment and tenure of banking ombudsman. The RBI is
the authority for appointment and deciding terms of appointment, etc. RBI also decides
the territorial jurisdiction of the banking ombudsman. We have seen about his powers
and duties and how he has to deal with the complaint.
27.9 KEYWORDS
Conciliation; Meditation.
1. Disputes amongst two banks can be taken up before the banking ombudsman.
(True/False)
2. Co-operative banks are not covered by the banking ombudsman scheme.
(True/False)
3. Banking ombudsman is appointed by a committee of Supreme Court Judges.
(True/False)
4. It is not within the powers of banking ombudsman to deal with the complaint
unless both parties
agree for his intervention. (True/False)
258
1. True; 2. False; 3. False; 4. False
1. What is the object of introducing the banking ombudsman scheme, 2006?
(a) For effective monitoring of the NPA accounts in the banks.
(b) It is the RBI agency to regulate the disputes amongst the banks.
(c) To enable resolution of complaints relating to banking services.
(d) For executing the orders passed by the DRT.
2. Complaints relating to non-acceptance of small denomination notes by a bank,
can be made
banking to a
ombudsman:
(a) Such small denomination notes and coins to be deposited with the Reserve
Bank.
(b) They may be deposited with a bank having a currency chest facility.
(c) Banking ombudsman can deal with the complaints under the scheme.
(d) The complainant can seek no remedy at all through banking ombudsman, but
has to approach
the consumer disputes redressal machinery.
3. Complaints can be made against promises made by sales agents but not fulfilled
by the bank
represented by them under the banking ombudsman Scheme 2006?
(a) No complaint is admissible as he is not the employee of the bank.
(b) The sales agent has no authority to make any promise and hence the bank is not
bound to
fulfil them.
(c) The banking ombudsman can entertain the complaint under the scheme.
(d) Agency functions are outside the purview of the banking ombudsman scheme.
Ans. 1. (c); 2. (c); 3. (c)
PROCEDURE FOR REDRESSAL OF GRIEVANCE
STRUCTURE
- CAIIB DISCUSSION
28.0 Objective
28.1 Introduction
28.2 Grounds of Complaint
28.3 Procedure of Filing Complaint
28.4 Power to Call for Information
28.5 Settlement of Complaint by Agreement
28.6 Award by the Banking Ombudsman
28.7 Rejection of the Complaint
28.8 Proceeding Before the Review Authority
28.9 Banks to Display Salient Features of the Scheme for Common Knowledge of
Public
28.10 Let Us Sum Up
28.11 Keywords
260
28.0 OBJECTIVE
The objective of this unit is to understand the procedure adopted by the banking
ombudsman for dealing with the grievance of the complainant. A banker must know, on
what issues and matters complaint can be filed.
28.1 INTRODUCTION
From procedural point of filing a complaint and the manner of dealing with it, this unit is
very important. The aspects on which a complaint can be filed are exhaustive and cover
all of the services the bank offers to its customers. The grounds include some matters
related to loans and advances also. Though there cannot be a complaint for not
sanctioning a loan, it can be for non-observance of RBI directives, delay in decision,
interest rate directives and non-acceptance of a loan application. In a broader sense, the
aspects also cover what the customers expect from the bank about its declared services.
For effectively dealing

for information from thewith the complaint
parties concerned.the
Thebanking ombudsman
complaint hasinpowers
needs to be writingtoand
call
supported by documents and declarations as given in the scheme. The limitation period
for filing a complaint is one year.
28.2 GROUNDS OF COMPLAINT
A complaint on any of the following grounds alleging deficiency in banking service may
be filed with the banking ombudsman having jurisdiction:
(i) non-payment/inordinate delay in the payment or collection of cheques, drafts, bills,
etc; (ii) non-acceptance, without sufficient cause, of small denomination notes or coins
tendered
for any purpose, and for creating a charge of commission in respect thereof; (iii) non-
payment or delay in payment of inward remittances; (iv) failure to issue or delay in issue
of drafts, pay orders or bankers cheques; (v) failure to honour a guarantee or letter of
credit commitments; (vi) failure to provide or delay in providing a banking facility (other
than loans and advances)
promised in writing by a bank or its direct selling agents;
(vii) delays, non-credit of proceeds to parties accounts, non-payment of deposit or non-
observance of the Reserve Bank directives, if any, applicable to rate of interest on
deposits in any savings, current and other account maintained with a bank; (viii) delay in
receipt of export proceeds, handling of export bills, collection of bills etc., for
exporters provided that the said complaints pertain to the bank's operations in India; (ix)
complaints form non-resident Indians having accounts in India in relation to their
remittances
from abroad, deposits and other bank related matters; (x) refusal to open deposit
- CAIIB DISCUSSION
accounts without any valid reason for refusal; (xi) levying of charges without adequate
prior notice to the customer; (xii) non-adherence by the bank or its subsidiaries to the
instructions of Reserve Bank on ATM/
Debit card operations or credit card operations;
(xiii) non-disbursement or delay in disbursement of pension (to the extent the grievance
can be attributed to the action on the part of the bank concerned, but not with regard to
its employees); (xiv) refusal to accept or delay in accepting payment towards taxes, as
required by Reserve
Bank/Government; (xv) refusal to issue or delay in issuing, or failure to service or delay
in servicing or redemption
of Government securities; (xvi) forced closure of deposit accounts without due notice or
without sufficient reason;
261
(xvii) refusal to close or delay in closing the accounts; (xviii) non-adherence to the fair
practices code as adopted by the bank;
(xix) any other matter relating to the violation of the directives issued by the Reserve
Bank of India in relation to banking services.
2. Complaints concerning loans and advances may also be filed, only in so far as
they relate to the
following:
(i) non-observance of Reserve Bank of India directives on interest rates.
(ii) delays in sanction, disbursement or non-observance of prescribed time schedule for
disposal
of loan applications.
(iii) non-acceptance of application for loans without furnishing valid reasons to the
applicant, (iv) non-observance of any other directions or instructions of the Reserve
Bank of India, as may be specified by it from time to time.
3. The banking ombudsman may also deal with such other matter as may be
specified by the Reserve
Bank
28.3 of India from time
PROCEDURE FORto FILING
time in this behalf.
COMPLAINT
1. Any person who has a grievance against a bank relating to the banking services
for reasons as
detailed above, may himself or through his authorised representative other than an
advocate make
a complaint to the banking ombudsman within whose jurisdiction the branch or office of
the bank
complained against is located. Complaints arising out of the operation of credit cards
shall be filed
before the banking ombudsman within whose jurisdiction the billing address of the
complainant is
located.
2. The complaint shall be in writing, duly signed by the complainant or his
authorised representative.
The complaint shall be in a form specified in Annexure - A of the scheme and shall state
clearly
following particulars:
(i) The name and address of the complainant
(ii) The name and address of the branch or office of the bank against which the
complaint is
made
(iii) The facts giving rise to the complaint (iv) The nature and extent of the loss caused to
the complainant (v) The relief sought from the banking ombudsman
- CAIIB DISCUSSION
3. No complaint to the banking ombudsman shall lie unless

(a) the complainant had before making a complaint to the banking ombudsman
made a written
representation to the bank and either the bank had rejected the complaint or the
complainant
had not received any reply within a period of one month after the bank concerned
received
his representation or the complainant is not satisfied with the reply given to him by the
bank;
(b) the complaint is made not later than one year after the cause of action has arisen
as per
Clause (a) above;
(c) the complaint is not in respect of the same subject matter which was settled
through the
office of the banking ombudsman in any previous proceedings;
(d) the complaint does not pertain to the same subject matter, for which any
proceedings
before any court, tribunal or arbitrator or any other forum is pending or a decree or
award
or a final order has already been passed by any such competent court, tribunal, arbitrator
or
forum;
(e) the complaint is not frivolous or vexatious in nature;
262
(f) It is made before the expiry of the period of limitation prescribed under the Indian
Limitation Act 1963 for such claims.
28.4 POWER TO CALL FOR INFORMATION
1. The banking ombudsman may require the bank named in the complaint or any
other related bank to
provide any information or furnish certified copies of any document relating to the
subject matter
of the complaint that is or is alleged to be in the possession of such bank. In the event of
the failure
of a bank to comply the requisition without any sufficient cause, the banking
ombudsman may
draw the inference that the information, if provided or copies if furnished, would be
unfavourable
to such bank.
2. The banking ombudsman shall not disclose any information or document to any
person except
with the consent of the person furnishing such information or document. However, the
banking
ombudsman may disclose information or document furnished by a party in complaint to
the opposite
side of the complaint, to the extent considered by him to be reasonably required to
comply with the
principles of natural justice and fair play in the proceedings.
28.5 SETTLEMENT OF COMPLAINT BY AGREEMENT
1. The banking ombudsman has to serve a notice of the receipt of complaint along
with a copy of the
complaint to the branch or office of the bank named in the complaint. He has to attempt
for a
settlement of the complaint by an agreement between the complainant and the bank
- CAIIB DISCUSSION
through
conciliation or mediation.
2. For the purpose of promoting a settlement of the complaint, the banking
ombudsman may follow
such procedures as he may consider appropriate and he shall not be bound by any legal
rule of
evidence.
3. The proceedings before the banking ombudsman shall be summary in nature.
28.6 AWARD BY THE BANKING OMBUDSMAN
1. If a complaint is not settled by agreement within a period of one month from
the date of receipt of
the complaint or such further period as the banking ombudsman may consider necessary,
he may
pass an award after affording the parties a reasonable opportunity to present their case.
He shall be
guided by the evidence placed before him by the parties, the principles of banking law
and practice,
directions, instructions and guidelines issued by the Reserve Bank of India from time to
time and
such other factors which in his opinion are necessary in the interest of justice.
2. The award passed under the sub-clause above shall state the direction(s), if any,
to the bank for
specific performance of its obligations in addition to the amount to be paid by the bank
to the
complainant by way of compensation for the loss suffered by him and may contain any
direction
to the bank.
The banking ombudsman shall not give any dir ection(s) in the award under sub-clause
above regarding payment of compensation in excess of that which is necessary to cover
the loss, suffered by the complainant, as a direct consequence of the commission or
omission
3. of case
In the bank, or for an relating
of complaints amount to
exceeding Rs.operations,
credit card 10 lakh whichever is lower.
the banking ombudsman
shall take into
account the loss of complainant's time, expenses incurred by the complainant, financial
loss,
harassment and mental anguish suffered by the complainant, while determining the
amount of
compensation. ;
263
4. A copy of the award shall be sent to the complainant and the bank named in the
complaint. An
award shall not be binding on a bank against which it is passed unless the complainant
furnishes to
it within a period of fifteen days from the date of receipt of copy of the award, a letter of
acceptance
of the award in full and final settlement of his claim in the matter. If the complainant
does not
accept the award passed by the banking ombudsman and fails to furnish his letter of
acceptance
within such time, without making any request for extension of time to comply with such
requirements, the award shall lapse and be of no effect.
5. The bank shall within one month from the date of receipt by it, of the
acceptance in writing of the
- CAIIB DISCUSSION
award by the complainant comply with the award and intimate the compliance to the
banking
ombudsman.
28.7 REJECTION OF THE COMPLAINT
1. The banking ombudsman may reject the complaint at any stage if it appears to
him that the complaint
made is:
(i) frivolous, vexatious, mala-fide; or (ii) without any sufficient cause; or
(iii) that it is not pursued by the complainant with reasonable diligence; or ! (iv) prima
facie, there is no loss or damage or inconvenience caused to the complainant; or (v)
beyond the pecuniary jurisdiction of the banking ombudsman under the scheme
2. The banking ombudsman may reject a complaint at any stage, if after
consideration of the complaint
and evidence produced before him the banking ombudsman is of the opinion that the
complicated
nature of the complaint requires consideration of elaborate documentary and oral
evidence and the
proceedings before the banking ombudsman are not appropriate for adjudication of such
a complaint.
The decision of the banking ombudsman in this regard shall be final and binding on the
complainant
of the bank.
28.8 PROCEEDING BEFORE THE APPELLATE AUTHORITY
1. Any person aggrieved by the award has the right to prefer an appeal against the
award before the
appellate authority within forty-five days form the date of receipt of the award. The
appellate
authority is empowered to allow a further period not exceeding thirty days on his being
satisfied
that the appellant had sufficient cause for not preferring the appeal in time. In case the
appeal is by
the bank, the filing of appeal should have been with the previous sanction of the
Chairman or in his
absence the Managing Director or Executive Director or the Chief Executive Officer or
any other
officer of equal rank.
2. The appellate authority after giving the parties a reasonable opportunity of
being heard, may pass
the following orders:
(a) dismiss the appeal; or

(b) allow the appeal and set aside the award; or
(c) remand the matter to the banking ombudsman for fresh disposal in accordance
with such
directions as the appellate authority may consider necessary or proper; or
(d) modify the award and pass such directions as may be necessary to give effect to
the award
so modified; or
(e) pass any other order as it may deem fit.
The order of the appellate authority has also the same effect as that of the award of the
banking ombudsman.
264
28.9 BANKS TO DISPLAY SALIENT FEATURES OF
- CAIIB DISCUSSION
THE SCHEME FOR COMMON KNOWLEDGE OF THE PUBLIC

1. The banks covered by the scheme shall ensure that the purpose of the scheme
and the name and
address of the banking ombudsman to whom the complaints are to be made by the
aggrieved party
are displayed in all the branch/office premises.
2. The banks covered by the scheme are required to ensure that a copy of the
scheme is made
available with the designated officer of the bank for perusal in the office premises of the
bank.
There should be a notice displayed at each office of the bank about the availability of the
copy of
the scheme with such a designated officer.
The banks covered by the scheme are required to appoint nodal officers at their
Regional/Zonal offices and inform the respective office of the banking ombudsman. The
nodal officer appointed shall be responsible for representing the bank and furnishing
information to the banking ombudsman in respect of complaints filed against the bank.
28.10 LET US SUM UP
We saw the grounds on which a complaint can be filed. It touches all aspects of banking
services. It relates to some issues about loans and advances also. The procedural part of
filing and dealing with the complaint is material and needs to be well noted. We have
seen how the information required by the banking ombudsman can be called and how he
deals with the complaint. How an award is passed. For awareness of the public, a notice
about the scheme is required to be displayed at each office along with copy of the
scheme.
28.11 KEYWORDS
Banking Ombudsman.
1. Bank can refuse acceptance of small denomination notes from the customer and
therefore, on
this
2. ground Onthere
validcannot
groundsbebank
a complaint to banking
can refuse ombudsman.
the opening (True/False)
of a new account, but on this
ground, complaint
before the banking ombudsman is maintainable. (True/False)
3. Can a prospective borrower go before the banking ombudsman for non-sanction
of his loan by
the bank? (Yes/No)
4. Banking ombudsman has powers to call for any information and certified
copies from bank when
he is dealing with the complaint.
5. For settling the complaint the banking ombudsman is bound by legal rules of
evidence.
(True/False)
6. What is the maximum amount the banking ombudsman can award as
compensation? (No limit /
10 lakh)
7. Limitation period for filing of the review application against the award given by
the banking
ombudsman is days. (60/45 days)
1. False; 2. False; 3. No; 4. Yes; 5. False; 6. Rs 10 lakh; 7.45
265
- CAIIB DISCUSSION
e and party
made bank, pyof
tonal inted sman
ss. It hthe Mhe . For with

1. Can a customer from whose account someone fraudulently has withdrawn
money make a complaint
before the banking ombudsman?
(a) No, as the offence committed, is of criminal nature, FIR with police has to be
filed.
(b) Yes, but if the police authorities who have received the FIR permit filing of the
complaint
with ombudsman.
(c) Yes, as this aspect comes under the powers of the banking ombudsman.
(d) No, as the loss caused to the customer is of a civil nature for recovery, civil suit
is required
to be filed.
2. Reserve Bank and the Central Government may forward a complaint to the
banking ombudsman?
(a) The right to complaint is given to the complainant only.
(b) Neither the Reserve Bank nor the Central Government has the right to refer the
matter to the
banking ombudsman under the scheme.
(c) Reserve Bank and the Central Government are empowered to send the
complaint received
by them to the banking ombudsman.
(d) Only an individual's complaint can be sent by the Reserve Bank and the Central
Government.
3. Can the complaint be filed through an advocate as the authorised representative
of
(a)the complainant?
Advocates are not allowed to act as authorised representatives of the
complainants under
the scheme.
(b) Advocates can file the complaint, provided he has been given the vakalatnama
by the party.
(c) Advocates can appear for the parties as they can present the case well before the
banking
ombudsman.
(d) Advocates are allowed to appear only if the party does not stay within the
jurisdiction of the
banking ombudsman.
Ans: 1. (c); 2. (c) and 3. (a).
!, on laint a by rhen ice. nit/ ting
UNIT
29

1993 (DRT ACT) PRELIMINARY
STRUCTURE
29.0 Objective
- CAIIB DISCUSSION
29.1 Introduction
29.2 Constitutional Validity of the Act
29.3 Preamble, Extent, Commencement, Application and Definitions
29.4 Let Us Sum Up
29.5 Keywords
268
29.0 OBJECTIVE
The objective of this unit is to understand the purpose of this specific legislation viz.,
Recovery of Debts due to Banks and Financial Institutions Act, 1993 (DRT Act 1993).
This is an Act enacted to cope up with the much felt requirement of time. The Act is
quite procedural in nature.
29.1 INTRODUCTION
Recovery of the dues from the borrowers through courts was a major cause of concern
for the banks and financial institutions due to huge back log of pending cases with
various courts. Even in recovery of decreed debts, considerable difficulties were faced
by them prior to the passing of this Act in 1993 it was observed and felt that the existing
laws are not adequate to solve the issues faced by the banks and financial institutions,
and huge assets were blocked as unproductive assets. Besides, in this process of recovery
considerable manpower of the banks and financial institutions gets involved wasting
their productivity. Because of delays involved in finalising of cases the industrial assets
were getting damaged and deteriorating in value in 1991, the Recovery of Debts due to
Banks and Financial Institutions Act, 1993 (DRT Act, as commonly known or called)
was passed and it came into operation from 24 June 1993. This Act constituted the
special, 'Debt Recovery Tribunals' for speedy recovery.
In this unit, we will see how the Act received legal challenges and subsequent
declaration of the Act as constitutionally valid by the Supreme Court. We will also see
the
29.2definitions of different words
CONSTITUTIONAL used in theOF
VALIDITY Act.
THE ACT
The constitutional validity of the Act was challenged by the Delhi High Court Bar
Association before the Delhi High Court. The Delhi High Court decided the law to be
unconstitutional, void and hit by Article 14 of the Constitution. The High Court held that
the Civil Courts who are directly under control and superintendence of the High Court
have been deprived of their jurisdiction and, therefore, it is against the theme of the
Constitution and independence of the judiciary.
However, on appeal in Union of India vs Delhi High Court Bar Association (2002)4
SCC 274, the Supreme Court decided in favour of the constitutional validity of the DRT
Act. The Supreme Court observed that the Parliament alone can enact law in regard to
banking business which includes recovery of bank's dues and for that purpose setting up
adjudicatory body like the Banking Tribunal is valid.
A question of applicability was referred to the Supreme Court regarding the applicability
of this Act to co-operative banks. However, it was decided that DRT mechanism is not
applicable to dues of Co¬operative banks since the recovery mechanism in those banks
is separate and if working satisfactorily.
29.3 PREAMBLE, EXTENT, COMMENCEMENT, APPLICATION AND
DEFINITIONS
1. The preamble to the DRT Act describes the Act as, 'An Act to provide the
establishment of tribunals
for expeditious adjudication and recovery of debts due to banks and financial institutions
and for
matters connected therewith or incidental thereto.'
- CAIIB DISCUSSION
2. The Act is applicable to the whole of India except the State of Jammu &
Kashmir. The Act is made
applicable from 24 June 1993, through the DRTs were established progressively across
the country.
The Act is applicable for the debt due to any bank or financial institution or a consortium
of them, when the debt is above Rupees ten lakh. The Central Government may, by
notification make the Act applicable to such other amount of debt not less than r upees
one lakh. At present there is no notification from the Government about any other
amount of debt less than Rupees ten lakh. Therefore, the jurisdiction of the DRT Act is
to the debt above Rupees ten lakh.
269
3. Some important definitions as per this Act are as under:
(i) 'Appellate Tribunal'It is a body established for the purpose of preferring an appeal
against the order passed by the tribunal. It is established under the sub-Section (1) of
Section 8 of the Act. (ii) 'Application' means an application made to a tribunal for
recovery of the debt, under section
19. (iii) 'Appointed day' in relation to a tribunal or an appellate tribunal, means the date
on which such
tribunal is established.
(iv) 'Bank' means, a banking company, a corresponding new bank, i.e., bank commonly
known as Nationalised Bank established with the Act that Nationalised them, State Bank
of India and its subsidiary bank or a Regional Rural Bank.
(v) 'Chairperson' means a chairperson of an appellate tribunal appointed under Section
9. (vi) The important definition is about the 'debt'. As the purpose of the Act is to have
faster recovery of debts due to banks and financial institutions, it is important to define
the debt to decide the jurisdiction of the tribunal under DRT Act As per the definition
given at Section 2(g) the expres¬sion 'debt' shall cover following categories of debts of
the banks and financial institutions: (i) any liability inclusive of interest, whether
secured, (ii) any liability inclusive of interest, whether insecured, or (iii) any liability
payable underora (iv)

or otherwise, decree
anyorliability
order of any Civil
payable Court
under or any arbitration
a mortgage awardon and legally
and subsisting
recoverable on the
date of application.
What constitutes debt has been interpreted by different courts in many cases. In G.V.
Films vs UTI [2000] 100 Compo Cases 257 (Mad) (HC), it was held that payment made
by the bank by mistake is a debt. In the State Bank of India vs S.S. Engineering
Corporation [1998] 1 BC 702 (Mad), it was held, that money overdrawn from a bank
account without any overdraft facility is a debt recoverable under the DRT Act.
The Supreme Court in United Bank of India vs DRT [1999] 4 SCC 69, held that if the
bank had alleged in the suit that the amounts were due to it from respondents as the
liability of the respondents had arisen during the course of their business activity and the
same was still subsisting, it is sufficient to bring such amount within the scope of
definition of debt under the DRT Act and is recoverable under that Act.
However, if an employee commits fraud and misappropriation of money, the amount
recoverable from him is not a debt within the meaning of DRT Act, Bank of India vs
Vijay Ramniklal AIR 1997 Guj. 75.
(vii) 'Financial institution' means a public financial institution within the meaning of
Section 4A of the Companies Act, 1956 and securitisation and reconstruction company
and such other institutions as the Central Government may, by notification, specify,
(viii) 'Presiding Officer' means the presiding officer of the Debts Recovery Tribunal
appointed
under sub-Section (1) of Section 4.
(ix) 'Recovery Officer' means a recovery officer appointed by the Central Government
- CAIIB DISCUSSION
for each tribunal under the sub-Section (1) of Section 7. These officers are appointed
under the Act for implementing the recovery orders passed by the Tribunal.
29.4 LET US SUM UP
There was need to have an effective law for recovery. Prior to this Act, the recovery laws
were found inadequate. Huge assets of the banks' were involved in recovery because of
huge pendency with
270
various courts. Introduction of the NPA norms aggravated the problems. This affected
the financial sector. The Act was introduced in 1993. Initially, Delhi High Court decided
the Act as constitutionally invalid. Supreme Court then decided the Act as valid.
Applicability to co-operative banks was decided only recently by Supreme Court.
Preamble to Act states that Act is for expeditious adjudication and recovery of debts.
The Act is applicable from 24 June 1993 and is applicable to debts above Rs 10 lakh. In
this chapter we have seen the definition of words which are very important and used in
the context of this Act.
29.5 KEYWORDS
Unproductive Assets; DRT Act; Presiding Officer; Recovery Officer.
1. DRT Act is applicable only if the debt recoverable is above Rs.
_.(Rs. 151akh/Rs. 10 lakh)
2. The debt recoverable through DRT may be secured or insecured. (True/False)
3. Overdrawn amount in an account is not a debt recoverable under DRT Act.
(True/False)
4. If a Civil Court has passed a decree it has to be executed through that court only
and cannot come
to recovery tribunal. (True/False)
1. Rs. 10 lakh; 2. True; 3. False; 4. False.
1. A bank
amount has allowed
is due. Whethera this
current A/c holder an
is recoverable ad hoc
under overdraft
provisions of of
DRTRs.Act?
15 lakh. The
(a) No, as it is not a regular loan.
(b) No, as only secured loans can be recovered under the DRT Act.
(c) Yes, as it is a legally recoverable amount by the bank.
(d) Yes, but if the tribunal grants special permission to lodge the case.
Ans. 1. (c)
incial nally ;ided i and lakh, itext
ESTABLISHMENT OF TRIBUNAL AND APPELLATE TRIBUNAL
kh)
me
e.
STRUCTURE
30.0 Objective
30.1 Introduction
30.2 Establishment of Tribunal
30.3 Composition of Tribunal
- CAIIB DISCUSSION
30.4 Qualification for Appointment as Presiding Officer and Term of Office

30.5 Staff of Tribunal
30.6 Establishment and Composition of Appellate Tribunal
30.7 Qualification for Appointment as Chairperson of the Appellate Tribunal and
Term of Office
30.8 Filling up of Vacancies at Tribunal and Appellate Tribunal
30.9 Finality of Orders Constituting Tribunal or an Appellate Tribunal
30.10 Let Us Sum Up
30.11 Keywords

272
30.0 OBJECTIVE
The objective of this unit is to understand about the appointment of the tribunals,
appellate tribunals and their powers.
30.1 INTRODUCTION
For implementation of the Act, establishment of the authorities and conferring on them
required powers is essential. Their jurisdiction is also to be decided. All these powers are
with the Central Government. Appellate authorities are also required to be set up. All the
authorities need the appropriate staff. In this unit we will see about all these
establishment aspects.
30.2 ESTABLISHMENT OF TRIBUNAL
The Central Government is empowered to establish one or more tribunal to be known as
debt recovery tribunal to exercise the jurisdiction, powers and authority conferred on
such tribunal by or under this Act. The section also empowers the Central Government
to decide and specify the areas within which the tribunal may exercise jurisdiction for
entertaining and deciding the applications filed before it. When the Government
exercises these powers and takes such decisions they are notified in the Official Gazette
of the Government.
30.3 COMPOSITION OF TRIBUNAL
The tribunal is made up of only one person called presiding officer and the appointment
is done by the Central Government by issuing a notification.
The Central Government by notification has the powers to authorise the presiding officer
of one tribunal to discharge also the functions of the presiding officer of another tribunal.
30.4 QUALIFICATION FOR APPOINTMENT AS
PRESIDING OFFICER AND TERM OF OFFICE
1. A person is qualified for appointment as presiding officer of a tribunal if he is,
or has been, or is
qualified to be appointed as a District Judge.
2. The presiding officer of a tribunal holds office for a term of five years from the
date on which he
enters upon his office or until he attains the age of sixty-two years, whichever is earlier.
30.5 STAFF OF TRIBUNAL
The Central Government shall provide the tribunal with one or more recovery officer
and such other officers and employees as the Government may think fit. The staff so
appointed shall work under the general superintendence of the presiding officer.
30.6 ESTABLISHMENT AND COMPOSITION OF APPELLATE TRIBUNAL
1. The Central Government is empowered to establish one or more appellate tribunals, to
be known as debt recovery appellate tribunal to exercise the jurisdiction, powers and
authority conferred on such tribunal by or under this Act. The Central Government is
also empowered to decide and specify the areas within which the tribunal may exercise
- CAIIB DISCUSSION
jurisdiction for entertaining and deciding the applications filed before it. The person
occupying the office of the appellate tribunal is called as the chairperson, appointed by
the Central Government.
273
2.
For administrative convenience, the Central Government has the powers to authorise the
chairperson of one appellate tribunal to discharge also the functions of the chairperson of
another appellate tribunal. As said earlier the Government decisions are required to be
notified in the Official Gazette. Appellate tribunal consists of only one person called as
Chairperson and the appointment shall be done by the Central Government.
30.7 QUALIFICATIONS FOR APPOINTMENT AS CHAIRPERSON OF

THE APPELLATE TRIBUNAL AND TERM OF OFFICE
1. A person shall not be qualified for appointment as the chairperson of an
appellate tribunal unless he
(i) is, or has been, or is qualified to be a Judge of a High Court;
(ii) has been a member of the Indian legal service and has held a post in grade I of that
service
for at least three years; or (iii) has held office as the presiding officer of a tribunal for at
least three years.
2. The chairperson of an appellate tribunal shall hold office for a term of five
years from the date on
which he enters upon his office or until he attains the age of sixty-five years, whichever
is earlier.
30.8 FILLING UP OF VACANCIES AT TRIBUNAL AND APPELLATE
TRIBUNAL
If there occurs any vacancy at tribunal or appellate tribunal, that is not of a temporary
nature, the Central

provisions Government
of the Act. When suchmay fill up suchare
appointments vacancy
made in
theaccordance
proceedingswith the on and
going
continued before the earlier presiding officer of the tribunal and chairperson of the
appellate tribunal continue further from the stage where they were.
30.9 FINALITY OF ORDERS CONSTITUTING TRIBUNAL
OR AN APPELLATE TRIBUNAL
No order of the Central Government appointing any person as the presiding officer of the
tribunal or the chairperson of the appellate tribunal shall be called in question in any
manner. Similarly, no act or proceeding before the tribunal or the appellate tribunal can
be questioned in any manner on the ground, merely of any defect in the constitution of a
tribunal or the appellate tribunal.
Presiding officer or chairperson can by a three months written notices, resign his office.
They cannot be removed, unless by an order of the Central Government on ground of
proved misbehaviour or incapacity after inquiry.
30.10 LET US SUM UP
Debt recovery tribunals were established by the Central Government. The Government
also decides their jurisdiction. The Tribunal consists one member called as presiding
officer appointed by the Central Government. Eligibility for appointment as presiding
officer is a minimum of a district Judge. The term is five years or sixty-two years. One
or more recovery officers are provided to the tribunal by the Central Government. For
filing an appeal the Central Government appoints the appellate recovery tribunal and a
person heading it is called chairperson. Qualification of chairperson must be a minimum
High Court Judge or presiding officer of tribunal for minimum three years. The
appointment is for five years or age of sixty-five years. The unit also includes the
- CAIIB DISCUSSION
provisions about filling up of vacancies. The presiding officer and the chairperson can
resign from the office. The authorities cannot be removed from the office unless proven
misbehaviour or incapacity after enquiry.
274
30.11 KEYWORDS
Jurisdiction of Tribunal; Appellate Tribunal; Chairperson.
1. Debt recovery tribunals are established by
2. Debt recovery tribunals consist benches of three persons. (True/False)
3. Jurisdiction of appellate tribunal is with the respective High Courts.
(True/False)
1. Central Government; 2. False; 3. False.
1. Can the order of Central Government in the appointment of the presiding officer of the
tribunal be challenged in any Court?
(a) Yes, before the appellate tribunal.
(b) No.
(c) No, unless the High Court permits for it.
(d) Yes, under Constitution Article 226 before the High Court.
Ans. 1. (b)
UNIT
31
JURISDICTION, POWERS AND AUTHORITY OF TRIBUNALS
STRUCTURE
31.0 Objective
31.1
31.2 Introduction
Jurisdiction, Powers and Authority of Tribunals
31.3 Bar of Jurisdiction of Civil Courts
31.4 Let Us Sum Up
31.5 Keywords
L.R.A.B-19
276
31.0 OBJECTIVE I
i
The objective of this unit is to know the jurisdiction, powers and authority of the
Tribunal and Appellate Tribunal.
31.1 INTRODUCTION
In any Act the jurisdiction, powers and authority of the judicial authorities is well
defined. In this unit, we will see these points related to Tribunal and Appellate Tribunal.
Very important provision is that for the matters where DRT has jurisdiction the Civil
Courts are debarred from entertaining any case.
31.2 JURISDICTION, POWERS AND AUTHORITY OF TRIBUNALS
1. Whenever the Tribunal or the Appellate Tribunal is established from its
appointed day, i.e., date
from which they function is declared in the notification, they exercise jurisdiction,
powers and
authority to entertain and decide applications or appeals, as the case may be, from the
- CAIIB DISCUSSION
banks and
financial institutions for and about recovery of debts due to them.
As already seen to have jurisdiction of Tribunal the claim for recovery of the debt must
be above Rupees ten lakh, including principal and interest.
In Bank of India vs Harshadrai Odhavji Mody [2002] 40 SCL 20, Bombay High Court
has held that an application for execution of the decree of foreign court can be
entertained by the Debt Recovery Tribunal.
2. Chairperson of Appellate Tribunal is given general power of superintendence
and control over the
Tribunals under his jurisdiction. The chairperson can transfer any application from any
Presiding
Officer within his jurisdiction to any other Presiding Officer within his jurisdiction, on
receiving
application for transfer of case or even on his own motion. However before such
transfer, he has
to give notice to the parties and hear them. He also has power of appraising work of
presiding
officers, under his control.
31.3 BAR OF JURISDICTION OF CIVIL COURTS
1. From the date of establishing the Tribunal, i.e., the appointed day, no court or
other authority shall
have any jurisdiction, powers or authority to deal within any way in recovery cases
above Rupees
ten lakh. Thus the Civil Courts or any other authority will loose and will not have the
jurisdiction
for cases where due amount recoverable is above Rupees ten lakh by banks and financial
institutions.
However, this is not applicable to High Courts and Supreme Courts exercising
jurisdiction under
Articles 226 and 227 of the Constitution.
2.
date when The
thisrelevant
Act date of bar of jurisdiction by the court or other authority is not the
came into application. The date is since when the Tribunal is established having
jurisdiction in that
particular area. In Bhanu Construction Company Ltd. vs Andhra Bank [2002] 37 SCL
769, a
question came whether the order passed by a Civil Court after coming into force of the
DRT Act
but before establishing the Tribunal is valid on jurisdiction point or not. The Supreme
Court held
that order passed by the Civil Court prior to establishment of a Tribunal but after
commencement
of DRT Act was well within the jurisdiction of the Civil Court.
31.4 LET US SUM UP
The Tribunal and Appellate Tribunal function from the appointed day, which is declared
in notification. Their powers, duties and jurisdiction is well declared and defined. High
Courts and Supreme Courts, however, have jurisdiction under Constitution Articles 226
and 227.
277
31.5 KEYWORDS
Tribunal; Appointed Day; Jurisdiction; Powers; Authority; High Court; Spreme Court;
- CAIIB DISCUSSION
Jurisdiction.
1. A decree passed by the foreign court can be executed by the Tribunal. (True or
False)
2. For reasons the Chairperson of the Appellate Tribunal can transfer any case
from one Tribunal to
other Tribunal within his jurisdiction. (True or False)
3. For the matters for which the Tribunals are empowered the Civil Courts have
no jurisdiction.
(True or False)
PROCEDURE OF TRIBUNALS
STRUCTURE
32.0 Objective
32.1 Introduction
32.2 Application to the Tribunal
32.3 Appeal to the Appellate Tribunal
32.4 Deposit of Amount of Debt Due, for Filing Appeal
32.5 Procedure and Powers of the Tribunal and the Appellate Tribunal
32.6 Limitation
32.7 Let Us Sum Up
32.8 Keywords
280
32.0 OBJECTIVE
The
with objective
the cases of this unit
before them.is to know the procedure followed at the Tribunals for dealing
32.1 INTRODUCTION
Filing of the application before DRT and its dealing with application involves procedural
aspects. The procedure has various stages and requirements that need to be followed
very strictly. This unit gives such procedure.
32.2 APPLICATION TO THE TRIBUNAL
1. The purpose for filing application is for recovery of the debt due to them. The
procedure has to be
followed properly and the interim relief and remedies are required to be properly prayed
for.
2. When a bank or a financial institution has to recover any debt from any
person/entity, it may make
an application to the Tribunal [Section 19(1)] within the local limits of whose
jurisdiction,
(i) the defendant at the time of making application for loan reside or carry on business or
personally works for gain; or (ii) any of the defendant, where there are more than one
defendant, reside at the time of making
application for loan or carry on business or personally works for gain; or (iii) the cause
of action, wholly or in part, arises.
3. Where a bank or a financial institution has filed application under Section 19(1)
before the Tribunal
for recovery of its debt and if from the same person another bank or financial institution
has also
- CAIIB DISCUSSION
to recover any debt, then such later bank or financial institution may join the applicant
bank or
financial institution in already filed application at any stage of the proceedings before the
final order
is passed [Section 19(2)] by making an application.
4. Every application to be filed before the Tribunal under Section 19(1) or 19(2)
shall be in such form
and accompanied by such documents or other evidence and by such fee as may be
prescribed.
However, when the Civil Suit already filed is transferred to the Tribunal as provided in
Section 31
(1) of the DRT Act no fees is required to be paid. This is because the plaintiff had
already paid court-
fees while filing the civil suit and the transfer of cases is due to statutory changes
[Section 19(3)].
5. On receipt of application under sub-Section (1) or (2) the Tribunal has to issue
summons to the
defendant requiring him to show cause within thirty days of the service of summons as
to why the
relief prayed for should not be granted [Section 19(4)].
6. The defendant has to present a written statement on or before the first hearing
or within such time
as the Tribunal may permit [Section 19(5)].
7. If the defendant claims any amount from the applicant and to have a set off
against the applicant's
demand with ascertained sum of money legally recoverable by him from such applicant,
the defendant
on the first date should make such claim in the written statement. If the claim is not
made on the
first hearing at the time of filing of written statement then it can be made only if
permitted by the 19(6)].

Tribunal [Section
8. When the written statement contains claim and set-off the written statement has
the same effect as
a plaint in a cross-suit so as to enable the Tribunal to pass a final order in respect of both
the
original claim and on set off [Section 19(7)].
9. A defendant in his application, in addition to his right of pleading a set off
under sub-Section (6)
may set up a counter claim against the claim of the applicant. Such counter-claim can be
for any
right 6r claim in respect of cause of action accruing to the defendant against applicant.
But such
281
or dealing with the cases

procedural aspects. The strictly. This unit gives
he procedure has to be perly prayed for. )n/entity, it may make se jurisdiction,
carry on business or
it the time of making ;or
' before the Tribunal institution has also ; applicant bank or :fore the final order
all be in such form
ay be prescribed.
- CAIIB DISCUSSION
:dedin Section 31
Ireadypaidcourt-
s [Section 19(3)].
summons to the
HIS as to why the
vithin such time
!the applicant's it, the defendant ot made on the emitted by the
same effect as ct of both the
:b-Section (6) in be for any int. But such
cause must be accruing either before or after the filing of the application by the applicant
but before the defendant submitting his defence in given time. The counter-claim can be
for damages also [Section 19(8)J.
10. A counter-claim filed under sub-Section (8) has the same effect as a complaint
in a cross-suit so as
to enable the tribunal to pass a final order in respect of both the original claim and on
counter-claim
[Section 19(9)].
11. The applicant is at liberty to file a written statement to the counter -claim of the
defendant within
such period as may be fixed by the tribunal [Section 19(10)].
12. If the applicant wants to contend that the counter-claim made by the defendant
ought not to be
disposed as a counter-claim but be disposed in an independent action, he should make
application
to that effect before the tribunal before the issues are settled. The tribunal on hearing
such application,
may pass such order as it deems fit [Section 19(11)].
13. The tribunal may pass an interim order against the defendant to debar him from
transferring,
alienating
him without or otherwise dealing with or disposing of any property or assets belonging to
the permission of the tribunal. Such an order may be by way of injunction or stay or
attachment
[Section 19(12)].
14. If at any stage of the proceeding the tribunal is satisfied by the affidavit or
otherwise that the
defendant, with intent to obstruct or delay or frustrate the execution of any order, for the
recovery
of debt that may be passed against him [Section 19(13A and 8)],
(i) is about to dispose of the whole or any part of his property, or
(ii) is about to remove the whole or any part of the property from the local limits of the
jurisdiction of the tribunal, or
(iii) is likely to cause any damage or mischief to the property or affect its value by
misuse or creating third party interest the tribunal may direct the defendant to furnish
security of the value of the property or to place said property at the disposal of tribunal
or value of the same, sufficient to satisfy the debt or to appear before the tribunal and
show cause why he should not furnish security.
If the defendant fails to show cause why he should not furnish security or fails to furnish
security required, the tribunal may pass order for attachment of the whole or part of the
property offered as security to the applicant or other property owned by the defendant,
sufficient for recovery of debt.
15. When the applicant wants that the properties of the defendant should be
attached, he is required to
- CAIIB DISCUSSION
specify the property required to be attached and the estimated value thereof [Section
19(14)J.
16. The tribunal can pass a conditional attachment order, of whole or part of the
property as the case
may be and as required [Section 19(15)].
17. Sub-Section (13) has contemplated that the attachment order can be passed on
satisfying the
tribunal on the points mentioned in that sub-Section by affidavit or otherwise. If any
attachment
order is passed without complying the requirements of sub-Section (13), then such order
is void
[Section 19(16)].
18. The tribunal has power to pass interim orders, attachment orders, etc., under
sub-Sections (12),
(13) and (18). If there is any breach of the orders so passed by the tribunal, the tribunal
may order
that the properties of the person guilty of the breach of the order be attached and the
person be
detained in civil prison for a term not exceeding three months [Section 19(17)].
19. If the tribunal finds it just and convenient, it may by order [Section 19(18)]
(i) appoint a receiver of any pr operty, whether before or after grant of certificate for
recovery
of debt;
(ii) remove any person from the custody or possession of the property; (iii) give
possession, custody or management of the property to the receiver;
282
(iv) confer powers to the receiver in respect of the property given in his possession for
bringing suits or defend it, file applications, collection of rents and profits, preservation,
realisation, management, protection, execution of documents, etc., and as the tribunal
may deem fit;

(v) appoint a commissioner for preparation of an inventory of the properties of the
defendant or for sale thereof.
20. If the recovery certificate is granted against a company registered under the
Companies Act, 1956,
the tribunal may order that the sale proceeds of such company be distributed among its
secured
creditors as provided in Section 529A of the Companies Act, 1956 and surplus, if any,
be paid to
the company [Section 19(19)].
21. The tribunal may, on giving opportunity to both the sides of being heard, pass
interim or final order
for payment of amount including interest thereon [Section 19(20)].
22. The tribunal is required to send a copy of every order passed by it to the
applicant and the defendant
[Section 19(21)].
23. The presiding officer of the tribunal has to issue a certificate under his signature
to the recovery
officer for recovery of the amount of debt specified in the certificate [Section 19(22)].
24. When the property of the defendant against whom the certificate of recovery is
issued is situated
in the local limits of jurisdiction of more than one tribunal, the tribunal issuing the
recovery certificate
will send copies of the recovery certificate to such other tribunal in whose jurisdiction
- CAIIB DISCUSSION
the property
is situated. If the tribunal which receives such certificate finds that it has no jurisdiction
to comply
with the certificate of recovery, it shall be returned back to the tribunal who has issued
the same
[Section 19(23)].
25. The sub-Section provides that the application received by the tribunal for
recovery of debt shall be
dealt with as expeditiously as possible and it should be attempted that the application is
disposed of
finally within 180 days from date of receipt of application [Section 19(24)].
26. The tribunal may make such orders and give such directions as may be
necessary or expedient to
give effect to its orders as well as to prevent abuse of its process or to secure the ends of
justice
[Section 19(25)].
In S. Ravindran vs DRT [1999] 95 Compo Cas. 825, the Karnataka High Court has held
that the purpose of the Act is to ensure expeditious disposal of application, long and
liberal adjournments should not be granted.
27. The DRT (Procedure) Rules at Rule 12(6) provide that DRT can order that any
fact may be proved
by affidavit and once affidavit is submitted tribunal will allow cross-examination of the
witness
only, if in the opinion of the tribunal it is necessary to do so. In the event of witness not
appearing
then the affidavit shall not be taken as evidence. Even prior to this rule coming into
operation, due
to amendment in the case of Union of India vs Delhi High Court Bar Association AIR
2002SC 1479,
the Supreme Court has held, that if evidence is taken by way of an affidavit, it is not
mandatory
the tribunalfor
to require production of witness for cross-examination. The Supreme Court
also
observed that when the Supreme Court and High Courts decide the matters on the basis
of documents
and affidavits, there is no reason why the Tribunal should not decide likewise.
In Keshrimal Jivji Shah and another vs Bank of Maharashtra [2004 (2) D.R.T.C. 682] the
Bombay High Court has held that if any transfer of property is made in violation of the
injunction order issued by the Court of Law it is no transfer at all as it confers no right,
title or interest in transferee and the transfer is void.
32.3 APPEAL TO THE APPELLATE TRIBUNAL
1. Any person aggrieved by the order passed by the Tribunal or deemed to have been
passed by the Tribunal under DRT Act, may prefer an appeal to an Appellate Tribunal
having jurisdiction in the
283
matter. However, if the order was made by the Tribunal with the consent of the parties
no appeal shall lie.
2. The appeal is required to be filed within forty-five days from the date on which
copy of the order
is received. At the time of filing the appeal as per Section 21 of the DRT Act, 50% of the
amount
(Max.) shown as due in the order passed by the Tribunal is required to be deposited by
the
- CAIIB DISCUSSION
appellant. The appeal is required to be in the form prescribed and along with the
prescribed fees.
The appeal filed after forty-five days may be entertained by the Appellate Tribunal if it
is satisfied
about the cause for not filing the appeal in time.
3. On receipt of the appeal the Appellate Tribunal after giving hearing to both the
parties pass such
orders as it thinks fit either confirming or modifying or setting aside the order passed by
the
Tribunal. Every order made by the Appellate Tribunal is sent to the parties to the appeal
and to the
Tribunal concerned.
4. The appeal filed before the Appellate Tribunal shall be dealt with as
expeditiously as possible and it
should be attempted that the appeal is disposed of finally within six months from date of
receipt of
appeal.
In Anamika vs DRT [2001] 104 Compo Cas. 273 (Kar) (HC) (DB) it was held that when
once the case is transferred from the Civil Court to the Tribunal appeal shall lie with the
Appellate Tribunal only and the contention of the party that he still continues to be
governed by Civil Procedure Code and can file appeal accordingly is not tenable.
5. There is no provision in the Act for further appeal against the order passed by
the Appellate Tribunal.
However writ jurisdiction of High Court under Article 226 and supervisory jurisdiction
of High
Court as well as Special Leave Petition before the Supreme Court are not barred.
32.4 DEPOSIT OF AMOUNT OF DEBT DUE FOR FILING APPEAL
1. When the defendant against whom the Debt Recovery Tribunal has passed
recovery order wants
to prefer appeal to the Appellate Tribunal, he is required to deposit 75 per cent of the
amount
determined by the Tribunal. Without such payment no appeal can be filed. However, the
Tribunal
has right to reduce or waive such payment for the reasons to be recorded in writing.
2. As the purpose of the Act is to have a fast track remedy for recovery of loans
given by banks and
financial institutions, the condition of deposit of 50% of the amount found due by the
Tribunal is in
accordance with the purpose of the Act. Otherwise the remedy of the appeal will be
routinely used
by the borrowers to delay the recovery procedure and actual recovery.
32.5 PROCEDURE AND POWERS OF THE TRIBUNAL
AND THE APPELLATE TRIBUNAL
1. The Tribunal and the Appellate Tribunal are not be bound by the procedure laid
down by the Civil
Procedure Code, 1908. It further provides that they shall be guided by the principles of
natural
justice and subject to the provisions of this Act and Rules there under, shall have powers
to regulate
their own procedure.
2. The Tribunal and the Appellate Tribunal are for the purpose of discharging their
functions under
the Act, have the same powers as are vested in a Civil Court under the Code of Civil
Procedure,
- CAIIB DISCUSSION
1908 while trying a suit. Such powers are in respect of summoning and enforcing the
attendance
of any person and examining him on oath, requiring the discovery and production of
documents,
receiving evidence of affidavits, issuing commissions for the examination of witnesses
or documents,
reviewing its decisions, dismissing an application for default or deciding it ex-parte,
setting aside
any order of dismissal of any application for default or any order passed by it ex-parte
any other
matter which may be prescribed.
284
3. The Tribunal and the Appellate Tribunal are deemed to be a Civil Court for all
purposes of Section 195 and Chapter XXVI of the Code of Criminal Procedure, 1973.
Any proceeding before Tribunal and the Appellate Tribunal is deemed to be a judicial
proceeding.
32.6 LIMITATION
For application to be filed before the Tribunal the Limitation Act, 1963 apply. This
means that the application must be filed by the bank or the financial institution within
three years from cause of action.
32.7 LET US SUM UP
Bank has to file application for recovery of loan taking into consideration jurisdiction
and cause of action. Other bank or financial institution can join the application.
Application has to be with fees, documents and evidence. For transfer from Civil Court
to Tribunal no fresh fee is required as transfer is due to effect of law. The section has
given elaborate provisions for summons and hearing. Tribunal can pass interim orders to
prevent defendant from transferring his property. The section also gives the procedure
for issuing recovery certificate. There are provisions for appeal to Appellate Tribunal.
However for preferring appeal 50% of the amount determined by the Tribunal is
required
bank hasto
tobe
filedeposited. Theapplication
the recovery Limitation Act applies
within threefor the cause
of the DRT cases
of thewhich
action.means
32.8 KEYWORDS
Application for Recovery; Cause of Action; set off Claim at First Date; Counter-claim;
Interim Order; Injunction; Attachment of Property; Receiver; Recovery Certificate.
1. DRT jurisdiction for a bank is where the head office of the bank is located.
(True/False)
2. If a bank has filed recovery application, other bank can join the application if
the defendants are
same. (True/False)
3. When a case get transferred from Civil Court to tribunal fresh court fee is
required to be paid.
(True/False)
4. A counterclaim field before DRT has the same effect as a .
5. Since DRT is not a Civil Court it cannot pass interim orders such as attachment,
injunction,
receiver, etc. (True/False)
6. A person who has to file appeal before the Appellate Tribunal has to pay
.
1. False; 2. True; 3. False; 4. plaint in cross-suit; 5. False; 6. 75 per cent of the debt
ordered by the Tribunal.
- CAIIB DISCUSSION

1. While filing appeal before the appellate tribunal if any amount is required to be
deposited?
(a) No, amount is required to be deposited until the appellate tribunal decides.
(b) Yes, Court-fee on the appeal amount is required to be paid.
(c) Yes, 75 per cent of the amount determined by the tribunal is required to be
deposited at the
timing of filing of the appeal.
(d) Yes, after admission of the appeal 75 per cent of the amount determined by the
tribunal is
required to be deposited.
Ans. 1. (c)
m
RECOVERY OF DEBTS DETERMINED BY TRIBUNAL AND MISCELLANEOUS
PROVISIONS
33.0 Objective
33.1 Introduction
33.2 Modes of Recovery of Debts
33.3 Validity of Recovery Certificate and Amendment Thereof
33.4 Stay and Amendment for Recovery Proceeding and Certificate
33.5 Other Modes of Recovery
33.6 Application of Certain Provisions of the Income Tax Act
33.7 Appeal Against the Order of Recovery Officer
33.8 Transfer of Pending Cases
33.9 Power of Tribunal to Issue Certificate of Recovery in Case of Decree or Order
33.10 Chairperson, Presiding Officer and Staff of Appellate Tribunal and
Tribunal Public Servants

33.11 Protection of Action Taken in Good Faith
33.12 Overriding Effect of the Act
33.13 Doctrine of Election
33.14 Powers to Make Rule
33.15 Let Us Sum Up
33.16 Keywords
286
33.0 OBJECTIVE
The objective of this unit is to understand the recovery procedure through the recovery
officers appointed under the Act.
33.1 INTRODUCTION
The tribunal issues Recovery Certificate to the applicant. There are recovery officers
appointed under the Act and attached to the tribunal. They are given adequate powers to
recover the amount awarded. These provisions and procedures are required otherwise the
award will as mere paper award. This chapter gives provisions and procedure for
recovery. There are provisions for transfer of cases from Civil Court to Tribunal
established under DRT Act, powers of Tribunal to issue r ecovery certificate where
decree is already passed by a Civil Court and other miscellaneous powers of Tribunal for
implementation of the Act. A legal protection is given to the authorities for immunity of
- CAIIB DISCUSSION
any action done in good faith.

33.2 MODES OF RECOVERY OF DEBTS
1. On receipt of the copy of the recovery certificate issued under Section 19(22),
the Recovery
Officer has to proceed to recover the amount specified in the certificate by one or more
of the
following modes:
(i) attachment and sale of movable and immovable property of the defendants; (ii) arrest
of the defendant and his detention in prison; (iii) appointment of a receiver for the
management of the movable and immovable properties of the defendant.
2. The Recovery Officer can sell any of the property owned by the defendant. The
provision for
arrest of the defendant though appears in the Act, its use will have to be made keeping in
view the
Supreme Court decision in case of George Verghese vs Bank of Cochin AIR 1980 SC
470. In this
case the Court has observed that putting a person in prison for his poverty and
consequential
inability to pay the contractual liability is too much violative of Article 21 of the
Constitution, unless
there is minimal fair proof of the wilful failure to pay in spite of his sufficient means.
33.3 VALIDITY OF RECOVERY CERTIFICATE AND AMENDMENT
THEREOF
1. The defendant is debarred from raising any dispute before the Recovery Officer
about the correctness
of the amount specified in the recovery certificate issued by the Tribunal. The Recovery
Officer
also cannot entertain any objection raised by the defendant on any other ground against
the certificate.
2. The Presiding Officer of the Tribunal who had issued the recovery certificate is
authorised
withdraw theto certificate or correct any clerical or arithmetical mistake in the certificate.
3. One of the Rules framed under the Act (5A) says that when any party wants to
have a review of the
order passed by the Tribunal or the recoyery certificate issued by the Tribunal on the
ground that
error is apparent on the face of the record, he can make application for review within
sixty days of
passing the order or issuing the certificate. Such application needs to be supported by
affidavit
verifying the contents. It is also required that the opposite party is given notice and
hearing before
the application is granted.
33.4 STAY AND AMENDMENT FOR RECOVERY
PROCEEDING AND CERTIFICATE
1. Even though a certificate has been issued to the recovery officer, the Presiding
Officer may grant
287
time for the payment of the amount. If such time is granted, the recovery officer has to
stay the proceedings until expiry of the time granted.
2. If after recovery certificate is issued there is any payment by the defendant or
any time is granted
for payment, the Presiding Officer has to keep the recovery officer informed.
- CAIIB DISCUSSION
3. If the order passed by the Presiding Officer of the Tribunal is modified in

appeal by the Appellate
Tribunal and the amount of recovery certificate is changed, the Presiding Officer who
has issued
the recovery certificate, has to amend or withdraw the recovery certificate accordingly.
33.5 OTHER MODES OF RECOVERY
1. In addition to the modes of recovery given at Section 25, Section 28 of this Act
has given additional
modes that can be adopted by the Recovery Officer. These powers are similar to the
powers given
to the Tax Recovery Officer under Section 226 of the Income Tax Act, 1961. These
powers are
also similar to passing of garnishee orders in respect of debt, share and other property
not in
possession of the judgement debtor under Order XXI, Rules 46 and 46A to 461 of the
Code of Civil
Procedure, 1908.
2. If any amount is due from any person to the defendant the Recovery Officer
may ask such person
by giving a notice in writing to pay the amount to the Recovery Officer and not to the
defendant.
It is then obligatory on that person to pay the amount to the Recovery Officer. However
for this
provision the exemption of the amount from attachment as provided is Section 60 of the
Code of
Civil Procedure, 1908 applies.
3. When such notice is issued to a bank, post office, financial institution or as
insurer, it shall not be
necessary to produce any passbook, deposit receipt, policy or any other document for
any purpose
like
rule entry
or or endorsement, etc., before making the payment. Even if there is any practice,
requirement that before payment any of the said document is required the provisions of
this Act
have overriding effect on it.
4. When the notice said above is issued in relation to any property, any claim
made against that
property subsequent to the notice is void.
5. These provisions also apply to any person who is holding any money for or on
account of the
defendant. In cases if there is joint-holding, then the equal shares of the joint-holders are
presumed
unless contrary is proved. A copy of notice will be sent to the defendant, as also to all
joint holders.
6. If any person receiving the notice from the Recovery Officer is not liable to pay
to or is not holding
anything for or on behalf of the defendant then he has to object the notice stating such
statement
on oath. However, if it is found that the statement is false then the person is personally
liable to the
Recovery Officer to the extent of amount payable or held by him or the liability of the
defendant,
whichever is less. If any court holds money belonging to the defendant, Recovery
Officer may
- CAIIB DISCUSSION
apply to the court for payment to him the money to discharge the amount of debt due.
7. When the person pays to the Recovery Officer in accordance with the notice
served on him by the
Recovery Officer, he shall be given receipt for payment. The person is then not liable
and is
discharged from liability to the defendant to the extent of amount paid to the Recovery
Officer.
8. If the person after receipt of the notice fails to pay to the Recovery Officer, he
is deemed to be
defendant in default in respect to the amount mentioned in the notice.
9. The Recovery Officer has powers to order at any stage of the execution of the
recovery certificate
to require any person against whom the recovery certificate issued, to declare on
affidavit the
particulars of his assets. If the defendant is a company such order will be issued to its
any of the
officer to so declare the assets of the company.
10. The Recovery Officer has also powers to sale the movable property by distraint
and recover the
amount in the same manner as laid down in I the Third Schedule to the Income Tax Act,
1961.
288
33.6 APPLICATION OF CERTAIN PROVISIONS OF THE INCOME TAX ACT
1. Provisions of Section 29 of this Act, are linked to certain sections of the Income Tax
Act, 1961. For its effective purpose and to avoid its repetition in this Act, it is stated that
these provisions will apply as if provided in this Act and Rules framed there under. This
also makes it possible that any amendment made in the Income Tax Act to those
provisions will automatically become applicable for this Act without there being
requirement to amend this Act.
The
Incomesection
Tax says
Act, that
1961the provisions
and of the
the Income TaxSecond Schedule
(Certificate and ThirdRule,
Proceedings) Schedule
1962,toasthe
in
force from time to time shall, as far as possible, apply with necessary modifications as if
those provisions and rules refer to debt due under this Act.
Due to this provision the debt due from the defendant to the bank or financial institution
is treated on par with Income Tax arrears and can be recovered like the arrears under the
income tax.
33.7 APPEAL AGAINST THE ORDER OF RECOVERY OFFICER
The Recovery Officer is given powers under Sections 25 and 28 to recover the amount
mentioned in the recovery certificate. As per Section 26, the defendant cannot question
or dispute before the Recovery Officer about the correctness of the amount mentioned in
the recovery certificate. When the Recovery Officer attaches and sells the property it is
possible that the third party having any interest in such property may get affected.
Therefore, Section 30 provides that any person aggrieved by the order of Recovery
Officer may appeal within thirty days to the Tribunal. The period of thirty days is to be
counted from the receipt of the copy of the order by such person. On receipt of the
appeal, the Tribunal has to hear the appellant and make enquiries as it deems fit.
Thereafter the order of the Recovery Officer may be either confirmed or modified or set
aside.
In R. Advaiah vs Union of India [2000] 102 Compo Cas. (AP) (HC) it was held that
since there is remedy of appeal available by way of Section 30 of the Act, no writ can be
entertained against the order of the Recovery Officer.
33.8 TRANSFER OF PENDING CASES
1. As the Act is specific one for recovery of dues of banks and financial
- CAIIB DISCUSSION
institutions, it was necessary

that the recovery cases to which DRT Act applies should be brought under one forum.
Therefore
all the suits or other proceedings pending before the Civil Court, where the Tribunal has
jurisdiction
since establishment of the Tribunal, stand transferred to the Tribunal. Since the
establishment of
the Tribunal no Civil Court has the jurisdiction on the matters where Tribunal is
conferred with the
jurisdiction. Such cases stand transferred to the Tribunal from the Civil Court. The
Tribunal on
receipt of the record has to deal with the suit or proceeding as if it is an application filed
under
Section 19 of the Act. The Tribunal may deal with it from the stage where it had reached
in Civil
Court. No de-novo, i.e new from the start, proceedings start after the transfer of case
from Civil
Court to the Tribunal. The section has used the word suits and proceeding that get
transferred
from Civil Court to DRT. Proceeding will include execution petitions and they also get
transferred
to DRT.
2. In Punjab National Bank vs Chajju Ram [2000] 102 Compo Cas. 41, the
Supreme Court has held
that execution is a proceeding before the Civil Court and hence on coming into operation
of the
DRT Act, the execution will stand transferred to the DRT.
289
33.9 POWER OF TRIBUNAL TO ISSUE CERTIFICATE OF
RECOVERY
1. If there is a IN CASE
decree or OF DECREE
order OR
passed by ORDER
any court before coming into operation the DRT
Act and the decree or order is not yet executed, the decree-holder may apply to the
Tribunal for issue of recovery certificate. There is fresh hearing or trial, etc., in such
cases and the tribunal has to directly issue the recovery certificate based on the decree of
the Civil Court.
33.10 CHAIRPERSON, PRESIDING OFFICER AND STAFF OF
APPELLATE TRIBUNAL AND TRIBUNAL PUBLIC SERVANTS
The Chairperson of an Appellate Tribunal, the Presiding Officer of a tribunal, the
Recovery Officer and other officers of the Appellate Tribunal and Tribunal are deemed
public servants within the meaning of Section 21 of the Indian Penal Code.
33.11 PROTECTION OF ACTION TAKEN IN GOOD FAITH
When anything is done in good faith under this Act or is intended to be so done, no suit,
prosecution or other proceeding shall lie against the Central Government, the
Chairperson, Presiding Officer or the Recovery Officer. This protection is given so that
the authorities can function without fear as well as hindrances that the borrower
otherwise can put while the authorities discharge their duties.
33.12 OVERRIDING EFFECT OF THE ACT
The provisions of this Act have overriding effect when there is inconsistency with any
other law or in any instrument by virtue of any other law for the time being in force.
In Allahabad Bank vs Canara Bank AIR 2000 SC 1535, it is held that this Act is a
special Act for recovery of debt due to banks and financial institutions. It has overriding
effect over the provisions of Companies Act, 1956 and, therefore, leave of the company
court is not necessary even if the company is under winding up proceedings.
- CAIIB DISCUSSION
In Viral Filaments vs Industrial Bank 33 SCL 132, the Bombay High Court has held that
a petition for winding up a company against which recovery proceedings are pending in
the Debt Recovery Tribunal is admissible, since jurisdiction to wind up a company is
wholly not available in the DRT Act.
Allahabad Bank vs Canra Bank 2000 AIR sew 1347
In this case one of the issues before the court was whether permission of Company Court
is required for filing case before the Debt Recovery Tribunal when winding up
proceedings are pending before the Company Court. The Honourable Supreme Court
after examining the Company Law and Recovery of Debts Due to banks and financial
Institutions Act (DRT Act) held that:
(A) Adjudication under DRT Act is exclusive and jurisdiction of Civil Court and
Company Court is
ousted.
(B) DRT proceedings cannot be stayed by Company Court nor proceedings can be
transferred to
Company Court.
(C) DRT Act overrides the Companies Act.
(D) In respect of moneys realised under DRT Act out of the assets not charged,
distribution between
Bank/FIs and other creditors, when no winding up order passed against the company, the
priorities
have to be decided subject to principles underlying Section 73 of CPC and principles of
natural
justice, ( Section 73 of CPC mentions about ratable distribution of sale proceeds of
execution
among decree holders).
290
(E) Moneys realised under DRT Act, distribution between bank and other secured
creditors, when
winding
subject toup proceedings pending in company court, priority of secured creditors is
provisions of 529A of Companies Act (the said section mentions about priority of
secured creditors
and workman over other dues and distribution inter se between secured creditors and
workmen
should be pari-pasu).
(F) DRT is a special law; it overrides Companies Act. Leave of Company or Court
u/s 446 is neither
necessary nor the recovery application needs to be transferred to the Company Court.
33.13 DOCTRINE OF ELECTION
By amending Act 30 of 2004, on 11-11-2004, the following provisos were inserted in
section 19(1) of the DRT Act, 1993.
'Provided that the bank or financial institution may, with the permission of the Debts
Recovery Tribunal, on an application made by it, withdraw the application, whether
made before or after the Enforcement of Security interest and Recovery of Debts Laws
(Amendment) Act, 2004 for the purpose of taking action under the Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, if no
such action had been taken earlier under that Act;
'Provided further that any application made under the first proviso for seeking
permission from the Debt Recovery Tribunal to withdraw the application made under
sub-Section (1) shall be dealt with by it as expeditiously as possible and disposed of
within thirty days from the date of such application;
'Provided also that in case the Debts Recovery Tribunal refuses to grant permission for
- CAIIB DISCUSSION
withdrawal of the application filed under this sub-Section, it shall pass such orders after
recording the reasons thereof
The question whether withdrawal of the Original Application in terms of the first proviso
to the Section 19(1) of the DRT Act, 1993 is condition precedent to taking recourse to
the SARFAESI Act, 2002 was decided by the Supreme Court in M/s Transcore vs Union
of India and Another (decided on 29-2-2006). The Supreme Court observed that there
are three elements of election, namely, existence of two or more remedies;
inconsistencies between such remedies and a choice of one of them. If anyone of the
three elements is not there, the doctrine will not apply. There is no repugnancy nor
inconsistency between the two remedies and therefore, the doctrine of election does not
apply. The SARFAESI Act is enacted to enforce the interest in the financial assets which
belongs to the bank/FI by virtue of the contract between the parties or by operation of
common law principles or by law. Essentially the Act deals with the right of the secured
creditor. DRT is tribunal, a creature of the statue. It has no inherent power which exists
in the civil courts. The object behind introducing the first proviso and the third proviso
to Section 19(1) of the DRT Act is to align the provisions of the DRT Act, the
SARFAESI Act and Order XXIII of the Code of Civil Procedure, 1908. Order XXIII
CPC is an exception to the common law principle of non-suit; hence the proviso to
Section 19 (1) became a necessity. Withdrawal of the Original Application before the
DRT under the DRT Act is not a pre-condition for taking recourse to the SARFAESI
Act. It is for banks/Fls to exercise its discretion as to cases in which it may apply for
leave and in cases where they may not apply for leave to withdraw. First proviso to
Section 19(1) is an enabling provision.
In view of the above judgement of the supreme court, the controversy as to whether
simultaneous actions under the DRT Act and SARFAESI Act will lie, has been set at
rest.
33.14 POWERS TO MAKE RULE
The Central Government has the power to frame rules under the Act to carry out the
provisions of the Act. These rules are required to be notified and placed before both the
Houses of Parliament. The Parliament may accept the rules or may modify the same.
291
33.15 LET US SUM UP
On receiving recovery certificate the recovery officer has to proceed for the r ecovery by
attachment and sale of movable and immovable property of defendant, arrest and
detention in prison of defendant and appointment of receiver. Defendant is debarred
from disputing the correctness of the amount given in recovery certificate. The presiding
officer can correct the clerical or arithmetical errors. The section has given wide
enabling provisions to call money from third party in whose hands defendants money are
lying. When amount of defendant is in the hands of third party and recovery officer
issues notice calling money the third party failing to pay is deemed as defendant. Orders
of recovery officer applicable within thirty days to the Tribunal. If there is already a
decree passed by the Civil Court, the DRT can issue recovery certificate thereon. The
chairperson, presiding officer and staff of both Tribunals are deemed public servants.
They are also protected from any action for their acts done in good faith. The act has
overriding effect when there is inconsistency with any other law.
33.16 KEYWORDS
Recovery Officer; Deemed Defendant; Recovery as Income Tax Dues as per Provisions
of Income Tax Act.
1. Recovery Officers appointed under DRT Act can attach and sell movable as
well as immovable
property of the person against whom order is passed even if the property is not charged
to the
- CAIIB DISCUSSION
creditor. (True/False)
2. The defendant can raise a plea before the Recovery Officer about correctness of
the amount
ordered to be paid. (True/False)
3. If the recovery certificate has clerical or arithmetical mistake can correct the
same.
4. For recovery the Recovery Officer can adopt the same methods as adopted for
recovery of
income tax under the Income Tax Act. (True/False)
5. Recovery Officer can ask the defendant to furnish by affidavit particulars of his
asset.
(True/False)
1. True; 2. False; 3. Presiding Officer of the Tribunal; 4. True; 5. True.
1. A company is under winding up process. Whether High Court permission is
required to a bank to
proceed against it before DRT?
(a)No, as the DRT Act being a special Law having overriding effect over other laws.
(b)Yes, as Companies Act specially provides to that effect. t
(c)Depends on the stage of winding up process.
(d) No permission but concurrence of High Court required.
2. Doctrine of election will come into play
(a) when there exixts two or more remedies;
(b) when there are inconsistencies between the remedies;
(c) when there is choice available to the party to opt for on e of them;
(d) when all the aforesaid elements are to be present in a case.
Ans: 1. (a); 2. (d).
\
L.R.A.U-20
THE BANKERS' BOOKS EVIDENCE ACT, 1891
STRUCTURE
34.0 Objective
34.1 Introduction
34.2 Applicability and Definitions
34.3 Conditions in the Printout
34.4 Mode of Proof of Certain Entries in Bankers' Books
34.5 Case in which Officer of Bank not Compellable to Produce Books
34.6 Inspection of Books by Order of Court or Judge
34.7 Costs of Application
34.8 Let Us Sum Up
34.9 Keywords
(I::
294
- CAIIB DISCUSSION
II!
34.0 OBJECTIVE
The objective of this unit is to understand the special provisions made for giving
evidentiary value to the extracts of the books of bankers while producing any evidence in
the courts for proving or establishing anything the original evidence is relied upon.
34.1 INTRODUCTION
Banks keep their accounting and its details in various ledgers, registers, etc. When any
claim of the bank is required to be established or proved in the Courts of Law or any
other such forums, these books are required to be produced in original. It is difficult to
do so. Therefore, its extracts and statement of accounts are produced. To facilitate the
production of such evidence in easy way and to have evidentiary value to the extracts
and copies, 'The Bankers' Books Evidence Act, 1891 was enacted to amend the Law of
Evidence with respect to bankers' books.
34.2 APPLICABILITY AND DEFINITIONS
1. The Act extends to the whole of India except the State of Jammu & Kashmir.
2. 'Company' means a company as defined in Section 3 of the Companies Act,
1956 and includes a
foreign company within the meaning of that Act. The Companies Act, 1956 gives
elaborately the
requirements for getting the company registered. It has several prerequisites.
3. 'Corporation' means any body corporate established by any law and includes the
Reserve Bank of
India, the State Bank of India and any subsidiary bank of the State Bank of India.
4. 'Bank' and 'banker' means
(i) any company or corporation carrying on business of banking.
(ii) any partnership or individual to whose books, provisions of this Act are made
applicable.
(iii) any post office saving bank or money order office.
5. 'Bankers' books' include ledgers, day books, cash books, account books and all
other records
used in the ordinary business of a bank. These records may be kept in written form or
stored in a
micro-film, magnetic tape or any other form of mechanical or electronic data retrieval
mechanism.
Such record can be either on site or at any off site location and includes a back-up or
disaster
recovery site.
6. '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 any other person authorised for the purpose by the magistrate or by any
law. Such other person to be authorised should not be a magistrate.
This definition of the word legal proceeding is very wide and covers different types of
inquiries, proceedings and investigations.
7. 'Court' means the person or persons before whom a legal proceeding is held or
taken.
8. 'Judge' means a judge of a High Court.
9. 'Trial' means any hearing before the Court at which evidence is taken.
For this definition also, if the earlier definitions of legal proceeding and Court are
considered together, the scope of word 'trial' is much wider.
- CAIIB DISCUSSION
10. 'Certified copy' means when the books of a bank;
295
(i) if maintained in the written form, a copy of any entry in such books together with a
certificate written at the foot of such copy mentioning that
(a) it is a true copy of such entry
(b) that such entry is contained in one of the ordinary books of the bank
(c) that such entry was made in the ordinary course of business
(d) that such book is still in the custody of the bank
(e) and if the copy was obtained by a mechanical or other process that in itself
ensures
the accuracy of the copy, a further certificate to that effect.
If after taking out the copy from the books of the bank, the original books are destroyed
in usual course of the bank's business a further certificate to that effect of ha ving
destroyed the book is necessary.
Each certificate mentioned above shall bear date and should be signed by the principal
accountant or manager of the bank with his name and official title, (ii) if maintained in
the electronic form
(a) consists of printouts of data stored in a floppy, disc, tape or any other
electromagnetic
data storage device, or
(b) a copy of such printout; and it should contain the certificate having all the
applicable
contents detailed above at sub-Para (i).
(iii) if maintained mechanical form
(a) a printout of any entry in the books of a bank stored in a microfilm, magnetic
tape, or
(b) any other form of mechanical or electronic data retrieval mechanism obtained
by a
mechanical or other process, and it should contain the certificate having all the
applicable
contents detailed above in sub-Para (i).
34.3 CONDITIONS IN THE PRINTOUT
1. When the books of the bank are not written in the handwritten and copies are
taken by way of
printout the copy must accompany following:
(i) a certificate by the principal accountant or the manager to the effect that it is a
printout of
such entry or a copy of such printout; and (ii) a certificate by a person in charge of
computer system containing a brief description of the
computer system and the particulars thereof,
(a) the safeguards adopted by the system to ensure that data is entered or any other
operation performed is only by authorised person;
(b) the safeguards adopted to prevent and detect unauthorised change of data;
(c) the safeguards available to retrieve data that is lost due to systemic failure or
any other
reasons;
(d) the manner in which the data is transferred from the system to removable media
like
floppies, discs, tapes or other electromagnetic data storage devices;
(e) the mode of verification in order to ensure that data has been accurately
transferred to
such removable media;
(f) the mode of identification of such data storage device;
- CAIIB DISCUSSION
(g) the arrangement for the storage and custody of such storage devices;
(h) the safeguards to prevent and detect any tampering with the system; and
(i) any other factor which will vouch for the integrity and accuracy of the system.
2. In addition to the above, a further certificate required is from the person in
charge of the computer
system to the effect that to the best of his knowledge and belief, such computer system is
operated
296
properly at the material time, he was provided with all the relevant data and the printout
in question represents correctly and is appropriately derived from the relevant data.
34.4 MODE OF PROOF OF CERTAIN ENTRIES IN BANKERS' BOOKS
A certified copy of any entry in a bankers' book shall in all legal proceedings be received
as prima facie evidence of the existence of such entry. Further it shall be admissible as
evidence of all the matters, transactions and accounts therein recorded in every case as
the original entry itself.
In Chandrahdar Goswami vs Gauhati Bank Ltd. AIR 1967 SC 1058, the Supreme Court
has held that to make a person liable mere entries in books of account are not sufficient
even though the books of account are kept in regular course of business. There has to be
further evidence to prove payment of the money by the bank which appear in the books
of account to make the person liable, except where the person accepts the correctness of
the books of account.
34.5 CASE IN WHICH OFFICER OF BANK NOT
COMPELLABLE TO PRODUCE BOOKS
In any proceeding where the bank is not a party, no officer of a bank shall be
compellable to produce any bankers' book contents of which can be proved under this
Act by production of certified copies. Similarly no officer of the bank shall be called as
witness
However, to the
prove the may
Court matters,
ordertransactions andspecial
otherwise for accounts recorded in the certified copies.
cause.
34.6 INSPECTION OF BOOKS BY ORDER OF COURT OR JUDGE
1. On application by any party to the legal proceeding, the Court or a Judge may
order that,
(i) such party be at liberty to inspect and take copies of any entries in a banker's book for
any of the purposes of the proceeding; or
(ii) the bank to prepare and produce, within time 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. This
further certificate also should be dated and signed as required for certified copy stated
above.
2. An order that bank officer should either produce the books of account or appear
as witness can be
made by the Court or Judge with or without summoning the bank. The order so passed
shall be
served on the bank at least three clear working days before the same is to be obeyed. The
bank may
at any time before the time limited for compliance of any such order either offer to
produce their
books at the trial or give notice of their intention to show cause against the order. If the
bank
chooses to give show cause against the order then the order passed by the Court or Judge
cannot
- CAIIB DISCUSSION
be enforced without further order.

34.7 COSTS OF APPLICATION
1. The costs of any application to the court
(i) under or for the purpose of this Act; and
(ii) the costs of anything done or to be done under an order of the court for the purpose
of this Act, shall be in the discretion of the court. The court may further order such costs
or part thereof to be paid by the bank to the party, if they have been incurred in
consequence of any fault or improper delay on the part of the bank.
2. Any order made under this section for payment of cost to or by a bank may be
enforced as if the
bank were a party to the proceeding.
297
3. Any order passed under this section awarding costs may on application to any Court
of Civil Judicature be executed by such court as if the order is a decree for money passed
by itself. However, the court who passed the order can also have the powers to enforce
of its own orders with respect to the payment of costs.
34.8 LET US SUM UP
The definition clause gives the meaning of different words in the context of the Act. The
certified copy needs a certificate giving some declarations. When the books of bank are
taken in printout form they need a further certificate as detailed in the Section. When
data is stored in computer form a certificate from person in charge of the computer
system is required. Certified copy is a prima facie evidence and admissible in evidence
as if original is produced. On production of certified copy no further evidence is
required. In any proceeding where bank is not a party and certified copies are produced
bank's officer cannot be called as witness as copy is admissible evidence. Court can
order inspection of books of accounts. The orders for inspection of books must give
three clear days for the bank to arrange for inspection. Court has discretion to award
costs for any application under the Act.
34.9 KEYWORDS
Certified
34.10 CHECKCopy. YOUR PROGRESS
1. If the books of the bank are maintained in the electronic form, does all the
provisions of this Act
are applicable to it. (Yes/No)
2. Does this Act apply to any investigation or inquiry under the Criminal
Procedure Code? (Yes/No)
3. A certified copy of any entry in a bankers' Book is received in legal proceeding
as
evidence for existence of such entry.
4. Unless the Court otherwise directs, bank officer cannot be compelled to
produce to
prove any banker's book's contents when copy is produced.
1. Yes; 2. Yes; 3. prima facie; 4. original books.
1. In a civil suit, to which bank is not a party, one of the parties has produced certified
copy of books of account. One party to the suit wants to call bank officer as witness to
prove the contents of copy. Can it be done?
(a) Yes, as it is the right of the party to get it reaffirmed in evidence.
(b) No, as the certified copy is a prima facie evidence that is admissible in
evidence.
(c) No, unless the bank volunteers to do so.
(d) Yes, but if Court allows the application to call the witness.
- CAIIB DISCUSSION
Ans. 1. (b) No
THE LEGAL SERVICES AUTHORITIES ACT, 1987: LOK ADALATS
STRUCTURE
35.0 Objective
35.1 Introduction
35.2 Organisation of Lok Adalats
35.3 Jurisdiction of Lok Adalats
35.4 Cognisance of Cases by Lok Adalats
35.5 Disposal of Cases by Lok Adalats
35.6 Nature of Award of the Lok Adalats

35.7 Let Us Sum Up
300
35.0 OBJECTIVE
The objective of this unit is to familiarise the readers with the system of Lok Adalats
organised under the Legal Services Authorities Act, 1987 for compromise or settlement
of disputes between parties.
35.1 INTRODUCTION
The functioning of Lok Adalats, their jurisdiction, the manner in which Lok Adalats take
cognisance of cases, the types of disposal of the cases or matters referred to the Lok
Adalats and the nature of award that may be passed by the Lok Adalats are discussed in
this unit.
35.2 ORGANISATION OF LOK ADALATS
Lok Adalat are organised by the State Authority, District Authority or the Supreme
Court
Legal Legal Services
Services Committee
Committee at suchorintervals
High Court
and Legal
placesServices Committee
for exercising or Taluk
jurisdiction and for
such areas as it thinks fit.
35.3 JURISDICTION OF LOK ADALATS
A Lok Adalats shall have jurisdiction to determine and arrive at a compromise or
settlement between the parties to a dispute. The dispute should be either a pending case
before any court for which the Lok Adalat is organised or a matter which is falling
within the jurisdiction but not pending in any court. The offences, which are
compoundable under any law cannot be brought within the purview of the Lok Adalats.
The monetary ceiling of amounts regarding which civil disputes can be settled under this
mechanism is presently Rs 20 lakh.
35.4 COGNISANCE OF CASES BY LOK ADALATS
Lok Adalats shall deal with the following types of cases or matters, viz.,
(a) the disputes the parties agree to refer;
(b) the disputes where one of the parties makes an application to the court to refer
to Lok Adalat and
the court is satisfied that there are chances of settlement. In this case the court shall give
an
opportunity to the other party before deciding the case to be referred to the Lok Adalat;
(c) the dispute which, in the opinion of the Court, it is appropriate to be taken
cognisance by the Lok
Adalat.
(d) Where in respect of a potential dispute, the authority or committee organising
Lok Adalat on
- CAIIB DISCUSSION
receipt of an application from anyone of the parties is of the opinion that the matter
needs to be
determined by the Lok Adalat, may refer such matter to the Lok Adalat for
determination.
35.5 DISPOSAL OF CASES BY LOK ADALATS
The Lok Adalats shall arrive at a compromise or settlement between the parties. They
shall act with utmost expedition to arrive at a compromise or settlement between the
parties and shall be guided by the principles of justice, equity, fair play and other legal
principles. Where no compromise or settlement could be arrived at between the parties,
the records of the case shall be returned to the court from which the reference was
received. The court shall proceed with the matter from the stage it had reached before
making a reference to the Lok Adalat. In respect of disputes which were not before the
court, in the absence of compromise or settlement between the parties to seek remedy in
a court.
301
35.6 NATURE OF AWARD
The award of Lok Adalat shall be deemed to be a decree of a civil court or an order of
any other court. In case of compromise or settlement arrived at by a Lok Adalat the court
fee paid in the case shall be refunded in the manner provided under the Court fees Act,
1870. Every award shall be binding on all the parties to the dispute. No appeal shall lie
to any court against the award.
35.7 LET US SUM UP
Lok Adalats are organised under the Legal Services Authorities Act, 1987.
They are intended to bring about a compromise or settlement in respect of any dispute or
potential dispute. Lok Adalats derive jurisdiction by consent of parties or on an
application made to the court by one of the parties to the dispute or the court is satisfied
that the dispute between the parties could be settled by Lok Adalat. In respect of a
potential dispute, any party may request the Authority or Committee organising Lok
Adalat to refer the dispute for determination. Lok Adalats shall be guided by the
principles
Award shall ofbe
justice, equity,
binding on thefairparties
play and other
to the legal No
dispute. principles. In case
appeal shall lie of
in settlement,
any court the
against the Award. If no settlement, the case shall be remitted back to the court which
referred the matter to the Lok Adalat. In case of potential court case, the Lok Adalat
shall advise the parties to seek remedy in court.
1. Lok Adalats are organised under the Lok Adalats Act. (True/False)
2. Lok Adalats are organised to settle only the existing disputes between the
parties. (True/False)
3. If one party intends to refer the dispute to Lok Adalat, the consent of the other
is not required.
(True/False)
4. Lok Adalats shall strive at arriving a compromise or settlement between the
parties. (True/False)
5. There shall be no appeal against the award of the Lok Adalat. (True/False)
1. False; 2. False; 3. False; 4. True; 5. True.
UNIT
36
THE CONSUMER PROTECTION ACT, 1986: PREAMBLE, EXTENT AND

DEFINITIONS
- CAIIB DISCUSSION
STRUCTURE
36.0 Objective
36.1 Introduction
36.2 Purpose of the Act, Preamble and Extent
36.3 Definitions
36.4 Act not Overriding on any Other Law
36.5 Let Us Sum Up
36.6 Keywords
304
36.0 OBJECTIVE
The objective of this unit is to get the knowledge of the purpose of this special
enactment, viz., The Consumer Protection Act, 1986 and the particular word defined for
appropriate use therein.
36.1 INTRODUCTION
To protect the interests of the consumers, 'The Consumer Protection Act was enacted.'
The word consumer and services has been defined in the Act very elaborately. In this
unit, we will see the purpose of enacting the Act and various definitions of words used in
the context of this Act.
36.2 PURPOSE OF THE ACT, PREAMBLE AND EXTENT
1. The Act was enacted with the objective, 'for better protection of the interests of
consumers".
Different authorities were established for the settlement of consumers' disputes. The Act
is social
welfare benefit oriented legislation for the consumer providing self-contained quasi-
judicial machinery
to provide speedy and simple redressal to consumer disputes. The said quasi-judicial
machinery
establishedisat the district, state and central levels. They observe the principles of natural
justice and
are empowered to give relief of specific nature and, if required, award compensation to
the
consumers. The Act also provides penalties for non-compliance of the orders given by
these
authorities.
2. In the preamble, it is made clear about the purpose of the Act. It says that the
Act is for,
(i) better protection of the interests of the consumers and for that purpose to make
provision for the establishment of consumer councils and other authorities for the
settlement of consumers' disputes.
3. The Act extends to the whole of India except the State of Jammu & Kashmir.
4. The Act applies to all goods and services, excluding goods for resale or for
commercial purpose
and services rendered free of charge and under a contract for personal service.
36.3 DEFINITIONS
1. 'Appropriate laboratory' means a laboratory or organisation recognised by the
Central Government
or by the state government, or any such laboratory or organisation established by or
under any law
for carrying out analysis or test of any goods with a view to determining whether such
goods
- CAIIB DISCUSSION
suffer from any defect.

2. 'Branch office' means any establishment described as a branch by the party or
any establishment
carrying on either the same or substantially the same activity as that carried on by the
head office
of the establishment.
3. 'Complainant' means
(i) a consumer, or
(ii) any voluntary consumer association registered under the Companies Act, 1956 or
under
any law for the time being in force, or
(iii) the Central Government or a state government, who or which makes the complaint,
or (iv) one or more consumers, where there are numerous consumers having the same
interest,
and (v) in case of death of a consumer, his legal heirs or representative.
4. 'Complaint' means any allegation in writing made by a complainant with a view
to obtaining any
relief provided by or under this Act that,
305
he
rd
lal
ry is id
tie se
of
se
nt w
ds
nt
:e
er
(i) an unfair trade practice or a restrictive trade practice has been adopted by any trader
or
service provider;
(ii) the goods brought by him or agreed to be brought by him suffer from one or more
defects; (hi) the services hired or availed of or agreed to be hired or availed of by him
suffer from
deficiency in any respect;
(iv) a trader or the service provider has charged for the goods or for the services
mentioned in the complaint, at a price in excess of the price
(a) fixed by or under any law, or
(b) displayed on the goods or any package containing such goods, or
(c) displayed on the pricelist exhibited by him by or under any law, or
(d) agreed between the parties.
(v) the goods which will be hazardous to life and safety when used, are being offered for
sale to the public
(a) in contravention of any standard relating to safety of such goods as required to
be
complied with, by or under any law,
(b) if the trader could have known with due diligence that the goods so offered are
unsafe
- CAIIB DISCUSSION
to the public,
(vi) the services which are hazardous or likely to be hazardous to life and safety of the
public when used, are being offered by the service provider which such person could
have known with due diligence to be injurious to life and safety.
5. 'Consumer' means any person who
A. (i) buys any goods for a consideration which has been paid or promised to be
paid or partly
paid and partly promised, or (ii) under any system of deferred payment, and (iii) includes
any user of such goods other than who buys the goods in the manner as said
above, or (iv) buys the goods under any system of deferred payment when such use is
made with the
approval of such person,
However, the definition does not include a person who obtains such goods for re -sale or
for
any commercial purpose.
B. (i) hires or avails of any services for a consideration which has been paid or
promised or partly
paid and partly promised, or (ii) under any system of deferred payment, and (iii) includes
any beneficiary of such services other than who hires or avails of the services in
the manner as said above, or (iv) avails the services under any system of deferred
payment when such services are availed of
with the approval of such person.
However, the definition does not include a person who avails of such services for any
commercial purpose.
The word 'commercial purpose' herein above does not include use by a person of goods
bought and used by him and services availed by him exclusively for the purpose of
earning his livelihood, by means of self-employment.
The definition of consumer is thus very elaborate and inclusive of many aspects.
6. 'Consumer dispute' means a dispute where the person against whom complaint
has been made,
denies or disputes the allegations contained in the complaint.

306
7. 'Defect' means any fault, imperfection, shortcoming in the quality, quantity,
potency, purity or
standard which is required to be maintained by or under any law or under any contract,
express or
implied or as is claimed by the trader in any manner whatsoever in relation to any goods.
8. 'Deficiency' means any fault, imperfection, shortcoming or inadequacy in the
quality, nature and
manner of performance which is required to be maintained by any law or has been
undertaken to
be performed by a person in pursuance of a contract or otherwise in relation to any
service.
In Jagannath Meher vs Branch Manager, State Bank of India (1993) II CPJ 146, it was
held that where a loan was sanctioned by the bank but the complaint that the loan was
inadequate to start the industry is not tenable. It was held that the Consumer Forum
cannot override the decision taken by the bank as that was a power of discretion of the
bank and there was no reason that the bank acted otherwise than in good faith.
9. 'District Forum' means a Consumer Dispute Redressal Forum established under
Clause (a) of
Section 9 under this Act.
10. 'Goods' means goods as defined in the Sale of Goods Act, 1930. The said Act
has stated that goods
- CAIIB DISCUSSION
means every kind of moveable property other than actionable claims and money.
However, it does
not include stocks and shares, growing crops, grass and things attached to or forming
part of the
land which are agreed to be served before sale or under contract of sale.
11. 'Manufacturer' means a person who
(i) makes or manufactures any goods or parts thereof; or
(ii) does not make or manufacture any goods but assembles parts thereof made or
manufactured
by others; or (iii) puts or causes to be put his own marks on any goods made or
manufactured by any other
manufacturers.
12. 'National Commission' means the National Consumer Disputes Redressal
Commission established
under Clause (c) of Section 9.
13. 'Notification' means a notification published in Official Gazette by the State or
Central Government.
14. 'Person' includes
(i) a firm whether registered or not; (ii) a Hindu undivided family; (iii) a co-operative
society;
(iv) every other association of persons whether registered under the Societies
Registration Act, 1860 or not.
15. 'Prescribed' means prescribed by the State or Central Government, as the case
may be, under this
Act.
16. 'Regulation' means the regulations made by the National Commission under this
Act.
17. 'Restrictive trade practice' means
(i) a trade practice which tends to bring about manipulation of price, or (ii) its conditions
of delivery, or
(iii)
mannerto affect flow on
to impose of supplies in the market
the consumers relating
unjustified coststoorgoods or services
restrictions in such a
and include,
(a) delay beyond the period agreed to by a trader on supply of such goods or in
providing
the services which has led or is likely to lead to rise in the price, and
(b) any trade practice which requires a consumer to buy, hire or avail of any goods
or
services as condition precedent to buying, hiring or availing of other goods or services.
307
18. 'Service' means
(i) service of any description which is made available to potential users and includes, but
not limited to, the provision of facilities in connection with banking, financing,
insurance, transport, processing, supply of electrical or any other energy, boarding or
lodging or both, housing construction, entertainment, amusement or the surveying of
news or other information. However, this does not include the rendering of any service
free of charge or under a contract of personal service.
The definition gives elaborately what amounts service from various sectors and lines. It
has specifically included the services rendered by the bank.
19. 'Spurious goods and services' means such goods and services which are claimed
to be genuine but
they are actually not so.
20. 'State Commission' means a Consumer Disputes Redressal Commission
established in a state
- CAIIB DISCUSSION
under Clause (b) of Section 9 of the Act.

21. 'Trader' in relation to any goods means a person who sells or distributes any
goods for sale and
includes the manufacturer thereof, and where such goods are sold or distributed in
package form,
includes the packer thereof.
22. 'Unfair trade practice' means a trade practice which, for the purpose of
promoting the sale, use or
supply of any goods or for the provision of any service, adopts any unfair method or
unfair or
deceptive practice. Such unfair practices include:
A. the practice of making any statement orally or in writing or visible representation
which
(i) falsely represents that the goods are of a particular standard, quality, quantity, grade,
composition, style or model;
(ii) falsely represents that the services are of a particular standard, quality or grade; (iii)
falsely represents any rebuilt, second-hand, renovated, reconditioned or old goods as
new
goods; (iv) represents that the goods or services have sponsorship, approval,
performance,
characteristic, accessories, uses or benefits which such goods or services do not have; (v)
represents that the seller or the supplier has a sponsorship or approval or affiliation
which
such seller or supplier does not have; (vi) makes a false or misleading representation
concerning the need for or the usefulness of
any goods or services; (vii) gives to the public any warranty or guarantee of the
performance, efficacy, or length of
life of a product or of any goods that is not based on an adequate or proper test thereof;
(viii) makes to the public a r epresentation in a form that purports to be,
(a) a warranty or guarantee of a product or of any goods or services; or
(b)
repeat or a promise to replace, maintain or repair an article or any part thereof or to
continue a service until it has achieved a specified result, if such purported warranty
or guarantee or promise is materially misleading or if there is no reasonable prospect
that such warranty, guarantee or promise will be carried out;
(ix) materially misleads the public concerning the price at which a product like products
of goods or services, have been or are, ordinarily sold or provided and for this purpose, a
representation as to price shall be deemed to refer to the price at which the product,
goods or services are sold or provided;
(x) gives false or misleading facts disparaging the goods, services or trade off another
person.
For the purpose of Clause (1) above, a statement that is:
(i) expressed on an article offered or displayed for sale or on it wrapper or container; or
308
(ii) expressed on anything attached to, inserted in or accompanying as an article offered
or displayed for sale or on anything on which the article is mounted for display or sale;
or
(iii) contained in or on anything that is sold, sent, delivered, transmitted or in any other
manner made available to the public, is deemed to be a statement made to the public by
the person who has caused the statement to be so expressed, made or contained.
B. Permits the publication of any advertisement for sale of goods or supply of
service in the
newspaper or otherwise at a bargain price that are in fact not at bargain price. Bargain
- CAIIB DISCUSSION
price
means a price stated to be a bargain price by reference to an ordinary price or a price at
which
the product is ordinarily sold or otherwise.
C. Permits
(i) offering of gifts, prizes or other items with the intention of not providing them as
offered or creating impression that something is being given or offered free of charge
when actually it is not so;
(ii) the conduct of any contest, lottery, game of chance or skill for the purpose of
promoting the sale, use or supply of any product or business interest.
D. Withholding of any participants of any scheme offering gifts, prizes or other
items free of
charge and informing the final results on the closure of the scheme.
E. Permits the sale or supply of goods intended to be used by consumers knowing
or having
reason to believe that the goods do not comply with the standards prescribed by
competent
authority relating to performance, composition, contents, design, construction, finishing
or
packaging as are necessary to prevent or reduce the risk of injury to the person using the
goods.
F. Permits the hoarding or destruction of goods, or refuses to sell the goods or to
make them
available for sale or to provide any service if such hoarding or destruction or refusal
tends to
raise the cost of goods or services.
G. Manufacture of spurious goods or offering such goods for sale or adopting
deceptive practices
in the provision of services.
The definition of 'unfair trade practice' is very exhaustive. Due to different unfair
practices adopted in
done all inclusive sale
and of goods
covering or offering
various services
possibilities theamount
that definition is required
unfair practice.to be
The
fundamental concept underlying the word 'fair' is that the transaction has nothing
underhand in it, is honest, just, equitable and upright and that the other party to the
contract has not taken any undue advantage. If the transaction lacks any of the contents
out of this, it can be termed as 'unfair'.
36.4 ACT NOT OVERRIDING ON ANY OTHER LAW
The provisions of this Act are in addition to other applicable laws and not overriding on
any other law, i.e. the provisions of this Act do not supercede any specific provision in
other Act. The Act provides additional means of obtaining remedy by a consumer but if
the remedy prayed is barred under any other Act, then the Forums constituted under this
Act cannot grant such remedy.
36.5 LET US SUM UP
The Act has been enacted for the settlement of consumer disputes. The Act is social
welfare benefit oriented legislation. It is for speedy disposal of the redressal of consumer
disputes. Deciding the consumer types and protections required the Act was made for
better protection of the interests of the
309
consumers establishing the consumer councils and authorities. The provisions of t he Act
are not overriding on any other law.
36.6 KEYWORDS
Quasi-judicial Authorities; Appropriate Laboratory; District Forum; State Commission;
National Commission; Restrictive Trade Practice.
- CAIIB DISCUSSION

1. Consumer Protection Act is enacted to protect the manufacturing conditions of
the Industries.
(True/False)
2. The agencies appointed under Consumer Protection Act are quasi-judicial in
nature. (True/False)
3. Can a voluntary consumer association file a complaint on behalf of consumer?
(Yes/No)
4. A consumer has purchased goods for resale. Can he file complaint? (Yes/No)
1. False; 2. True; 3. Yes; 4. No.
1. 'N. has purchased a draft from a bank favouring 'B'. The draft is lost in transit and for
duplicate draft in lieu of first bank need some formalities to be completed by 'N'. Can 'B'
file a consumer case against the formalities as it is delaying payment to him.
(a) No, as he is not consumer of the bank and is not taking any service from the
bank.
(b) No, as he has not paid the demand draft commission.
(c) Yes, as because of bank, his payment is getting delayed.
(d) Yes, his money is lying in the bank, he is deemed as account holder of the bank.
Ans. 1. (a)
UNIT
37
CONSUMER PROTECTION COUNCILS
STRUCTURE
37.0 Objective
37.1 Introduction
37.2
37.3 Central
ProcedureConsumer Protection
for Meeting CouncilCouncil
of the Central
37.4 Objects of the Councils
37.5 State Consumer Protection Council
37.6 District Consumer Protection Council
37.7 Let Us Sum Up
312
37.0 OBJECTIVE
The objective of this unit is to understand the appointment and functions of the consumer
councils appointed. They have to discharge the functions and use their power keeping in
mind the purpose of the enactment to protect the rights of the consumers.
37.1 INTRODUCTION
To promote and protect the right of the consumer councils are established. Their scope is
not regarding directly dealing with the consumer complaints at initial or appellate scope
but to promote and protect the rights of consumer. The function is more of promoting the
rights and spreading awareness by education. The highest council is the Central Council
who has the jurisdiction for the entire country. Then below it is the State Council for
each state. Below that is the District Council for each district. This unit gives the
provisions for establishment of these councils, their objects and procedure for their
meetings.
- CAIIB DISCUSSION
37.2 CENTRAL CONSUMER PROTECTION COUNCIL

The Central Government has established a council known as the Central Consumer
Protection Council, called as Central Council.
The Central Council shall consist of the following:
(i) The Minister-in-Charge of the Consumer Affairs in the Central Government, who
shall be the
Chairman of the Council, and (ii) Such number of other official or non-official members
representing such interests as may be
prescribed.
37.3 PROCEDURE FOR MEETING OF THE CENTRAL COUNCIL
The Central Council shall meet as and when necessary but at least once in a year. For
transacting the business of the meeting the procedure shall be as may be prescribed.
37.4 OBJECTS OF THE COUNCILS
The objects of the Council shall be to promote and protect the rights of the consumers
such as
(i) the right to be protected against the marketing of goods and services which are
hazardous to life
and property; (ii) the right to be informed about the quality, quantity, potency, purity,
standard and price of goods
or services so as to protect the consumer against" unfair trade practices; (iii) the right to
be assured wherever possible for access to a variety of goods and services at competitive
price; (iv) the right to be heard and to be assured that consumers' interests will receive
due consideration at
appropriate forums; (v) the right to seek redressal against unfair trade practices or
restrictive trade practices or unscrupulous
exploitation of consumers; and (vi) the right to consumer education.
37.5 STATE CONSUMER PROTECTION COUNCIL
The State Government shall establish Consumer Protection Councillor the State Council
by issuing a notification. The State Council shall consist of following members:
313
(i) the Minister-in-Charge of the Consumer Affairs in the State Government who shall be
the Chairman
of the Council, (ii) such number of official and non-official members representing such
interests as may be prescribed
by the State Government, (iii) such number of other official and non-official members
not exceeding ten, as may be nominated
by the Central Government.
The State Council shall meet as and when necessary. There has to be at least two
meeting every year. For transacting the business of the meeting the procedure shall be as
may be prescribed by the State Government.
37.6 DISTRICT CONSUMER PROTECTION COUNCIL
1. For every district the State Government establishes the District Consumer
Protection Council
called as District Council.
The District Council shall consist of following members:
(i) the Collector of the district who shall be the Chairman of the Council, (ii) such
number of other official and non-official members representing such interests as may be
prescribed by the State Government.
2. The District Council shall meet as and when necessary. There has to be at least
two meeting every
year. For transacting the business of the meeting the procedure shall be as may be
prescribed by
the State Government.
- CAIIB DISCUSSION
37.7 LET US SUM UP

Central Government has to establish Central Council and notify the same. It consists
Minister-in-Charge of the Consumer Affairs in the Central Government and such other
persons as the government may prescribe. In similar way State Government has to
establish State Council and District Council. Compositions of State Council and District
Council are different and as laid down in the section.
1. Central Consumer Protection Council is the apex council having all India
jurisdiction. (True/
False)
2. Minister-in-Charge of consumer affairs in the Central Government is the
Chairman of Central
Consumer Protection Council. (True/False)
3. State Consumer Protection Council is appointed by Central Government.
(True/False)
4. State Consumer Protection Council has to meet at least in a year.
37.9 ANSWERS TO "CHECK YOUR PROGRESS'
1. True; 2. True; 3. False; 4. Twice.
1. Who is the Chairman of the Central Consumer Protection Council?
(a) Chief Justice of the Supreme Court.
(b) Judge of the Supreme Court appointed by the Chief Justice of the Supreme
Court.
(c) Minister-in-Charge of Law and Judiciary in the Central Government.
(d) Minister-in-Charge of Consumer Affairs in the Central Government.
Ans. 1. (d)
CONSUMER DISPUTES REDRESSAL AGENCIES
STRUCTURE
38.0 Objective
38.1 Introduction
38.2 Establishment of Consumer Disputes Redressal Agencies
38.3 Composition of District Forum
38.4 Jurisdiction of District Forum
38.5 Form of Complaint
38.6 Procedure on Admission of Complaint
38.7 Finding of the District Forum
38.8 Appeal
38.9 Composition of the State Commission
38.10 Jurisdiction and Procedure of State Commission
38.11 Transfer of Cases
38.12 Appeals
38.13 Composition of the National Commission
38.14 Jurisdiction and Powers of National Commission
38.15 TVansfer of Cases
38.16 Finality of Order if no Appeal is Preferred
38.17 Limitation Period
38.18 Enforcement of Orders
38.19 Dismissal of Frivolous or Vexatious Complaints
38.20 Penalties and Protections
38.21 Service of Notice
38.22 Let Us Sum Up
- CAIIB DISCUSSION

316
38.0 OBJECTIVE
In this unit we are looking at different agencies that function for redressal of the
complaints of the consumers. The purpose of the Act itself is the protection of the
consumer interest. Therefore the functions of these agencies have much significance.
38.1 INTRODUCTION
For resolving and dealing with the consumer complaints different fora are established at
district level, state level and national level. These forums have different laid down
composition. They have to work and deal with the complaints in the prescribed manner.
Their jurisdiction and powers are decided. All these aspects are laid down in the Act in
detail giving full procedural particulars. In this unit, we will see these issues. They are on
various aspects and with minute details.
38.2 ESTABLISHMENT OF CONSUMER DISPUTES REDRESSAL AGENCIES
1. For the purposes of this Act, there shall be following agencies established by the
state government or the Central Government, as the case may be.
(i) District Forum established by the state government at each district. The government
may
establish more than one District Council for any district, (ii) State Commission
established by the state government for the state, (iii) National Commission established
38.3 COMPOSITION OF DISTRICT FORUM
1. Each District Forum shall consist of following:
A. A person who shall be or has been qualified to be a District Judge, who shall be
the President
of the District Forum.
B. Two other members, one of whom shall be a woman having qualifications as
under:
(i) be not less than thirty-five years of age,
(ii) possess a bachelor's degree from a r ecognised university,
(iii) be person of ability, integrity and standing, and have adequate knowledge and
experience
of at least ten years in dealing with problems relating to economics, law, commerce,
accountancy, industry, public affairs or administration.
2. Every appointment as member of the District Forum has to be made by the state
government on
the recommendations of the selection committee consisting of the following:
(i) the President of the State Commission, who shall be the Chairman of Selection
Committee, (ii) Secretary, Law Department of the state, who shall be the member of
Selection Committee, (iii) Secretary-in-Charge of the department dealing with Consumer
Affairs in the state, who shall be the member of Selection Committee.
If for any reason the President of the State Commission is absent or otherwise, the state
government may refer the matter to the Chief Justice of the High Court for nominating a
sitting Judge of that High Court to act as Chairman.
3. Every member of the District Forum shall hold office for a term of five years or
up to the age of
sixty-five years, which ever is earlier. If the member fulfils the qualifications of
appointment, he
may be reappointed on expiry of initial term of five years. A member may resign from
his office in
writing under his hand addressed to the state government.
- CAIIB DISCUSSION
Tribunal or any authority set up under any law.

38.6 PROCEDURE ON ADMISSION OF COMPLAINT
1. If the complaint admitted by the District Foram relates to any goods, the said Foram
shall
318
(i) Refer a copy of complaint within twenty-one days from the date of admission to the
opposite party to give his version of the case. The opposite party is required to give his
version within thirty days or extended period of not more than fifteen days.
(ii) If the opposite party denies or disputes the allegation contained in the complaint or
fails to submit any of his version, then the consumer dispute is dealt with further as
provided herein.
(iii) Where the complaint alleges a defect in the goods that cannot be determined without
proper analysis or test of the goods, the District Forum shall obtain a sample of the
goods from the complainant and refer the sample in sealed condition to the appropriate
laboratory for analysis or test. The report of the laboratory is required to be received
within forty-five days or extended period, if and as, allowed by the District Forum. The
sample to be sent to the laboratory has to be sealed and authenticated by the District
Forum as prescribed.
(iv) Before the sample of the goods is sent to the laboratory for analysis or test the
complainant is required to deposit the fees as may be specified for payment to the
laboratory for analysis or test.
(v) On receipt of the report from the laboratory about the analysis or test of the goods,
copy of the laboratory report along with such remarks as the District Forum may feel
appropriate are required to be sent to the opposite party.
(vi) If any of the party to the complaint dispute in any way the report received from the
laboratory about the analysis or test of the goods such party has to submit in writing his
objections about the report.
(vii) The District

complaint Forum
for giving theirafter
say giving
on the rreasonable opportunity
eport and the tohas
objections both
tothe parties
make to the
appropriate
orders thereon.
2. If the complaint relates to services or about the goods for which procedure
given above cannot be
followed, the District Forum shall refer a copy of the complaint to the opposite party to
give his
version of the case. The opposite party is required to give his version within thirty days
or extended
period of not more than 15 days.
If the opposite party denies or disputes the allegation contained in the complaint or fails
to submit any of his version, then the consumer dispute is settled:
(a) on the basis of evidence brought to its notice by the complainant and the
opposite party; or
(b) ex parte on the basis of the evidence brought to its notice by the complainant
where the
opposite party has not appeared.
(c) If the complainant fails to appear on the date of hearing the District Forum may
either dismiss
the complaint for default or decide it on merits.
3. No proceedings stated above can be called in question in any Court on the

ground that the principles
of natural justice have not been complied with.
- CAIIB DISCUSSION
4. Every complaint has to be heard as expeditiously as possible and there has to be

attempt that the
complaint is decided within three months from the date of receipt of notice by the
opposite party.
If the goods under reference to the complaint are required to be analysed or tested then
the complaint
should be decided within five months. Unless sufficient cause is shown for adjournment
and noted
in writing, adjournment is ordinarily not granted in proceedings under this Act. The
District Forum
has to impose cost for the adjournment on the party concerned. If the time limits
prescribed above
for disposal of any dispute is not observed and the dispute is decided beyond the
stipulated time
then the District Forum has to mention the reasons for delay while disposing the case.
5. If the District Forum feels appropriate, it can pass suitable necessary interim
orders during tendency
of any proceedings.
6. For the purposes of this section, the District Forum shall have the same powers
as are vested in a
319
7.
Civil Court under the Code of Civil Procedure, 1908 while trying a civil suit in respect
of the following matters:
(i) the summoning and enforcing attendance of any defendant or witness and examining
the
witness on oath;
(ii) the discovery

evidence; (iii) theand production
reception of any document
of evidence or other
on affidavits; material
(iv) the object producible
requisitioning as
of the report
of the analysis or test concerned from the appropriate laboratory
or from any other relevant source;
(v) issuing of any commission for the examination of any witness; and (vi) any other
matter that may be prescribed.
Every proceeding before the District Forum shall be deemed to be a judicial proceeding
within the meaning of Sections 193 and 228 of the Indian Penal Code and the District
Forum shall be deemed to be a Civil Court for the purposes of 195 and chapter 26 of the
Code of Criminal Procedure.
38.7 FINDING OF THE DISTRICT FORUM

1. If after the proceedings under Section 113 are conducted and, the District
Forum is satisfied that,
(i) the goods complained against suffer from any of the defects specified in the
complaint, or (ii) any of the allegations made in the complaint about the service are
proved;
it shall issue an order to the opposite party directing him to do one or more of the
following things to:
1. remove the defect pointed out by the laboratory from the goods in question;
2. replace the goods with new goods of similar description which shall be free
from any defect;
3. return to the complainant the price or the charges paid by the complainant, as
the case may
- CAIIB DISCUSSION
be;
4. pay such amount as may be awarded by it as compensation to the consumer for
any loss or
injury suffered by the consumer due to the negligence of the opposite party and if
deemed fit
grant punitive damages;
5. remove defects in goods or deficiencies in the services in question;
6. discontinue the unfair trade practice or restrictive trade practice or not to repeat
them;
7. refraining from offering hazardous goods for sale;
8. withdraw hazardous goods from being offered for sale;
9. cease manufacturing hazardous goods and to desist from offering services that
are hazardous
in nature;
10. pay such sum, which shall not be less than 5 per cent of the value of such goods
sold or
services provided as may be determined if loss or injury has been suffered by a large
number
of consumers who are not identifiable conveniently and pay to such consumer and utilise
such sum so obtained as may be prescribed;
11. issue corrective advertisement to neutralise the effect of misleading
advertisement at the cost
of the opposite party responsible for issuing such misleading advertisement;
12. provide for adequate costs to the parties.
2. Every proceeding as said above has to be conducted by the President of the

District Forum and at
least one member of the Forum.
3. Every order made under this section has to be signed by the President and the
member or members
who conducted the proceedings. If the President and one member conduct the
proceeding and
they differ on any point, the point of difference has to be referred to the other member
for hearing
on such point and thereafter the opinion of majority shall be the order of the District
Forum.
320
4. The procedure relating to the conduct of the meetings of the District Forum, its
sittings and other matters shall be as may be prescribed by the state government.
In Narsuns Battery Manufacturing Company vs General Manager, Andhra Bank 1992
CPC 707 (NC), the National Commission has passed an order that bank asking from a
small-scale industry main as well as collateral security four times the values of loan was
within the bank's power of advancing money and asking for adequate security. The
contention of the applicant-borrower that excessive security was asked and asking
collateral security from a small-scale industry was against the guidelines of the IBA was
not accepted by the National Commission.
38.8 APPEAL
Any person aggrieved by the order passed by the District Forum may prefer as appeal to
the State Commission within a period of thirty days from the date of order, in the form
and manner as may be prescribed. The State Commission has the powers to condone
delay in preferring an appeal on getting satisfied about the cause of delay. If the order of
the District Forum involves payment of any amount by the person preferring the appeal,
- CAIIB DISCUSSION
the appeal cannot be filed without payment of 50 per cent or the amount ordered to be
paid or Rs. 25,000, whichever is less.
38.9 COMPOSITION OF THE STATE COMMISSION
1. Each State Commission shall consist of following:
A. A person who is or has been Judge of a High Court, who shall be its President.
His appointment
has to be made only after consultation with the Chief Justice of the High Court.
B. Not less than two other members and not more than such number of members
as may be
prescribed, one of whom shall be a woman having qualifications as under,
(i) be not less than thirty-five years of age;
(ii) possess a bachelor's degree from a r ecognised university; and
experience
However, not more than 50 per cent of the members shall be from amongst persons
having a judicial background, i.e. minimum ten years knowledge and experience as
presiding officer of District Court, Tribunal or equivalent level.
2. Every appointment as member of the State Commission has to be made by the
state government on
the recommendations of the Selection Committee consisting of the following:
(i) the President of the State Commission, who shall be the Chairman of Selection
Committee, (ii) Secretary, Law Department of the state, who shall be the member of
Selection Committee, (iii) Secretary-in-Charge of the department dealing with Consumer
Affairs in the state, who shall be the member of Selection Committee.
If for any reason the President of the State Commission is absent or otherwise, the state
government may refer the matter to the Chief Justice of the High Court for nominating a
sitting Judge of that High Court to act as Chairman.
3. The jurisdiction, powers and authority of the State Commission may be
exercised
thereof. by Benches
If the Members of the Bench differ on any point, the point has to be decided by majority.
If there
321
is equality in differing members, then the point of difference has to be referred to the
President. The President may hear the point of difference himself or refer it to some
other member for hearing. The point of difference has to be then decided by majority of
the members who heard the case initially and after reference of difference.
4. Every member of the State Commission shall hold office for a term of five years or up
to the age of sixty-seven years, which ever is earlier. But he will be eligible for
appointment for another term of five years or up to the age of 67 years whichever is
earlier. A member may resign from his office under his hand addressed to the state
government.
38.10 JURISDICTION AND PROCEDURE OF STATE COMMISSION
1. Subject to the other provision of the Act the State Commission has jurisdiction
(a) to entertain complaints where the value of the goods or services and
compensation, if any,
claimed exceeds Rs. 20 lakh but does not exceed Rs. 1 crore and appeals against the
orders
of any District Forum within the state, and
(b) to call for the records and pass appropriate orders in any consumer dispute that
is pending
- CAIIB DISCUSSION
before or has been decided by any District Forum within the state where the State
Commission
is of the opinion that the District Forum has acted without jurisdiction or with material
irregularity.
2. A complaint has to be instituted in a State Commission within the local limits of
whose jurisdiction,
(i) the opposite party actually and voluntarily resides or carries on business or has a
branch office or personally works for gain, at the time of the institution of the complaint,
or
(ii) when one of opposite parties, do not reside or carry business then either with
permission of State Commission or acquiescence of such party,
(iii) the cause of action, wholly or in part arises.
3. For disposal of disputes by the State Commission same procedure, with
necessary modifications,
is applicable as given at Sections 12, 13 and 14 for District Forum.
38.11 TRANSFER OF CASES
On the application of a complainant or on its own motion the State Commission may
transfer any proceeding at any stage from one District Forum to another District Forum
if in the interest of justice it so requires.
38.12 APPEALS
1. Any person aggrieved by the order passed by the State Commission may prefer
as appeal to the
National Commission within a period of thirty days from the date of order, in the form
and manner
as may be prescribed. The National Commission has the powers to condone delay in
preferring an
appeal on getting satisfied about the cause of delay. If the order of the State Commission
involves
payment of any amount by the person preferring the appeal, the appeal cannot be filed
without
payment
whichever ofis50 per cent or the amount ordered to be paid or Rs. thirty-five thousand,
less.
2. An appeal filed before the State Commission or the National Commission has
to be heard as
expeditiously as possible. There has to be an attempt to dispose appeal finally within a
period of
ninety days of its admission.
Ordinarily no adjournment is granted. However the State Commission or the National
Commission
322
may grant adjournment on sufficient cause shown by the party seeking adjournment and
the
reasons are recorded.
The State Commission or the National Commission can make orders for the imposition
of costs
occasioned by the adjournment.
If any appeal is disposed by the State Commission or the National Commission, as the
case may be,
beyond the specified period of ninety days the Commission has to give the reasons for
delay while
passing final order disposing the appeal.
3. Any person aggrieved by an order made by the National Commission in exercise of
- CAIIB DISCUSSION
powers under Section 21 of the Act may prefer an appeal against such order to the
Supreme Court within a period of thirty days from the date of such order.
The Supreme Court may entertain an appeal after expiry of the specified period of thirty
days on getting satisfied that there was sufficient cause for not filing the appeal in time.
If the order against which appeal is to be preferred involves payment of any amount by
the person preferring the appeal, the appeal cannot be filed without payment of 50 per
cent of the amount ordered to be paid or Rs. 50 thousand, whichever is less.
38.13 COMPOSITION OF THE NATIONAL COMMISSION
1. Each National Commission shall consist of following:
A. A person who is or has been Judge of the Supreme Court, who shall be its
President. His
appointment has to be made by the Central Government only after consultation with the
Chief
Justice of India.
B. Not less than four other members and not more than such number of members
as may be
prescribed, one of whom shall be a woman having qualifications as under,
(i) be not less than thirty-five years of age.
(ii) possess a bachelor's degree from a r ecognised university.
experience
However, not more than 50 per cent of the members shall be from amongst persons
having a judicial background. For this section the expression judicial background means
knowledge and experience for at least ten years as a presiding officer at the district level
Court or any tribunal at equivalent level.
2. Every appointment as member of the National Commission has to be made by
the Central Government
on the recommendations of the Selection Committee consisting of the following:
(i)
of a person who is a Judge of the Supreme Court, to be nominated by the Chief Justice
India, who shall be the Chairman of Selection Committee, (ii) Secretary, in the
Department of Legal Affairs in the Government of India, who shall be the
member of Selection Committee, (iii) Secretary of the Department dealing with
Consumer Affairs in the Government of India,
who shall be the member of Selection Committee.
3. The jurisdiction, powers and authority of the National Commission may be
exercised by Benches
thereof. If the President and one member conduct the proceeding and they differ on any
point, the
point of difference has to be referred to the other member for hearing on such point and
thereafter
the opinion of majority may be exercised by Benches thereof. A Bench may be
constituted by the
President with one or more members, as the President may deem fit.
4.
5.
323
If the Members of the Bench differ on any point, the point has to be decided by majority.
If there is equality in differing members, then the point of difference has to be referred to
the President. The President may hear the point of difference himself or refer it to some
- CAIIB DISCUSSION
other member for hearing. The point of difference has to be then decided by majority of
the members who heard the case initially and after reference of difference.
Every member of the National Commission shall hold office for a term of five years or
up to the age of seventy years, which ever is earlier. Member will be eligible for
reappointment for another term of 5 years or up to age of 70 years. A member may
resign from his office under his hand addressed to the Central Government.
The salary or honorarium and other allowance payable to, and other terms and conditions
of service of the member of the National Commission shall be such as may be prescribed
38.14 JURISDICTION AND POWERS OF NATIONAL COMMISSION

1. Subject to the other provision of the Act the National Commission has
jurisdiction,
(a) to entertain complaints where the value of the goods or services and
compensation, if any,
claimed exceeds Rs. 1 crore and appeals against the orders of any State Commission, and
(b) to call for the records and pass appropriate orders in any consumer dispute that
is pending
before or has been decided by any State Commission where the National Commission is
of
the opinion that the State Commission has acted without jurisdiction or with material
irregularity.
2. For disposal of disputes by the National Commission same procedure, with
necessary modifications,
is applicable as given at Sections 12, 13 and 14 for District Forum.
The National Commission has also powers to review any order made by it when there is
error apparent on the face of record.
3. If the National Commission passes any ex parte order against the opposite party
or the complainant,
the aggrieved party may apply to the Commission to set aside the ex parte order in the
interest of
justice.
38.15 TRANSFER OF CASES
In the interest of justice the National Commission may transfer, on the application of the
complainant or on its own motion, any proceeding at any stage from one District Forum
of one state to a District Forum of another state and from one State Commission to
another State Commission.
38.16 FINALITY OF ORDER IF NO APPEAL IS PREFERRED
Every order of a District Forum, State Commission or of the National Commission is
final if no appeal is preferred against such order under the provisions of the Act.
38.17 LIMITATION PERIOD
For filing any complaint before a District Forum, State Commission or the National
Commission the limitation period is two years from the date of cause of action.
The District Forum, State Commission or National Commission may entertain a
complaint after the specified period of two years if sufficient cause is shown for the
delay and the Forum or Commission, as the case may be, records the reasons for
condoning the delay.
324
38.18 ENFORCEMENT OF ORDERS
1. If any interim order passed under this Act by the District Forum, State
Commission or National
Commission, as the case may be, is not complied with the District Forum, State
Commission or
- CAIIB DISCUSSION
National Commission may order that the property of the person who is not complying
the order be
attached.
2. If within three months of attachment of the property as stated above, the person
does not comply
with the order, the attached property is sold. From the sale proceedings of the property
the District
Forum, State Commission or National Commission, as the case may be, may order
payment of
compensation to the complainant. The balance amount, if any, out of sale proceeds after
payment
of compensation is paid to the party entitled thereto.
3. Where any amount is due from any person under an order made by the District
Forum, State
Commission or National Commission, as the case may be, the person entitled to the
amount has
to make an application to the respective authority that has passed the order. On the
application
such authority has to issue a certificate for the said amount to the Collector of the
district. The
Collector has to then proceed to recover the amount mentioned in the certificate as
arrears of
land revenue.
38.19 DISMISSAL OF FRIVOLOUS OR VEXATIOUS COMPLAINTS
If the District Forum, State Commission or National Commission, as the case may be,
finds that the complaint instituted before it is frivolous or vexatious, it shall dismiss the
complaint after recording in writing the reasons. The order shall also be for the cost, not
exceeding Rs. ten thousand, that the complainant should pay to the opposite party.
38.20 PENALTIES AND PROTECTIONS
1. Where a trader or a person against whom a complaint is made or the
complainant
comply with fails or omits
any order madeto by the District Forum, State Commission or National
Commission, as
the case may be, such trader or person or complainant shall be punishable with
imprisonment for
a term of not less than one month but which may extend to three years, or with fine of
minimum
Rs. 2,000 that may extend to Rs. ten thousand or with both.
2. For the trial of offences under this Act the District Forum, State Commission or
National Commission,
as the case may be, is deemed as and is conferred with powers of the First Class Judicial
Magistrate.
3. All offences under this Act are tried summarily by the District Forum, State
Commission or National
Commission, as the case may be.
4. No suit, prosecution or other legal proceedings lie against the members of the
District Forum,
State Commission or National Commission or any officer or person acting under the
direction of
the District Forum, State Commission or National Commission for execution of any
order made by
it. Similarly no action can lie for anything done in good faith or intended to be done in
good faith by
such member, officer or person under this Act or rules made there under.
- CAIIB DISCUSSION
38.21 SERVICE OF NOTICE

1. The service of notice may be made by delivering a copy thereof by registered
post acknowledgement
due addressed to the party against whom complaint is filed or to the complainant. It can
also be
sent by speed post or through the courier service approved by the District Forum, State
or National
Commission, as the case may be, or by fax.
2. The District Forum, State Commission or National Commission, as the case
may be shall declare
that the notice had been duly served to the addressee in following circumstances:
325
3.
(i) when an acknowledgement or any other receipt purported to be signed by the

addressee is
received; or (ii) the communication sent in any manner as stated above is received back
with the remarks
made by postal employee or the authorised person of the courier agency that the
addressee
has refused to accept the delivery; or
(iii) the addressee has refused to take delivery of the notice sent by any other means, and
(iv) in case the notice was properly addressed, prepaid and duly sent by registered post
acknowledgement due the declaration of service of notice can be made within thirty days
from the date of posting of the notice even if the acknowledgement receipt has not been
received back or lost or not found.
All notices required to be served on the opposite party are deemed to be sufficiently
served if addressed to the place where business or profession is carried by him.
38.22 LET US SUM UP

For dealing with complaints by consumer there are District Forum, State and National
Commission. First two are established by the state government, National Commission
established by Central Government. Jurisdiction respectively the district, the state and
the entire country. District forum has powers to deal with cases up to Rs. 20 lakh.
Complaints have to be in prescribed manner. Complaint should be made with full details,
evidence and prescribed fee. Supporting affidavit is required. Admissibility of complaint
needs to be decided within twenty-one days. The District Forum after conducting the
case if finds that complaint is true, can award compensation, replacement of goods etc.
Against the order of District Forum appeal within 30 days to State Commission. If order
involves payment to other party then at the time of appeal 50 per cent amount is required
to be deposited. National Commission has powers to make regulations not inconsistent
with Act and Rules.
1. To appoint a person as President of District Forum, he must be qualified to be a
District Judge.
(True/False)
2. Appointment of District Forum is made by the High Court. (True/False)
3. Can few consumers file a representative complaint on behalf of general
consumers at large?
4. As the agencies appointed for under the Act are quasi-judicial, they do not have
powers of Civil
Court while conducting the case. (True/False)
- CAIIB DISCUSSION

1. True; 2. False; 3. Yes, but with permission of District Forum; 4. False.
1. District Forum has passed order to pay compensation. How recovery of the ordered
amount is made?
(a) By filing execution in Civil Court.
(b) By filing execution before District Forum.
(c) By filing Civil Suit.
(d) By referring the order to collector for making recovery as if it is land revenue
recovery.
Ans. 1. (d)
THE LAW OF LIMITATION
STRUCTURE
39.0 Objective
39.1 Introduction
39.2 Definition
39.3 Limitation and its Computation
39.4 Acts Giving Rise to Fresh Period of Limitation
39.5 Certain Important Provisions in Schedule to the Limitation Act
39.6 Let Us Sum Up
m
328
39.0 OBJECTIVE
The objective of this unit is to familiarise the aspects relating to the Limitation Act, 1963
in
39.1so far as they are relevant to the banks and financial institutions.
INTRODUCTION
The Limitation Act, 1963 has significant application to the banks and financial
institutions. These entities provide financial assistance to borrowers and in default by the
borrowers; they are required to take appropriate action for the recovery of the money
lent. The Recovery of Debts due to Banks and financial institutions Act, 1993 and the
Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 specifically state that actions under those Acts are permissible only if
the claim is within the period of limitation. The Limitation Act, 1963 is an Act to
consolidate and amend the law for the limitation of suits and other proceedings.
39.2 DEFINITION
Period of limitation is always in relation to a document which entitles the beneficiary to
take action in a court of law. Period of limitation means the period of limitation
prescribed for any suit, appeal or application by the Schedule, andprescribedperiod
means the period of limitation computed in accordance with the provisions of this Act.
Suit does not include an appeal or an application.
39.3 LIMITATION AND ITS COMPUTATION
It is absolutely necessary that every suit or application or appeal shall have to be made
within the period of limitation. Section 3 of the Limitation Act declares that every suit
instituted, appeal preferred, and application made after the prescribed period shall be
dismissed although limitation has not been set up as a defence. A suit is instituted when
the plaint is presented to the proper officer in the court. In the case of set off or
counterclaim, they shall be treated as a separate suit and shall be deemed to have been
instituted:
- CAIIB DISCUSSION
(a) in the case of a set off, on the same date as the suit in which the set off is
pleaded;
(b) in the case of a counterclaim, on the date on which the counter-claim is made in
court.
Computation of the period of limitation
(a) When the period of limitation expires on a day when the court is closed, the
suit, appeal or
application may be instituted, preferred or made on the day when the court reopens.
(b) Any appeal or any application other than execution petitions may be admitted
after the prescribed
period, if the appellant or applicant makes out sufficient cause for not preferring the
appeal or
application within the period of limitation.
(c) In computing the period of limitation, the day from which such period is to be
reckoned, shall be
excluded. The computation of the period of limitation for filing appeal shall exclude the
day on
which the judgment complained was pronounced and the time taken for obtaining a copy
of the
decree, sentence or order appealed. Time required for obtaining a copy of the order or
award
shall be excluded while computing the time limit for filing revision or review application
or an
application to set aside the award.
(d) For an application for execution of decree, the period during which the
institution or execution
has been stayed by injunction or order, the day on which the order was issued or made
and the
day on which it was withdrawn shall be excluded.
329
(e) For filing any suit of which notice has to be given, or for which the previous
consent or sanction
of the Government or any other authority is required, in accordance with the
requirements of any
law for the time being in force, the period of such notice, or the time required for
obtaining such
consent or sanction shall be excluded.
(f) In computing the period of limitation for any suit, the time during which the
defendant has been
absent from India and from the territories outside India under the administration of the
Central
Government shall be excluded.
39.4 ACTS GIVING RISE TO FRESH PERIOD OF LIMITATION
There are two instances which will give rise to fresh period of limitation. In these cases
the period of limitation will be computed as if the starting point is the happening of the
instances.
1. Where before the expiration of the prescribed period for a suit or application in
respect of any
property or right, an acknowledgement of liability in respect of such property or right
has been
made in writing signed by the party against whom such property or right is claimed, or
by any
person through whom he derives his title or liability, a fresh period of limitation shall be
- CAIIB DISCUSSION
computed
from the time when the acknowledgement was so signed.
2. Where payment on account of a debt or of interest on a legacy is made before
expiration of the
prescribed period by the person liable to pay the debt or legacy or by his agent duly
authorised in
this behalf, a fresh period of limitation shall be computed from the time when the
payment was
made. In this case 'debt' does not include money payable under a decree or order of a
court.
39.5 CERTAIN IMPORTANT PROVISIONS IN SCHEDULE TO THE
LIMITATION ACT
Some of the important aspects that are required to be noted for filing suits of different
types are given below:
Description of Suits Period of Limitation Time from which Period begins to

Run
For money payable for money lent Three years When the loan is made
For money lent under an agreement that it shall be payable on demand Three years
When loan is made
On a bill of exchange payable at sight, or after sight, but not at a fixed time Three
years When the bill is presented
On a bill of exchange or promissory note payable at a fixed time after sight or after
demand Three years When the fixed time expires
On a promissory note or bond payable by instalments Three years The expiration
of the first term of payment as to the part then payable; and for the other parts, the
expiration of the respective terms of payment
For arrears of rent Three years When the arrears become due.
For specific performance of a contract Twelve years The date fixed for the
performance, or if no such date is fixed, when the plaintiff has noticed that performance
is refused
330
To enforce payment of money secured by a mortgage or otherwise charged upon

immovable property Thirty years When the money sued for becomes due
By a mortgagee (a) for foreclosure Twelve years When the money secured by the
mortgage become due
(b) for possession of immovable property Thirty years When the mortgagee
become entitled to possession
Any suit (except a suit before the Supreme Court in the exercise of its original
jurisdiction) by or on behalf of the Central Government or any State Government,
including the Government of the State of Jammu and Kashmir Three years When
the period of limitation would begin to run under this Act against a like suit by a private
person
Any suit for which no period of limitation is provided elsewhere in this Schedule
Thirty years When the right to sue accrues
39.6 LET US SUM UP
The Law of Limitation plays an important role in filing a suit, appeal or application in
court. The suit, appeal or application instituted, preferred or made after the prescribed
period shall be dismissed although limitation has not been set up as a defence. The Act
provides exclusion of certain period while computing the period of limitation.
Acknowledgement in writing and payment on account of a debt give rise to a fresh
period of limitation from the time when the acknowledgement was signed or the
- CAIIB DISCUSSION
payment made, as the case may be Schedule to the Act provides the limitation period and
the time from which it is to be computed.
1. In the Limitation Act, the definition of 'suit' does not include appeal or
application. (True/False)
2. The defendant is required to set up the plea of limitation if he has to succeed in
a suit instituted
beyond the period of limitation. (True/False)
3. A suit is said to be instituted when the plaint is presented before the proper
officer. (True/False)
4. Acknowledgement in writing gives rise to fresh period of limitation.
(True/False)
5. Part payment of a debt within the period of limitation entails the plaintiff to
compute fresh period
of limitation from the date of payment. (True/False)
6. Limitation for a mortgage suit is three years from the date when the mortgage
money becomes
due. (True/False)
7. A suit on demand promissory note can be filed within three years from the date
on which the
demand was made. (True/False)
1. True; 2. False; 3. True; 4. True; 5. True; 6. False; 7. False
TAX LAWS
STRUCTURE
40.0 Objective
40.1 Introduction
40.2
40.3 Income Tax Tax
Fringe Benefit
40.4 Banking Cash Transaction Tax
40.5 Service Tax
40.6 Let Us Sum Up
40.9 Multiple Choice Questions
332
40.0 OBJECTIVE
This unit is intended to provide an outline on the basic aspects of the laws relating to
Income tax, fringe benefit tax, banking cash transaction tax and service tax limiting the
discussions on the applicability of the above tax laws to banks and financial institutions.
40.1 INTRODUCTION
The banks and financial institutions are required to implement the provisions of the tax
laws by deducting taxes at source, crediting the tax deducted at source to the income tax
authorities and also have regard to the provisions relating to Banking Cash Transaction
Tax, Service Tax, etc., in their day to day operations.
40.2 INCOME TAX
The law relating to taxation of income is governed by Income Tax Act 1961.
This Act envisages taxation of income of an assessee on the basis of his
(a) Residence; (b) Place of source of income.
Meaning of Income
- CAIIB DISCUSSION
The definition of 'income' is inclusive and not exhaustive in nature. Thus no precise
definition as to what constitutes income.
Assessee and Assessment year
The income accruing, or arising, to a person (called 'Assessee') is taxed on the basis of
'Assessment Year'. The term Assessment Year represents the period of 12 months
beginning from 1st April every year. The income arising in the 'previous year' is taxed in
the assessment year. Previous year is the financial year immediately preceding the
assessment year of an assessee.
Residential status
The residential status of an assessee is determined on the basis of the number of days an
assessee was present in India during the previous year. In the case of corporates, it is
determined on the basis of location of control and management of the company and also
the place of registration. When a company is an Indian company, that is a company
registered under Companies Act of India or a body corporate set up by statute or a
company whose control and management of a company is based in India, such a
company is treated as resident in India.
There is also a third category called resident but not ordinarily resident which is relevant
only for assessees who are individuals and Hindu undivided families.
The income declared by the resident assessee from anywhere in the world is taxable
under Income Tax Act in India. As against this in the case of non-resident and persons
who are not ordinarily resident in India, any income derived abroad is not taxable and
only income accruing or arising in India is liable to tax in India. Heads of income
Under IT Act - Other applications are:
(a) Quoting PAN for opening a/c, purchase of DD, Term Deposit above Rs.
20,000.
(b) Declaration in Form 60 and 61.
(c) Repayment of T. Deposit above Rs. 20,000 by pay-order
(d) Reporting high value transactions - above Rs. 1 lakh
333
Income Tax Act, 1961

1. Salaries envisages
2. Income fromtaxation of income under following heads:
house property
3. Profits and gains from business or profession 4. Capital gains 5. Income from
other sources
Computation of income
Computation of Taxable income involves the following steps. Income arising under
various heads to income is computed separately as per the relevant sections covering
such incomes. After having computed the income under each head separately, the 'gross
total income' representing the sum of above amounts computed under such heads is
arrived at. Chapter VIA of the Income Tax Act provides for various deductions
allowable from the gross total income. The taxable income of the assessee is arrived at
after deducting such amounts covered under Chapter VIA of the Income Tax Act.
Income exempt from tax
Certain categories of income are exempt from tax and such income is not taken into
account in the computation of income. They are excluded from the computation at the
beginning.
Assessment Proceedings
Every person whose total income in a previous year exceeds the maximum amount
which is not liable to tax is required to file his return by the due date prescribed in
section 139. A company or partnership firm has to file its return of income.
A corporate assessee is required to file its return of income in the prescribed Form No 1.
Corporate assesses are required to file the return of income in computer media (e-filing).
The due date for filing of this return is presently October 31 of the Assessment year.
A return of income can be revised to correct any mistake in computation of income in
- CAIIB DISCUSSION
the original return by filing another return within one year from the end of the
assessment year or before completion of assessment whichever is earlier. A return
declaring loss should be filed before the due date and any delay in filing of such return
declaring loss will result in denial of the benefit of carry forward of such loss and set off
in future years.
The returns filed by an assessee is assessed by an officer duly designated for this purpose
(Assessing Officer - AO). The assessment could be in the nature of summary assessment
where the return of income is accepted u/s 143(1) by AO without any further enquiry.
The AO may also scrutinise the return furnished by the issuing a notice u/s 143 (2) of the
Act and complete the assessment under Section 143(3) which is commonly called as
'Scrutiny Assessment'.
The AO determines the total income and issues an assessment order along with the
notice of demand. The demand if any, raised after scrutiny assessment is payable within
30 days of the service of the assessment order and the demand notice on the assessee.
When a person fails to file his return of income as prescribed in the Act, the AO can
issue a notice under section 142 calling him to file a return and proceed to assess the
income. AO can also reopen and reassess the income under prescribed circumstances.
Payment of Taxes
Advance tax is payable as per the provisions of section 210 of the Income Tax Act.
Advance tax arises from the concept of 'pay as you earn'. In the case of corporate
assessees, advance tax is payable in four instalments as given below:
(a) By June 15-15 per cent
(b) By September 15-30 per cent
334
(c) By December 15-60 per cent
(d) By March 15-100 per cent of the advance tax payable.
The advance tax which is paid by an assessee on the basis of estimation of income may
at times fall short of the tax payable as per the return of income. Such a shortfall if any
shall be paid by way of 'self-assessment tax' under Section 140A of the Income Tax Act.
Deduction/collection
Members of Co-operative of taxbank
source
are exempted from TDS. Apart from advance taxes and
self-assessment, income tax is also payable through other modes, viz.. Deduction of Tax
at Source (TDS) and Collection of Tax at Source (TCS).
The provisions relating to TDS are important in the normal day-to-day business activities
of a bank and are relevant when payments of specific nature are made. The following
payments generally occur during the course of business activities of a bank and are
covered under TDS under the Income Tax Act, 1961.
(i) Salaries - Section 192
(ii) Interest on securities - Section 193
(iii) Payment of interest, other than interest of securities - Section 194A (iv) Payment to
contractors or sub-contractors - 194C (v) Payment of brokerage and commission -
Section 194H (vi) Payment by way of rent - Section 1941 (vii) Payment of professional
and technical fees - Section 194J (viii) Payment to non-resident - Section 195
The compliance with regard to provisions of the Act relating to TDS requires special
attention as it casts an onerous responsibility on the person paying such amounts.
Firstly, the person deducting tax at source is required to obtain Tax Deduction Account
Number (TAN) by filing an application in Form 49B. Tax shall be deducted at source as
per the rates given in the Finance Act of the respective years. The tax deducted at source
is required be deposited in the Government account, generally within one week from the
end of the month in which tax is deducted at source. It should be noted that whenever the
amount payable by way of interest, professional fees, rent, etc., are credited into the
account of payee in the books of the payer without actually making payment to the
person concerned, it is deemed to be a payment and there is an obligation to deduct tax at
- CAIIB DISCUSSION
source.
Frequently payments are requirement to be made to non-residents. It should be noted that
the relevant
section 195 covers payment interest and any other sum not being salaries. The rate of
deduction of tax
on payments made to non-residents under Section 195 is also given in the Finance Act of
the relevant
year. The Government of India enters into agreements for avoidance of double taxation
of income both
on the basis of residence and source with other countries. The rate given in the Double
Taxation
Avoidable Agreement (DTAA) with the respective country where the recipient is
resident will have to
be taken into account. The rates applicable as per the DTAA will have to be applied for
the purposes of
TDS, when it is lower than the rates given in the Finance Act. '
A person deducting tax at source is required to file quarterly return of TDS in prescribed
form for salaries, other than salaries and payments to non-residents. These returns are
also required to be filed in computer media.
It should be noted that as per the provision of Section 40(a) of the Act, any failure to
deduct tax at source or payment of TDS into Government account, results in
disallowance of the relevant expenditure in computation of income of the bank, e.g. a
payment of Rs. 1 lakh is to be made by a bank to a contractor on which tax has not been
deducted at source, then entire amount of Rs. 1 lakh will be
335
added back and treated as income of the bank in the computation of income and the bank
will be liable to pay tax on the same. Besides, improper or non-compliance with regard
to TDS also attracts levy of interest, penalty and prosecution.
Non-compliance with provisions relating to TDS attracts
1. Levy
the date on of interest @ 12 per cent p.a. on the amount on tax payable at source from
which
it is deductible until the date of payment.
2. Recovery of tax deductible at source from the person responsible for deduction.
3. Non-payment of tax deducted at source into Government a/c attracts
prosecution proceedings
under Section 276B of the Income Tax Act.
4. Any failure to file returns/statements in this regard attracts penalty @ of Rs.
100 per day for the
period of default.
40.3 FRINGE BENEFIT TAX
Fringe Benefit Tax [FBT] was introduced by Finance Act 2005 and is applicable for the
previous year beginning 1.4.2005 (i.e. For AY 2006-2007 onwards).
FBT intends to tax fringe benefits, which are provided or deemed to have been provided,
by an employer to its employee during the previous year. It is in the nature of a
presumptive tax levied on an employer in respect of various expenses incurred by the
employer on behalf of its employee.
FBT is payable at the rates applicable to the assessee on the 'Value' of such fringe
benefit, this tax is payable by an employer in addition to the income tax. The definition
of the term fringe benefit is contained in Section 115(w)(b) of the Income Tax Act.
There are two parts in the definition. First part defines three categories of benefit, which
are specifically taken to mean 'Fringe Benefit'. The second part treats certain benefits or
expenditure incurred by the employer as 'Deemed Fringe Benefit'.
The value 'Deemed Fringe Benefit' as defined in Section 115(w)(b) is to be calculated at
- CAIIB DISCUSSION
the rates specified on the total expenditure incurred. In other words, only part of the
expenditure and not the entire amount expended is taken into account as 'value of fringe
benefit' for the purpose of payment of FBT.
The Act also envisages payment of FBT in advance on the basis of expenses incurred at
the end of every quarter. FBT by way of advance tax is payable on or before 15th day of
the month following each quarter. However, for the quarter ending 31st March of the
financial year, it shall be paid before 15th March of the same financial year.
Return of FBT is also required to be filed before due date for filing of return under the
Income Tax Act. In practice, presently there is no separate return but it is made as a
separate section of the Income tax return.
40.4 BANKING CASH TRANSACTION TAX
Banking Cash Transaction Tax [BCTT] was introduced with effect from 01/06/2005 to
cover certain specific transactions involving withdrawal of cash from accounts
maintained by branches of the scheduled banks. This tax is payable @ 0.1 per cent of the
value of every taxable banking transaction.
'Taxable Banking Transaction' is defined in Clause 8 of Section of 94 of the Finance Act
2005 to mean,
(a) A transaction, being withdrawal of cash (by whatever mode) on any single day from
an account (other than a saving bank account) maintained with any scheduled bank,
exceeding:
336
(i) Fifty thousand rupees, in cash such withdrawal is from the account maintained by any
individual or Hindu undivided family (ii) One lakh rupees, in case such withdrawal is
from the account maintained by a person other
than any individual or Hindu undivided family or
(b) A transaction, being receipt of cash from any scheduled bank on any single day on
encashment of one or more term deposits, whether on maturity or otherwise, from that
bank, exceeding-(i) Fifty thousand rupees, in case such term deposit or deposits are in
the name of any individual
or
areHindu
by anyundivided family;
person other than(ii)
an One lakh rupees, in case such term deposit or deposits
individual or Hindu undivided family.
The tax collected by way of BCTT is payable to the credit of Central Government by
15th day of the month immediately following the month in which such tax is collected.
A branch of the bank is required to maintain a statement prepared in Form No.l, A
monthly statement in Form No. 2 is also to be filed by the following month. A return in
Form No. 3 is to be filed in computer media by 31 st July in respect of the year ending
31st March.
Any default in payment of BCTT attracts interest @ 1 per cent for every month or part
thereof for the period of delay. The relevant legislation also contains the procedure for
assessment, rectification, appeals and levy of penalty for non-compliance with aforesaid
law relating to BCTT.
40.5 SERVICE TAX
Service Tax was introduced by Finance Act, 1994. Initially it covered just 3 services,
viz., telephone, general insurance and stock broking. No Separate Act exists for Service
Tax. Over the years, amendments have been made to the Finance Act and various other
services were brought within the ambit of service tax. There will be no service tax if the
turnover does not exceed Rs. 8 lakh. If the turnover exceeds this limit, the person
providing the services covered will have to pay service tax.
Among the services covered, the service tax is leviable on banking and financial service
w.e.f. 16/7/ 2001. The term banking and financial services covers various kinds of
business activities of the bank. It has also been extended to lending related activities of
the banks, fees, commission, etc. It is not payable on interest income of the bank.
- CAIIB DISCUSSION
Various services like merchant banking activities, securities and foreign exchange
brokerage, advisory services, safe deposit locker service, etc., are covered.
Besides the above, there are some other services on which service tax is payable, e.g.
credit and debit card services, business auxiliary services, etc. In the event of an
obligation arising under any category of service, the service provider will have to obtain
separate registration for each such service.
The service tax registration can be obtained by filing Form ST-1 with the service tax
authorities. With the introduction of centralised accounting system in various banks there
is also scope to obtain centralised registration for all the branches. Centralised
Registration can be obtained from the Commissioner of Service Tax at the location
which the accounting activities are centralised.
Service tax is at present payable @ 12 per cent along with education cess 3 per cent
thereon (total 12.36 per cent) on the fee income received. Obligation to pay service tax is
on the person providing service and is payable on actual receipt of fee income. The law
also provides that in the event of service tax is not collected separately by the service
provider, the amount received by way of value for the service provided can be bifurcated
into fee, income and service tax component by reverse arithmetical calculation. E.g. if
the amount received is x, service tax can be worked out as follows:
X/112.4 multiplied by 12.4
The amount so arrived at can be paid as service tax and the balance can be reported as
value for services rendered. Service tax is payable to the credit of the Government by 5th
of the month following
___„_.._ -__ „__„__ 337
I:
the month in which the income is received [except in the month of March when it is
required within the same month]. The return in Form ST-3 is required to be filed half
yearly on April 25 and October 25 and every year covering half period ending 31st
March and 30th September respectively.
Cenvat Credit
If service
extent taxper
of 20 paid is by
cent of an
theassessee
liability for input services,
on output services.the same
Such setcan
off be set off
to the to the
extent of 20
per cent of the service tax liability is across all input services. Rule 6[l][iii] of Cenvat
credit rules, also provides for set off to the extent of 100 per cent of service tax liability
in respect of service tax paid on certain specified input services. In other words, service
tax paid on input service includes specific category of service, the limit of 20 per cent
mentioned above can be breached and credit for the entire amount paid for input service
can be taken against the liability on output service.
Export and Import of Services
Service tax is not applicable when service are rendered outside India or exported.
Conversely service tax is leviable when services are imported. The relevant rules
regarding service tax chargeable in respect of imported services is contained in Import of
Service Rules, 2006.
Whenever service tax is payable on import of services, the liability to pay such service
tax is on the person importing such services. Such a person is required to obtain
registration for each category of service imported.
Any delay in payment of service tax to Government account attracts levy of interest at a
specified rate (presently 13 per cent p.a.) which is required to be paid along with the
service tax. Non-compliance with the law relating to the service tax also attracts penalty
equivalent to the amount of Service Tax payable.
40.6 LET US SUM UP
As a business entity, banks are r equired to comply with various tax laws. Income is
computed under separate heads and the gross total income is calculated. Taxable Income
is arrived at after deduction allowable under Chapter VIA. Fringe benefit Tax and
- CAIIB DISCUSSION
Banking Cash Transactions tax also require independent compliances. Income Tax and
Fringe Benefit Tax are payable in instalments by way of advance tax. Tax is deductible
at source at the specified rates on making certain types of payment. There are separate
compliance requirement in respect of TDS.
Service Tax is payable on various services rendered by banks and which are mainly
covered under 'Banking and Financial services'. However, Compliance may be required
to be made through separate registration for other services. Cenvat credit is available on
service tax payable on the basis of service tax on input services.
1. Liability to pay income tax arises on account of residential status and place of
the source of
income. (True/False)
2. Assessment year represents the period of 12 months beginning from 1st April
each year.
l(True/False)
3. Previous year is the financial year immediately preceding the assessment year
(True/False)
4. Income is taxed only on salaries. (True/False)
5. Income exempt from tax is to be deducted out of taxable income before
computation of tax
(True/False)
338
6. Assessment is of two types (a) summary assessment and (b) scrutiny
assessment (True/False)
7. Partnership firm, if it has no income, need not file a tax return. (True/False)
8. Tax assessed by AO shall be paid within days. (30/45)
9. Entire advance tax is to be paid by 15th March. (True/False)
10. Tax deduction is to be made before making payment to non-residents.
(True/False)
11. Tax deducted at source is to be deposited within one week from the end of the
month in which it
is to be deducted. (True/False)
12. Person deducting tax at source is required to file a quarterly return of TDS.
(True/False)
13. FBT consists of specific items and certain benefits or expenditure incurred by
the employer as
deemed fringe benefit. (True/False)
14. For FBT a separate return has to be filed. (True/False)
15. Service Tax Act deals with levy of tax on services. (True/False)
16. Cenvat credit can be availed of in respect of tax paid on certain specified input
services.
(True/False)
40.8 ANSWERS TO CHECK YOUR PROGRESS1
HI
1. True; 2. True; 3. True; 4. False; 5. False; 6. True; 7. False; 8. 30; 9. True; 10. True; 11.
True; 12. True; 13. True; 14. False; 15. False; 16. True.
40.9 MULTIPLE CHOICE QUESTIONS
1. Failure to deduct tax at source will result in
(a) disallowance of expenditure;
(b) only tax with interest shall be payable
- CAIIB DISCUSSION
(c) tax will be collected from the person receiving payment;

(d) no effect on the person making payment.
2. Banking Cash Transaction Tax is payable if withdrawal by an individual
exceeds
(a) Rs. 10,000; (b) Rs. 10,000 in a week;
(c) Rs. 50,000 in a day; (d) Rs. 25,000 in a day.
3. Banking Cash Transaction Tax is payable to the credit of the Central
Government by
(a) 15th day of the next month; (b) 7th day of the next month;
(c) last day of the current month; (d) 10th day of the next month
Ans: 1. (a); 2. (c); 3. (a)
MODULE -D
COMMERCIAL LAWS WITH REFERENCE TO BANKING OPERATIONS
Unit 41. Meaning and Essentials of a Contract
Unit 42. Contracts of Indemnity
Unit 43. Contracts of Guarantee
Unit 44. Contract of Bailment
Unit 45. Contract of Pledge
Unit 46. Contract of Agency
Unit 47. Meaning and Essentials of a Contract of Sale
Unit 48. Conditions and Warranties
Unit 49. Unpaid Seller
Unit 50. Definition, Meaning and Nature of Partnership
Unit 51. Relations of Partners to One Another
Unit 52. Relations of Partners to Third Parties
Unit 53. Minor Admitted to the Benefits of Partnership
Unit 54. Dissolution of a Firm
Unit 55. Effect of Non-Registration
Unit 56. Definition and Features of a Company
Unit 57. Memorandum

Unit 58. Types of Companies
of Association and Articles of Association
Unit 59. Doctrines of Ultra Vires/Constructive Notice/Indoor Management
Unit 60. Membership
Unit 61. Prospectus
Unit 62. Directors
Unit 63. Foreign Exchange Management Act, 1999
Unit 64. Transfer of Property Act, 1882
Unit 65. The Right to Information Act, 2005
Unit 66. Right to Information and Obligations of Public Authorities
Unit 67. The Prevention of Money Laundering Act, 2002
Unit 68. Information Technology Act, 2000
L.R.A.B-23
UNIT
41
MEANING AND ESSENTIALS OF A CONTRACT
STRUCTURE
41.0 Objective
41.1 Introduction
41.2 Meaning of Contract
41.3 Key Components to Form a Contract
- CAIIB DISCUSSION
41.4 Essentials of a Valid Contract

41.5 Let Us Sum Up
41.6 Keywords
342
41.0 OBJECTIVE
The objective of this unit, is to enable the candidates to have a broad understanding of
the essential elements of a contract.
41.1 INTRODUCTION
The law of contract constitutes the most important branch of commercial law. It affects
the entire trade, commerce and industry in the country. In India, the law relating to
contracts is governed by the Indian Contract Act, 1872. The Act is broadly divisible into
two parts. Part one describes the general principles of a contract which are applicable to
all types of contracts. The second part deals with special types of contracts, namely
indemnities, guarantees, etc.
41.2 MEANING OF CONTRACT
Contract means an agreement enforceable by law. It has two major constituents:
1. An agreement between two persons or more.
2. The agreement must be enforceable by law (i.e. the rights and obligations
arising out of it).
41.3 KEY COMPONENTS TO FORM A CONTRACT
When one person signifies to another person, his willingness to do or not to do
something, with a view to obtaining the consent of that other person, he is said to make a
proposal.
When a person to whom the proposal is made, signifies his assent (consent), the proposal
is said to be accepted.
A proposal becomes a promise when it is accepted. The person making the proposal is
called the 'promisor'. The person accepting the proposal is called 'promisee'.
41.4
Proposal ESSENTIALS
and AcceptanceOF A VALID CONTRACT
There must be a lawful proposal by one party and the other party must accept the
proposal. Illustration
A proposes by a letter to B to sell his car for Rs. 10,000. This is known as a proposal. A
is the promisor. If B accepts the proposal then he becomes the promisee. This results into
a contract.
An Agreement may be Oral or Written
While valid cnntwte ^^ w» ^J^ uiax agreements, under certain laws an agreement is
required to be in writing only and is also required to be registered and attested. If such
formalities are not complied with, then the agreement cannot be enforced before a court
of law. This applies for example, in the case of sale or mortgage of immoveable
property, lease, etc.
Consideration
There must be a lawful consideration for both the parties to enter into an agreement.
Consideration here means 'something in return'. Hence, when both (or more) parties to
an agreement give something to one another and get something in return, then the
agreement becomes enforceable at law.
343
The Contract Act defines consideration as under.
When, at the desire of the promisor, the promisee or any other person
• has done or abstained from doing, or
• does or abstains from doing, or
- CAIIB DISCUSSION
• promises to do or to abstain from doing something.

such act or abstinence or promise is called a consideration for the promise.
(abstains means refrains/avoids)
Illustration
A agrees to sell his car to B provided that B gives Rs 1 lakh to A. Here, As promise to
sell the car is a consideration for B's promise to pay the money and B's promise to pay
the money is a consideration for A's promise to sell the car. These are lawful
considerations and the contract is enforceable at law.
It has always to be remembered that an agreement without consideration is void. (Void
means, it is of no legal effect and is not enforceable by law.) However, in the following
cases an agreement without consideration is valid:
• An agreement made out of natural love and affection.
• Between parties standing in near relation to each other.
• Which is in writing and registered.
Illustration
Mr A out of his natural love and affection, promises to give to his son B, a sum of Rs.
1000. A puts his promise in writing and registers it. This is a valid contract even though
there is no consideration from B.
A promise to compensate a person, who has already done something voluntarily for the
promisor (or done something voluntarily, that the promisor was legally bound to do) is
enforceable at law.
Illustration
A finds B's watch and gives it to him. B promises to give A a sum of Rs. 100. This is a
contract.
The agreement must be entered for lawful objects, e.g. it should not be forbidden by law
or must not be fraudulent (i.e. to commit a fraud/must not be immoral/must not be
opposed to public policy, etc.).
Free Consent
Free consent of the parties to a contract is required. A consent is said to be free when the
parties agree to the same thing in the same sense.
Capacity
The partiesto to
Contract
an agreement must be legally competent to enter into a contract. Section
11 of the Contract Act lays down that every person is competent to enter into a contract
if,
• he has attained the age of majority, and
• he is of sound mind, and
• he is not disqualified from entering into an contract by any law to which he is
subject.
Minor's Contracts
An agreement made by minor is void ab initio. The principle behind this is that a minor
is not supposed to have a mature judgement and hence, he cannot decide what is good or
bad for him. A minor is hence, not liable to perform any promise made by him under any
agreement.
This leading case of Mohiri Bibi vs Dharmodas Ghose (1903) 30 Cal539: 39IA 114 (PC)
settled this law.
344
In this case a minor borrowed a certain sum and as a security to repay it, he gave a
mortgage of certain immoveable property. Later on, the minor sued for setting aside the
mortgage. The mortgagee demanded the return of the money given by him to the minor.
The Court held that the agreement made by the minor was void ab initio and there was
no question of refunding the money.
41.5 LET US SUM UP
Contract means an agreement enforceable by law. There must be a lawful proposal by
- CAIIB DISCUSSION
one party and the other party must accept the proposal to enter into a contract. An
agreement may be oral or written. There must be a lawful consideration for both the
parties to enter into an agreement. The parties to an agreement must be legally
competent to enter into a contract. An agreement made by minor is void ab initio.
41.6 KEYWORDS
Void Agreement; Enforceable by Law; Suit; Voidable Agreement; Person of Sound
Mind; Ab Initio; Sue; Sued; Registration/Registered Agreement, etc.; Damages.
1. Fill in the blanks from the alternatives provided.
(i) A is free when the parties to the contract agree to the same thing in the same
sense, (consent/contract/agreement)
(ii) A contract without is void, (cash/consideration/indemnity/guarantee)
(iii) A person who makes a proposal is known as (promisor/principal debtor/surety/
guarantor)
(iv) A person is said to be competent to contract if (he is a major/he is of sound
mind/he is a major and of sound mind)
2. Identify whether the following statements are True or False.
(i) A enters into an agreement with B to rob C and share the money. B runs away with all
the
money. A can file a suit against B to recover the money.
(ii) Mr. X (aged 17) can enter into an agreement with Mr. Y (aged 25) to buy a car. (iii)
A contract is concluded only when the party to whom the proposal is made, accepts the
proposal.
1. (i) consent; (ii) consideration; (iii) promisor; (iv) He is a major and of sound
mind.
2. (i) False; (ii) False; (iii) True.
CONTRACTS OF INDEMNITY
un
ed
he UNIT
42
ind
en. an
ab STRUCTURE
ue;
42.0 Objectives
42.1 Introduction
42.2 Rights of Indemnity Holder
42.3 Let Us Sum Up
me
ay/ ind
the
the
3.46
42.0 OBJECTIVES
The objective of this unit is to enable the candidates to understand:
• What can be construed as a Contract of Indemnity?
• What are the rights and liabilities of the indemnity holder and the indemnifier?
42.1 INTRODUCTION
- CAIIB DISCUSSION
43.9 Discharge of Principal Debtor

43.10 Forbearance to Sue
43.11 Release of One Co-surety does not Discharge Other
43.12 Surety can Claim His Dues from the Principal Debtor
43.13 Security
43.14 Misrepresentation Made by the Creditor
43.15 Implied Promise by the Principal Debtor to Indemnify the Surety
43.16 Co-sureties for the Same Debt
43.17 Let Us Sum Up
43.18 Keywords-
348
43.0 OBJECTIVE
The objective of this unit is to impart knowledge of the basic elements of a Contract of
Guarantee and the role and obligations of the guarantor in various contracts and
discharge of his obligations in various contingencies/circumstances.
43.1 INTRODUCTION
A 'Contract of Guarantee' is a contract to perform the promise, or discharge the liability,
of a third person in case of latter's default. A guarantee may be either oral or written. The
question whether a particular contract is a contract of indemnity or guarantee has to be
decided by examining the language of the documents entered into between the parties
and the nature of transaction.
43.2 PARTIES TO THE CONTRACT
The person who gives the guarantee is called the 'surety'.
The person in respect of whose default the guarantee is given is called the 'principal
debtor'.
The person to whom the guarantee is given is called the 'creditor/beneficiary'.
Illustration
'A' wants
fears that to take anot
A may loan of Rs.
return the10,000
money.from
C isB, but Bfriend
a good does not know
of A. 'A' B
C tells very
thatwell
if Aand
does
not return the money to B, C will personally, pay it to B. Under this assurance by C to B,
B lends the money to A. On the date on which the money was to be returned, A fails to
pay back Rs. 10,000. Can B now, demand this money from C?
Yes, he can. The contract, described above is called a Contract of Guarantee. This
contract involves three persons. Under the above illustration, A is the principal debtor. B
is the creditor. C is the surety. Therefore, in the above scenario, C shall pay to B Rs.
10,000.
However, it is important to note that the contract does not end here. B can, after he has
paid the amount to C, claim the same amount from A. This is the unique feature of a
Contract of Guarantee. There are actually two separate agreements each between two of
the parties. The first is an express contract between the person standing guarantee
(surety) and the person to whom the guarantee is made (creditor). The second agreement
is between the person who is being guaranteed (principal debtor) and the surety and this
is an implied contract (discussed later).
43.3 BASIC PRINCIPLES OF CONTRACT TO BE COMPLIED
All the principles and rules, which apply to other contracts, like what can form
consideration, or what would be a valid contract, also apply to a Contract of Guarantee.
43.4 CONSIDERATION
Anything done, or any promise made, for the benefit of the principal debtor, is a
sufficient consideration to the surety for giving the guarantee. This is explained by the
following illustrations:
Illustration
- CAIIB DISCUSSION
(a) B requests A to sell and deliver to him goods on credit. A agrees to do so, provided C
will give gua¬rantee the payment of the price of the goods. C promises to guarantee the
payment in consideration of A's promise to deliver the goods. This is a sufficient
consideration for C's promise.
349
(b) A sells and delivers goods to B. C afterwards requests A to forbear to sue B for
the debt for a year
(i.e. not to take legal action for recovery) and promises that if he does so C will pay for
them in
case of default by B. A agrees to forbear as requested. This is a sufficient consideration
for C's
promise.
(c) A sells and delivers goods to B. C afterwards, out of nothing and without any
request or promise
to him by any party, agrees to pay for the goods in default of B. This is a void (invalid)
contract
as there is no consideration for C's promise.
43.5 THE LIABILITY OF THE SURETY
The liability of the surety is co-extensive with that of the principal debtor. This means
that once, if the principal debtor is unable to pay the debt, the surety takes the place of
the principal debtor. Therefore, any sum of money owed by the principal debtor becomes
payable by the surety. This includes, even the interest that the principal debtor may owe
to the creditor. Again, once the surety has paid the debt, he then occupies the place of the
original creditor. He can then claim from the principal debtor, the entire sum he has paid
to the original creditor.
Illustration
'A' guarantees to B the payment of a bill of exchange by C, the acceptor. The bill is
dishonoured by C. A is liable not only for the amount of the bill, but also for any interest
and charges which may have become due on it.
43.6 CONTINUING
A guarantee which extendsGUARANTEE
to a series of transactions, is called, a 'continuing guarantee'.
This type of guarantee is not limited to only one transaction but to many transactions.
Illustration
Mr. A contracts with Mr. B, a shopkeeper to allow Mrs. A to take whatever goods she
may need from his shop, up to the amount of Rs. 20,000. Mr. A will be liable for the
debts incurred by Mrs. A up to the given amount.
A continuing guarantee may at any time be revoked by the surety, as to future
transactions, by notice to the creditor.
Say Mr. A and his wife are now living separately; Mr. A may inform Mr. B that the
guarantee stands revoked from that point on. Then, any debts incurred by Mrs. A after
such a revocation would not be payable by Mr. A.
43.7 DEATH OF SURETY
Normally, when the surety dies, the guarantee ends from that date. However, this is not
true in all cases. It depends upon the terms of the contract and the intention of the parties
as regards future transactions.
Generally all guarantees obtained by banks are continuing guarantees and in the case of
death of a surety, the guarantee would stand revoked for future transactions. The is the
precise reason when the information of a guarantor's death is received, banks prefer to
break the running accounts of a borrower.
43.8 VARIANCE IN TERMS OF THE CONTRACT
Any variance (change/modification) made without the surety's consent, in the 'terms of
contract'
- CAIIB DISCUSSION
II:
350
guaranteed by him, between the principal debtor and the creditor discharges the surety as
to transactions subsequent to the variance.
In a Contract of Guarantee, the surety gives his guarantee on his own terms. If the
principal debtor and the creditor change the terms of the guarantee without the consent
of the surety, obviously, this would not be fair to the surety. Therefore, if there is any
variance in the terms of the guarantee, the surety will be discharged from liability for any
future debts, incurred after any such variance.
Illustration
Let us assume that in the above example, the surety that Mr. A had given strict
instructions to the shopkeeper not to allow his wife to buy any cosmetics on credit. If the
shopkeeper allows Mrs. A to buy these items, the terms of the guarantee are changed and
therefore, Mr. A would not be liable to pay to the shopkeeper for any future transactions
from that point onwards.
43.9 DISCHARGE OF PRINCIPAL DEBTOR
The surety is discharged if the principal debtor is released by the creditor. Illustration
A gives a guarantee to C for goods to be supplied by C to B. C supplies goods to B and
afterwards B contracts with his creditors (including C) to assign/sell them certain
properties of his, in consideration of all the creditors, releasing B from all their demands.
Here B is now, after the settlement, not a debtor to C. A is therefore discharged from his
surety-ship to C.
The consent/permission of the surety must be obtained by the creditor and the principal
debtor, before making any settlement which would affect the liability of the principal
debtor and consequently, the liability of the surety. Otherwise, the surety would be
discharged from his liability.
43.10 FORBEARANCE TO SUE
Further, mere forbearance on the part of the creditor to sue the principal debtor or to
enforce any other remedy against him, does not discharge the surety unless the parties
had agreed for such discharge.

Illustration
B owes to C a debt guaranteed by A. The debt becomes payable. However, C does not
sue B for a year after the debt has become payable. Despite this forbearance A is not
discharged from his surety-ship.
43.11 RELEASE OF ONE CO-SURETY DOES NOT DISCHARGE OTHER
Where there are co-sureties, a release by the creditor of one of them does not discharge
the others. Also, the surety released does not become free from his responsibility to the
other sureties.
43.12 SURETY CAN CLAIM HIS DUES FROM THE PRINCIPAL DEBTOR
Once the surety makes the payment or performs the act which the principal
debt6r*bM'failed to pay/ perform, the surety steps into the shoes of the creditor and he
can claim his dues from the principal debtor.
43.13 SECURITY
A surety is entitled to the benefit of every security which the creditor has against the
principal debtor at the time when the contract of surety-ship is made, whether the surety
knows of the existence of such
351
security or not. If the creditor loses such security, then the surety is discharged to the
extent of the value of the security.
Illustration
A, as a surety for B, makes a bond to C, to secure a loan from C to B. Afterwards, C
obtains from B a further security for the same debt. Subsequently, C gives up the
- CAIIB DISCUSSION
security. A is not discharged in this case because the security was not in existence at the
time when the contract of surety-ship was entered into (i.e. when the bond was made). If
the security was taken simultaneously at the time of getting the surety or prior to that,
then A would have been discharged from his surety-ship to the extent of the value of
security.
43.14 MISREPRESENTATION MADE BY THE CREDITOR
Any guarantee obtained by means of misrepresentation made by the creditor is invalid.
Any guarantee which the creditor has obtained by means of keeping silent as to the
material circumstance is also invalid.
Illustration
A engages B as a clerk to collect money for him. B fails to account for some receipts and
A calls upon him to furnish a security for his due accounting. C gives his guarantee for
B's due accounting. A does not inform C of B's previous misconduct. B afterwards
makes default. The guarantee is invalid.
43.15 IMPLIED PROMISE BY THE PRINCIPAL DEBTOR
TO INDEMNIFY THE SURETY
In every Contract of Guarantee there is an implied promise by the principal debtor to
indemnify the surety. The surety is entitled to recover from the principal debtor whatever
sum he has rightfully paid under the guarantee (but no sums which he has paid
wrongfully).
Illustration
(a) B is indebted to C and A is surety for the debt. C demands payment from A and
on his refusal sues
him for the amount. A defends the suit, having reasonable grounds for doing so, but he is
compelled
to pay the amount of debt with costs. He can recover from B the amount paid by him for
costs as
well as the principal debt.
(b) A guarantees to C to the extent of Rs. 20,000 as payment for rice to be supplied
by C to B. C
supplies
Rs. to B, rice to a lesser amount than Rs. 20,000 but obtains from A, a payment of
20,000 in respect of the rice supplied. A cannot recover from B more than the price of
the rice
actually supplied.
43.16 CO-SURETIES FOR THE SAME DEBT
Where two or more persons are sureties for the same debt, whether with or without the
knowledge of each other, the co sureties are liable to pay an equal share of the whole
debt, or of that part of it which remains unpaid by the principal debtor.
Illustration
A, B and C are sureties to D for the sum of Rs. 30,000 lent to E. E makes a default in
payment. All of A, B and C are liable between themselves to pay Rs. 10,000 each.
In the case of guarantees obtained by banks in our country, the creditor bank has the full
liberty to choose to proceed against among the principal debtor, various sureties so long
as there is legal recourse available with him to proceed against the principal debtor.
352
43.17 LET US SUM UP
A Contract of Guarantee is a contract to perform the promise, or discharge the liability,
of a third person in case of his default.
43.18 KEYWORDS
Discharge; Express; Implied; To Revoke; To forbear; Mere; Misrepresentation; Co-
Surety;
- CAIIB DISCUSSION

(i) In a Contract of Indemnity the indemnifier is primarily liable.
(ii) In a Contract of Guarantee the liability of the surety is secondary.
(iii) Anything done for the benefit of the principal debtor is a sufficient consideration to
the surety
for giving the guarantee, (iv) Where there are co-sureties, a release by the creditor of one
of them does not discharge the
others, (v) Principal debtor need not pay the surety after the surety has paid the amount
to the creditor.
2. Fill in the blanks from the available alternatives.
(i) Surety is also known as the (indemnifier/bailor/guarantee or/bailee)
(ii) Liability of the surety is that of the principal debtor, (co-extensive
with/primary
to/secondary to)
(iii) A guarantee which extends to a series of transactions is known as a guarantee.
(continuing /invalid/ irrevocable/ general)
(iv) Surety is if the principal debtor is released by the creditor, (discharged/liable)
(v) Guarantee obtained by is invalid, (misrepresentation/consent/agreement/contract)
1. (i) True; (ii) True; (iii) True; (iv) True; (v) False.
2. (i) Guarantor; (ii) Co-extensive with; (iii) Continuing; (iv) Discharged; (v)
Misrepresentation.
CONTRACT OF BAILMENT
STRUCTURE
44.0 Objective
44.1 Introduction
44.2 Meaning of Bailment
44.3
44.4 Bailor
Bailee Bound
to TaketoCare
Disclose to the Bailee
of Goods
44.5 Effects of Mixing of Goods; Miscellaneous Expenses
44.6 Duties of the Bailee with Return the Goods
44.7 Bailee's Lien
44.8 Let Us Sum Up
354
44.0 OBJECTIVE
The objective of this unit, is to make the candidates aware as to when a contract of
bailment arises and what constitutes a bailment and the rights and duties of the bailor
and the bailee.
44.1 INTRODUCTION
A 'bailment' is the delivery of goods by one person to another for some purpose. When
the purpose is accomplished, the goods are to be returned or otherwise disposed of
according to the direction of the person delivering them.
The person delivering the goods is called the 'bailor'.
The person to whom they are delivered is called the 'bailee'.
We come across the applicability of this law in case of pledge facilities granted to
borrowers including pledge of jewellery articles and also when we take over the assets of
- CAIIB DISCUSSION
a defaulting borrower in our efforts to recover the bank's dues.

44.2 MEANING OF BAILMENT
When one person delivers to another, certain goods to be used for a certain purpose, the
contract is known as a contract of bailment. Here, the contract will specify the time for
which the goods will remain with the person taking them. Also, the person who gives the
goods can direct the other either to return the goods after the requisite time has expired
or, direct him to dispose off the goods in a particular manner.
44.3 BAILOR BOUND TO DISCLOSE TO BAILEE
The bailor is bound to disclose to the bailee faults in the goods bailed
(a) of which the bailor is aware,
(b) and which materially interfere with the use of them,
(c) or expose the bailee to extraordinary risk;
and if he does not make such disclosure, he is responsible for damage arising to the
bailee directly from such faults. If the goods are bailed for hire, the bailor is responsible
for any damage whether he was aware of the existence of such faults in the goods bailed
or not.
Illustrations
(a) A lends a horse, which he knows to be vicious, to B. He does not disclose the
fact that the horse is
vicious. The horse runs away. B is thrown and injured. A is responsible to B for damage
sustained.
(b) A hires a carriage of B. The carriage is unsafe, though B is not aware of it and
A is injured. B is
responsible to A for the injury.
44.4 BAILEE TO TAKE CARE OF GOODS
In all cases of bailment, the bailee is bound to take care of the goods bailed to him as he
would do for his own goods. The bailee (in the absence of any special contract) is not
responsible for the loss, destruction or deterioration of the thing bailed if he takes such
care.
On the other hand, if the bailee does anything different or inconsistent with what was
supposed to be done
damage suffered as awith
resultthe
ofgoods, the bailor can demand that the bailee must pay the
these acts.
355
A contract of Bailment is voidable at the option of the bailor, if the bailee does any act
with regard to the goods bailed, inconsistent with the conditions of the bailment.
If the bailee makes any use of the goods bailed, which is not according to the conditions
of the bailment, he is liable to make compensation to the bailor for any damage arising to
the goods from or during such use of them.
Illustrations
(a) A lends a horse to B for his own riding only. B allows C, a member of his
family, to ride the horse.
C rides with care but the horse accidentally falls and the horse is injured. B is liable to
make
compensation to A for the injury done to the horse.
(b) A hires a horse in Mumbai from B to go to Lonavla. A rides with due care but
marches to Khandala
instead. The horse accidentally falls and is injured. A is liable to make compensation to
B for the
injury to the horse.
44.5 EFFECTS OF MIXING OF GOODS AND EXPENSES
(a) If the bailee (with the consent of the bailor), mixes the goods of the bailor with
his own goods, the
bailor and the bailee shall have an interest, in proportion to their respective shares, in the
- CAIIB DISCUSSION
mixture
thus produced.
(b) If the bailee, without the consent of the bailor, mixes the goods of the bailor
with his own goods
and the goods can be separated or divided, the property in the goods remain with the
parties
respectively. The bailee is bound to bear the expense of separation or division, and any
damage
arising from the mixture.
Illustration
A bails 100 sacks of cotton marked with a particular mark to B. B without A's consent
mixes the 100 sacks with other sacks of his own bearing a different mark. A is entitled to
have his 100 sacks returned and B is bound to bear all the expenses incurred in the
separation of the sacks and any other incidental damage.
(c) If the bailee, without the consent of the bailor, mixes the goods of the bailor
with his own goods
in such a manner that it is impossible to separate the goods bailed from the other goods,
and
deliver them back, the bailor is entitled to be compensated by the bailee for the loss of
the goods.
Illustration
A bails a bag of flour worth Rs. 100 a bag to B. B without A's consent mixes the flour
with another flour worth Rs. 75 a bag. B must compensate A for the loss in value of his
flour.
44.6 DUTIES OF THE BAILEE WITH REGARD TO GOODS
(a) It is the duty of the bailee to return the goods bailed as soon as the time for
which they were
bailed has expired or the purpose for which they were bailed has been accomplished.
(b) The bailee is responsible to the bailor for any loss, destruction or deterioration
of the goods if the
goods
(c) areInnot
thereturned
absenceon
of time.
any contract to the contrary, the bailee is bound to deliver to
the bailor any
increase or profit which may have arisen from the goods bailed.
Illustration
A leaves a cow in the custody of B. B agrees to take care of the cow. The cow delivers a
calf. B is bound to deliver the calf as well as the cow to A.
356
Rights of Bailee with Regard to Goods
(a) The bailor is responsible to the bailee for any loss which the bailee may sustain
because of the
reason that the bailor was not entitled to make the bailment or to receive back the goods.
(b) If the bailor has no title to the goods and the bailee, in good faith delivers them
to the bailor or
according the directions of the bailor, the bailee is not responsible to the owner in respect
of such
delivery.
(c) If the goods are to be kept or to be carried, or to have work done upon them by
the bailee for the
bailor, and the bailee is to receive no remuneration, the bailor shall repay to the bailee
the necessary
expenses incurred by him for the purpose of the bailment.
44.7 BAILEE'S LIEN
- CAIIB DISCUSSION
If the bailee has rendered any service involving the exercise of labour or skill in respect
of the goods bailed to him, he has a right to retain such goods until he receives due
remuneration for the services he has rendered.
Illustrations
(a) A delivers a rough diamond to B, a jeweller, to be cut and polished which is
accordingly done. B is
entitled to retain the stone till he is paid for the services he has rendered.
(b) A gives some cloth to B, a tailor, to make into a coat. B promises to deliver the
coat as soon as it is finished
and to give a three months credit for the price. B is not entitled to retain the coat till he is
paid.
Bankers, factors (financiers who purchase receivables and also offer related services),
Attorneys of a High Court and policy brokers can, in the absence of a contract to the
contrary, retain any goods bailed to them as a security for a general balance of account.
Others do not enjoy such right unless there is express contract to that effect.
44.8 LET US SUM UP
A bailment is the delivery of goods by one person to another for some purpose. When
the purpose is accomplished, the goods are to be returned or otherwise disposed of
according to the direction of the person delivering them.
(i) Bailor is a person who delivers his goods to the surety to enable him to give a
guarantee, (ii) Bailee can use the goods given by the bailor, in the manner as he likes,
(iii) The bailee can keep the goods bailed to him and he need not return the same to the
bailor, (iv) Giving a product on rent for use to another person is a contract of bailment,
(v) If ornaments kept in the safe locker of bank are stolen, in spite of due care by the
bank, the
bank is liable to the depositor of ornaments.
(vi) It is the obligation of the bailee to keep his goods separate from the goods of the
bailor, (vii) The bailor is liable for any loss to the bailee if the goods bailed are defective
and the bailor

knowingly does not disclose this fact to the bailee.
(viii) If the bailee has rendered any service involving the exercise of labour or skill in
respect of the goods bailed to him, he has a right to retain such goods until he receives
due remuneration for the services he has rendered.
1. (i) False; (ii) False; (iii) False; (iv) True; (v) False; (vi) True; (vii) True; (viii) True.
CONTRACT OF PLEDGE
STRUCTURE
45.0 Objective
45.1 Introduction
45.2 Nature of Pledge
45.3 Let Us Sum Up
358
45.0 OBJECTIVE
The objective of this unit is to highlight a particular form of bailment known as pledge
and the purpose of such a contract.
- CAIIB DISCUSSION
45.1 INTRODUCTION
The bailment of goods as security for payment of a debt or performance of a promise is
called 'pledge'. The bailor is in this case called 'pawnor'. The bailee is called 'pawnee'.
45.2 NATURE OF PLEDGE
(a) If the pawnor makes default in payment of the debt in respect of which the
goods were pledged,
the pawnee may bring a suit against the pawnor and retain the goods pledged as a
security (or) he
may sell the goods pledged, after giving notice of the sale to the pawnor.
(b) If the proceeds of such sale are less than the amount due, in respect of the debt,
the pawnor 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 pawnor.
For example, say A takes a loan of Rs. 20,000 from B. As an assurance that he will pay
this money back, A keeps his car, as security, with B.
Thus, if after the fixed date, if A is unable to pay the money back to B, B can either
bring a suit for this purpose while he retains the car, or he can sell the car for the purpose
of recovering his dues. If B chooses to sell the car, the two possibilities are as follows:
He may receive less than the amount due, in which case, A will still have to pay him the
balance, or he may receive more than the amount due, in which case he must return the
excess amount to A.
(c) It is important to note, that in all contracts of bailment, the bailee, while he is in
possession of the
goods, steps into the shoes of the owner for the purpose of legal remedy. Thus, if any
person were
to deprive the bailee of the goods - by way of theft, etc. - the bailee, himself, would have
the right
to file a suit against such other person. If, any damages are received from such a suit, it
would be
split between the bailor and the bailee, according to the proportion of their losses or
damages.
(d) The pawnee can retain the goods pledged, not only for payment of the
debt/interest on the debt but
also for all necessary expenses incurred by him in preservation of the goods pledged.
The pawnee is entitled to receive from the pawnor, extraordinary expenses incurred by
him for the preservation of the goods pledged.
45.3 LET US SUM UP
The bailment of goods as security for payment of a debt or performance of a promise is
called pledge.
Identify whether the following statements are True or False.
(i) In a pledge, the goods are delivered to be kept as security for a debt or for
performance of a promise.
(ii) The pawnee can sell the goods, if the pawnor fails to pay.
(iii) The pawnee can sell the goods without giving notice to the pawnor.
(iv) The pawnee can keep the goods even after the pawnor has paid the dues.
fi) True; (ii) True; (iii) False; (iv) False.
CONTRACT OF AGENCY
STRUCTURE
- CAIIB DISCUSSION
46.0 Objective
46.1 Introduction
46.2 Meaning of Agency
46.3 Normal Rules of Contract
46.4 Persons to be Majors and of Sound Mind
46.5 Consideration \
46.6 Authority of an Agent
46.7 Extent of Agent's Authority
46.8 Agent's Authority in an Emergency
46.9 When Agent cannot Delegate
46.10 Right of Person as to Acts Done for Him Without His Authority - Effect of
Ratification
46.11 Termination of Agency
46.12 Agent's Duty in Conducting Principal's Business
46.13 Agent's Accounts
46.14 Right of Principal when Agent Deals, on His own Account, in Business of
Agency Without
Principal's Consent
46.15 When Agent's Remuneration Becomes Due
46.16 Agent not Entitled to Remuneration for Business if He is Guilty of Misconduct
46.17 Agent's Lien on Principal's Property
46.18 Agent to be Indemnified Against Consequences of Lawful Acts
46.19 Agent to be Indemnified Against Consequences of Acts Done in Good Faith
46.20 Let Us Sum Up
46.21 Keywords
360
46.0 OBJECTIVE
The
• objective of this unit
The concept is to understand:
of entering into contracts through agents
• The parties involved in such contracts
• The role, duties and liabilities of the principal and the agent
46.1 INTRODUCTION
To understand contracts of an agency, it is first necessary to understand what the terms
'agent' and 'principal' mean.
An agent, is a person employed to do any act for another person or to represent another
person in dealings with some third person.
The person for whom such act is done (or who is represented) is called the principal.
When banks collect various financial instruments for their customers, this law would
come into force. The authority of the agent is restricted to what is explicitly mentioned
by the principal and the agent cannot construe some additional authority.
46.2 MEANING OF AGENCY
The actual test of agency is as follows:
The person should be authorised to do an act for a person in such a manner, as to bind
that person, i.e. to make him answerable for such acts done on his behalf. The agent
creates contractual relations between two separate persons when he enters into a contract
on behalf of one of the parties.
46.3 NORMAL RULES OF CONTRACT
The contract between the principal and his agent is a contract in itself and that is also
governed by the normal rules of contract.
46.4 PERSONS TO BE MAJORS AND OF SOUND MIND
Any person who is a major according to the law of which he is subject, and who is of
- CAIIB DISCUSSION
(ii) agent renouncing (giving up) the business of the agency; or

(iii) business of the agency being completed; or
(iv) either the principal or agent dying or becoming of unsound mind; or
(v) the principal being adjudicated an insolvent.
362
46.12 AGENT'S DUTY IN CONDUCTING PRINCIPAL'S BUSINESS
An agent is bound to conduct the business of his principal according to the directions
given by the principal. In the absence of any such directions, conduct business according
to the customs, which prevails in doing business of the same kind at the place where the
agent conducts such business. If the agent, acts otherwise and if any loss be sustained, he
has to make it good to his principal and if any profit accrues, he must account for it.
Illustrations
(a) A, an agent, engaged in carrying on for B, a business, in which, it is the custom
to invest from
time to time at interest the money which may be in hand, makes such an investment. A
must make
good to B the interest usually obtained by such investments.
(b) B, a broker in whose business it is not the custom to sell on credit sells goods of
A on credit to C,
whose credit at the time was very high. C, before payment, becomes insolvent. B must
make
good the loss to A.
46.13 AGENT'S ACCOUNTS
An agent is bound to render proper accounts to his principal on demand.
46.14 RIGHT OF PRINCIPAL WHEN AGENT DEALS ON HIS OWN ACCOUNT
IN BUSINESS OF AGENCY WITHOUT PRINCIPAL'S CONSENT
If an agent deals on his own account in the business of the agency without the consent of
the principal, the principal may repudiate the transaction, if any material fact has been
dishonestly concealed from him by the agent, or the dealings of the agent have been
disadvantageous
Illustrations to him.
(a) A directs B to sell A's estate. B buys the estate for himself in the name of C. A,
on discovering that
B has bought the estate for himself, may repudiate the sale, if he can show that B has
dishonestly
concealed any material fact, or that the sale has been disadvantageous to him.
(b) A directs B to sell A's estate. B, on looking over the estate before selling it,
finds a mine on the
estate which is unknown to A. B informs A that he wishes to buy the estate for himself
but
conceals the discovery of the mine. A allows B to buy, in ignorance of the existence of
the mine.
A, on discovering that B knew of the mine at the time he bought the estate, may either
repudiate
or adopt the sale at his option.
46.15 WHEN AGENT'S REMUNERATION BECOMES DUE
An agent can detain money received by him on account of goods sold, even if all the
goods consigned to him for sale are not sold.
46.16 AGENT NOT ENTITLED TO REMUNERATION FOR
BUSINESS IF HE IS GUILTY OF MISCONDUCT
An agent who is guilty of misconduct is not entitled to any r emuneration in respect of
that part of the business which he has not conducted properly.
Illustrations
- CAIIB DISCUSSION
(a) A employs B to recover Rs. 1,00,000 from C, and to lay it out on good security. B
recovers the Rs. 1, 00,000 and lays out Rs. 90,000 on a good security, but lays out Rs.
10,000 on security
363
(b)
which he ought to have known to be bad, whereby A loses Rs. 2,000. B is entitled to
remuneration for recovering the Rs. 1, 00,000 and for investing the Rs. 90,000. He is not
entitled to any remuneration for investing the Rs. 10,000, and he must make good the Rs.
2,000 to B. A employs B to recover Rs. 1,000 from C. Through B's misconduct the
money is not recovered. B is entitled to no remuneration for his services and must make
good the loss.
46.17 AGENT'S LIEN ON PRINCIPAL'S PROPERTY

In the absence of anything contrary in the contract, an agent is entitled to retain goods,
papers, and other property of the principal which is received by him, until the amount
due to the agent for commission, disbursements and services in respect of the same has
been paid or accounted for to him.
46.18 AGENT TO BE INDEMNIFIED AGAINST
CONSEQUENCES OF LAWFUL ACTS
The principal is bound to indemnify the agent against the consequences of all lawful acts
done by the agent in exercise of the authority conferred upon him.
Illustrations
(a) B, at Singapore under instructions from A of Calcutta, contracts with C to
deliver certain goods
to him. A does not send the goods to B, and C sues B for breach of contract. B informs A
of theand A authorises him to defend the suit. B defends the suit, and is compelled to pay
suit,
damages
and costs, and incurs expenses. A is liable to B for such damages, costs and expenses.
(b) B, a broker at Calcutta, by the orders of A, a merchant there, contracts with C
for the purchase
of ten casks of oil for A. Afterwards A refuses to receive the oil, and C sues B. B
informs A, who
repudiates the contract altogether. B defends, but unsuccessfully, and has to pay
damages and
costs and incurs expenses. A is liable to B for such damages, costs and expenses.
46.19 AGENT TO BE INDEMNIFIED AGAINST CONSEQUENCES
OF ACTS DONE IN GOOD FAITH
The principal is liable to indemnify the agent against the consequences of acts done by
him in good faith, though it may cause an injury to the rights of third person.
Illustrations
(a) A, a decree-holder and entitled to execution of B's goods requires the officer of
the Court to seize
certain goods, representing them to be the goods of B. The officer seizes the goods, and
is sued
by C, the true owner of the goods. A is liable to indemnify the officer for the sum which
he is
compelled to pay to C, in consequence of obeying his directions.
(b) B, at the request of A, sells goods in the possession of A, but which, A had no
- CAIIB DISCUSSION
right to dispose of.

B does not know this, and hands over the proceeds of the sale to A. Afterwards C, the
true owner
of the goods, sues B and recovers the value of the goods and costs. A is liable to
indemnify B for
what he has been compelled to pay to C, and for B's own expenses.
46.20 LET US SUM UP
Agent is a person employed to do any act for another person or to represent another
person in dealing with some other person. Unlike other contracts, no consideration is
essential for a contract of agency. It is agent's duty to perform as per the principal's
lawful direction and get paid for services and be indemnified against consequences.
364
46.21 KEYWORDS
Adjudicated; Insolvent; To repudiate; To consign goods; Lien.
1. Fill in the blanks from the available alternatives.
(i) Agent can be appointed by (express appointment/implication of law/ratification
_. (power of attorney/indemnity
by principal/any of the three modes)
(ii) The usual form of contract of agency is by way of a
bond/guarantee bond) (iii) When a person by his words or conduct appoints someone as
his agent it is known as agency
by (estoppel/promise/conduct/action)
(i) Consideration is the most essential element in any contract of agency.
(ii) A contract of agency is terminated if the agent does not wish to continue as agent any
more.
(iii) An agent can have a lien on the goods of the principal for the dues payable by the
principal
the agent.to
(iv) Minor can be a principal or an agent, (v) The principal has to indemnify the agent
for all the lawful acts done by the agent in the course
of his duties.
1. (i) Any of the three modes; (ii) Power of attorney; (iii) Estoppel.
2. (i) False; (ii) True; (iii) True; (iv) False; (v) True.
UNIT
47
MEANING AND ESSENTIALS OF A CONTRACT OF SALE
STRUCTURE
47.0 Objective
47.1 Introduction
47.2 Meaning of Some of the Important Terms Defined Under the Sale of Goods Act
47.3 Meaning of Contract of Sale of Goods
47.4 Features of Contract of Sale of Goods
47.5 Sale and Agreement to Sell
47.6 Distinction between a Sale and an Agreement to Sell
47.7 Let Us Sum Up
47.8 Keywords
- CAIIB DISCUSSION

366
47.0 OBJECTIVE
The objective of this unit on the Sale of Goods Act, is to provide a basic level knowledge
and understanding to the candidates about the contractual rights and liabilities of the
seller and the buyer in a contract for sale of goods. These rights and liabilities are in
addition to the rights and liabilities of the parties to a contract as laid down in the
Contract Act.
47.1 INTRODUCTION
The Contract Act covers the aspects of general principles and essentials of contracts
made in the commercial world. A contract for the sale of goods is also governed by the
general principles and essentials as stated in the Contract Act. However, the Sale of
Goods Act is specially enacted to lay down the law relating to the sale and purchase of
moveable goods in the country. The provisions of the Sale of Goods Act spell out the
contractual rights and liabilities of the seller and buyer in detail.
47.2 MEANING OF SOME OF THE IMPORTANT TERMS DEFINED
UNDER THE SALE OF GOODS ACT, 1930
'Goods' means every kind of moveable pr operty (other than actionable claims and
money) and includes
• stock and shares
• growing crops, grass
• things attached to or forming part of the land which are agreed to be severed
before sale or under
the contract of sale.
'Buyer' means a person who buys or agrees to buy goods.
'Seller' means a person who sells or agrees to sell goods.
'Price' means the money consideration for a sale of goods.
'Delivery' means voluntary transfer of possession fr om one person to another.
'Document of title to goods'

certificate, wharfingers' includes
certificate, bill of receipt,
railway lading, dock-warrant, warehouse-keeper's
multimodal transport document,
warrant or order for the delivery of goods and any other document used in the ordinary
course of business as proof of the possession or control of goods authorised by
endorsement or delivery to transfer or receive goods as possessor of document.
'Future goods' means goods to be manufactured or produced or acquired by the seller
after making of the contract of sale.
'Specific goods' means goods identified and agreed upon at the time a contract of sale is
made.
'Mercantile agent' means an agent having authority either to sell goods, or to consign
goods for the purposes of sale, or to buy goods, or to raise money on the security of
goods.
47.3 MEANING OF CONTRACT OF SALE OF GOODS
A contract of sale of goods is a contract under which the seller transfers or agrees to
transfer the property in goods to the buyer for a price. When the property in the goods is
transferred from the seller to the buyer, the contract is called a sale.
47.4 FEATURES OF CONTRACT OF SALE OF GOODS
(a) Bilateral: contract: A sale involves two persons - The buyer and the seller.
(b) Money consideration: The consideration for a sale of goods must be money,
called the price
payable for the transfer of goods. It cannot be a barter, where goods are exchanged for
goods.
(c) Moveable property: The Sale of Goods Act covers only the sale of moveable
goods and not
- CAIIB DISCUSSION
367
immoveable property like land and building. The contracts relating to transfer of
immoveable property are governed by the Transfer of Property Act and not Sale of
Goods Act. (d) No particular form: The Sale of Goods Act does not make it mandatory
to enter into written contracts for the sale of goods. However, if any particular law
provides for sale of certain types of goods to be done by a contract in writing, then that
law has to be complied and the contract has to be in writing.
The contract may be oral or written or can be implied by the conduct of the parties. A
contract of sale is made by an offer to buy or sell goods for a price and the acceptance of
such offer.
The contract may provide for:
• Immediate delivery of the goods immediate payment of the price.
• For the delivery or payment by instalments.
• Postponement of delivery or payment.
47.5 SALE AND AGREEMENT TO SELL
A contract of sale may be absolute or conditional. In an absolute contract for sale of
goods, there are no conditions to be fulfilled by the seller or the buyer for the sale and
purchase of the goods. In a conditional sale, the parties to the contract (seller and buyer)
agree that the sale of goods shall be regarded as final only on the fulfilment of certain
conditions either before or after the conclusion of the contract for sale of goods.
When the transfer of the property in the goods is to take place at a future time or subject
to some condition, thereafter to be fulfilled, the contract is called an agreement to sell.
An agreement to sell becomes a sale when the time elapses or the conditions are
fulfilled, subject to which the property in the goods is to be transferred. Thus, when an
agreement to sell provides that the property in goods (the ownership) shall pass on a
certain date, then the agreement to sell becomes a sale on that date. Further, if an
agreement to sell provides that the ownership in goods shall pass only on the fulfilment
of such and such conditions by the seller and such and such conditions by the buyer, the
agreement to sell becomes a sale, only on the fulfilment of such conditions as agreed to
between
47.6 the parties.
DISTINCTION BETWEEN A SALE AND AN AGREEMENT TO SELL
Table 47.1 Difference in Sale and Agreement to Sell
Sale
1. A sale is a contract in which the parties have
already performed their part.
2. In a sale the ownership of goods have already
passed, irrespective of whether the goods are
delivered or not.
3. The risk in goods is with the buyer.
4. In a sale, if the seller does not deliver the goods,
the buyer can file a suit and demand specific
performance and delivery of the goods.
5. If the buyer does not pay for the goods the
seller can claim file a suit and demand the price.
He also has the right to stop the deliver of goods
p onnds
>: Agreement to Sell

An agreement to sell an act in which the parties are yet
to perform their mutual promises.
In an agreement to sell the ownership of goods is yet
to pass from the seller to the buyer at a later date after
- CAIIB DISCUSSION
the fulfilment of certain conditions, as agreed upon by

the seller and the buyer.
The risk in goods is still with the seller and passes to the
buyer only after the agreement to sell becomes a sale.
In an agreement to sell, if the seller does not deliver
the goods, the buyer can only claim damages in a suit
and cannot demand the delivery as the sale is not yet
concluded.
In an agreement to sell the seller may not part with the
goods until he is paid the price. In case he parts with
the possession, he can sue for return of goods or
Davment of price.
368
47.7 LET US SUM UP
A sale involves two persons, the buyer and the seller. A contract of sale of goods is a
contract under which the seller transfers the goods to the buyer for a price. When the
property in the goods is transferred from the seller to the buyer, the contract is called a
sale. The consideration for a sale of goods is the money payable for the transfer of
goods. The Sale of Goods Act covers only the sale of moveable goods and not
immoveable property.
When the transfer of the property in the goods is to take place at a future time or subject
to some condition thereafter to be fulfilled, the contract is called an agreement to sell. An
agreement to sell becomes a sale when the time elapses or the conditions are fulfilled,
subject to which the property in the goods is to be transferred.
47.8 KEYWORDS
Breach; Encumbrance.
1. Fill in the gaps from the available options given in the brackets.
(i) means the consideration for a sale of goods. (Price/Lien Delivery/Shares)
(ii) Goods as defined under Sale of Goods Act do not include . (actionable claims/
shares/stock/grass)
(iii) goods are to be manufactured/produced/acquired by the seller after making of
the contract of sale. (Future/Specific/Moveable/Immoveable)
(iv) goods means goods identified and agreed upon at the time a contract of sale is
made. (Future/Specific/Moveable/Tmmoveable)
(v) means voluntary transfer of possession from one person to another. (Delivery/
Lien/Indemnity/Suit) (vi) When the transfer of the property in the goods is to take place
at a future time or subject to
some conditions thereafter to be fulfilled, the contract is called . (agreement to
sell/contract of sale/contract of future goods/contract of specific goods)
(vii) In the ownership of goods is yet to pass from the seller to the buyer, (agreement
to sell/contract of sale/contract of future goods/contract of specific goods)
(i) Shares are goods within the meaning of the Sale of Goods Act.
(ii) Fixtures can be regarded as moveable goods only if they are intended to be severed
and sold separately.
1. (i) price; (ii) actionable claim; (iii) future; (iv) specific; (v) delivery; (vi)
agreement to sell;
(vii) agreement to sell.
2. (i) True; (ii) True.
- CAIIB DISCUSSION
CONDITIONS AND WARRANTIES
STRUCTURE
48.0 Objective
48.1 Introduction
48.2 Meaning of Condition and Warranty
48.3 Implied Conditions and Warranties
48.4 Let Us Sum Up
48.5 Keywords

370
48.0 OBJECTIVE
The objective of this unit is to give an understanding of the concepts of warranties and
its implications.
48.1 INTRODUCTION
Every contract of sale of goods has certain stipulations, terms and conditions regarding
the nature, quality, quantity of the goods, etc. There are also many obligations under the
contract for sale of goods. However, the importance of every such term, stipulation and
obligation is not equal.
48.2 MEANING OF CONDITION AND WARRANTY
Under the Sale of Goods Act, the stipulations in a contract of sale with reference to
goods are classified based on their importance as condition or a warranty.
If the stipulation agreed to between the parties is essential to the main purpose of the
contract and is of such a nature that if the stipulation is breached (i.e. violated/not
complied) then a party to the agreement would have a right to treat the contract as
repudiated (cancelled) then such a stipulation is known as a condition.
On the other hand, a warranty is a stipulation collateral to the main purpose of the
contract.cannot
parties The breach of such
reject the a stipulation
goods gives
and treat the rise toasarepudiated.
contract claim for damages only. The
Whether a stipulation in a contract of sale is a condition or a warranty depends on the
type of contract. Even if the parties have agreed that a stipulation is a warranty, in fact, it
may be a condition if it is the basis of the contract.
If a contract of sale is subject to any condition to be fulfilled by the seller and the seller
does not fulfil it, the buyer, can waive the fulfilment of the condition or he can treat it as
non-fulfilment of a warranty. This is left to the buyer. However, if the buyer has
accepted the goods, then such a choice is not available to the buyer and the buyer has to
treat the non-fulfilment of condition by the seller as a breach of warranty only, unless
there is express or implied term of contract.
48.3 IMPLIED CONDITIONS AND WARRANTIES
In a contract of sale of goods conditions and warranties may be either expressed or
implied. Expressed conditions and warranties are those, which are expressly stated in the
contract. Implied conditions and warranties are those, which the law implies into every
contract of sale of goods. However, such implied conditions and warranties can be
excluded by the parties to the contract if they agree expressly on these issues.
A. Title of the seller
There is an implied condition on the part of the seller that,
• he has a right to sell the goods (in the case of a sale), or
• he will have a right to sell the goods at the time when the ownership is to pass
to the buyer (in the
case of an agreement to sell).
Illustration
- CAIIB DISCUSSION
A buys a second-hand car from B and pays him. Police takes away the car, as it was a
stolen one. A can recover the price paid, from B, as he has violated the implied condition
above.
CONDI
371
B. Sale of goods by description

In the sale of goods by description, there is an implied condition that the goods shall
correspond with the description.
Illustration
A sells certain curtains to B by describing them to be of seventeenth century. Later on B
discovers, that the curtains are not of the seventeenth century. A can reject the goods and
claim back the price.
C. Sale by sample
In case of a sale by sample there is an implied condition that the
(a) bulk shall correspond with the sample in quality;
(b) buyer shall have an opportunity to compare the bulk with the sample;
(c) goods shall be free from any defect, rendering them unmerchantable, which
would not be apparent
on reasonable examination of the sample.
Illustration
A wants to buy rubber material of a certain length and width. B shows a sample to A. A
approves the sample but B delivers the same material with a variation in the length of the
rubber. A can reject the goods as the goods did not correspond with the sample in
quality.
D. Sale is by sample as well as by description
If the sale is by sample as well as by description, the goods must correspond not only to
the sample but also to the description given.
Illustration
A sells to B, 'foreign rape-seed refined oil'. He even shows a sample to B. Afterwards the
oil according to the sample is delivered to B. When the oil is delivered to B, he discovers
that there is some 'hemp oil' also mixed in it. B can reject the goods because he was
delivered as per the sample but the sample and oil itself were not 'foreign rape-seed
refined oil' as described by A.
£. Quiet possession
There is an implied warranty that the buyer shall have and enjoy quiet possession of the
goods. F. Goods are free from any charge or encumbrance
There is an implied warranty that the goods shall be free from any charge or
encumbrance in favour of any third party not declared or known to the buyer before or at
the time when the contract is made. This means that the buyer can assume that the goods
that are being sold to him would be his absolute property and no one would claim any
right over the goods in future once he pays the price and purchases then from the seller.
G Quality or fitness of goods for any particular purpose
There is no implied warranty or condition as to the quality or fitness of goods for any
particular purpose except in the following case:
If the buyer discloses to the seller the purpose for which he wants the goods and he relies
on the seller's skill/judgement and if the goods are in the course of the seller's business to
supply then in such case, there is an implied condition that the goods shall be reasonably
fit for such purpose.
Illustration
A buys a hot water bottle from B (a retail chemist). A asked B whether it would hold hot
water. B says it is meant to hold hot water only. As wife is injured as the hot water bottle
- CAIIB DISCUSSION
bursts. B was held liable for breach of implied condition as to the quality or fitness of the
hot water bottle.
L.R.A.B-25
372
• If goods are bought by description from a seller who deals in goods of that
description, there is an
implied condition that the goods shall be of merchantable quality. However, if the buyer
has examined
the goods, there is no implied condition as regards defects which can be revealed by
examination.
• The usage of trade may give an implied warranty or condition as to quality or
fitness of goods for
any particular purpose.
It is to be noted that an express warranty or condition given by any party is always in
addition to the implied warranties or conditions as explained above.
H. Caveat Emptor (Buyer beware)
Caveat means a warning, a caution. According to the doctrine of caveat emptor, the
person who buys goods must keep his eyes open, his mind active and be cautious while
buying the goods. In other words, the buyer must examine the goods thoroughly. Later
on, if the goods do not serve his purpose or he depends upon his own judgement and he
makes a bad choice, he cannot blame the seller for selling him such goods. The Sale of
Goods Act also enshrines doctrine by stating that 'There is - ( implied warranty or
condition as to the quality or fitness of goods for any particular purpose' except in cases
specifically explained above.
48.4 LET US SUM UP
If a stipulation agreed to between the parties is essential to the main purpose of the
contract it is known as a condition. On the other hand, a warranty is a stipulation
collateral to the main purpose of the contract.
48.5 KEYWORDS
Warranty:
48.6 Caveat YOUR
CHECK Emptor.PROGRESS
1. Fill in the gaps from the available options given in the brackets.
(i) If the stipulation agreed to between the parties is essential to the main purpose of th e
contract
then such a stipulation is known as a . (condition/warranty/implied condition/
guarantee)
(ii) A is a stipulation, collateral to the main purpose of the contract, (condition/
warranty/implied condition/guarantee)
(iii) There is an implied condition on the part of the seller that he has a right to the
goods, (use/sell/retain/resell)
(iv) If the sale of goods is by there is an implied condition that the goods shall
correspond with the description, (description/sample/oral agreement/written contract)
(i) In every contract of sale it is implied that the seller has got the right to sell the goods,
(ii) An implied warranty as to quality or fitness for particular purpose may be annexed
by the usage of trade.
1. (i) condition; (ii) warranty; (iii) sell; (iv) description.
UNPAID SELLER
- CAIIB DISCUSSION
STRUCTURE
49.0 Objective
49.1 Introduction
49.2 Rights of an Unpaid Seller
49.3 Let Us Sum Up
374
49.0 OBJECTIVE
The objective of this unit is to impart knowledge on the meaning of an 'Unpaid Seller' in
a contract of sale and the rights of such a person.
49.1 INTRODUCTION
The seller of goods is deemed to be an 'unpaid seller',
(a) When the whole of the price has not been paid or tendered;
(b) When the payment for the goods is received in the form of a cheque or other
negotiable instrument
and the same is dishonoured for financial or other reasons
Here, the term 'seller' includes any person who is in the position of a seller, e.g., an agent
of the seller, to whom the bill of lading has been endorsed, or a consignor or agent who
has paid for goods to the seller.
49.2 RIGHTS OF AN UNPAID SELLER
Table 49.1 Rights of Unpaid Seller Against Goods and the Buyer
^^^^^^^^Rights against the goods Rights against the buyer
^^HB personality
®* Where the property in the goods have passed Where the property in the goods
have not passed Suit for price Suit for damages Repud¬iation contr¬act Suit for
interest I
Lien Stoppage in transit Resale delivery Withholding in transit
Stoppage
Unpaid seller's rights against the goods

The following rights are available to the unpaid seller, whether the property in the goods
has passed to the buyer or not
(a) a lien on the goods for the price while he is in possession of them;
(b) in case of insolvency of the buyer, a right of stopping the goods in transit after
he has parted with
the possession of them;
(c) a right of resale.
If the property in goods has not passed to the buyer, the unpaid seller also has a right of
withholding delivery of the goods.
Unpaid seller's lien
The unpaid seller of goods (who is in possession of them), is entitled to r etain possession
of them until payment of the price is made in the following cases:
(a) if the goods have been sold without any stipulation as to credit;
(b) if the goods have been sold on credit, but the term of credit has expired;
(c) if the buyer becomes insolvent.
Where an unpaid seller has made part delivery of the goods, he may exercise his right of
lien on the balance goods, unless he makes part delivery under circumstances to show
that he would waive the
- CAIIB DISCUSSION
375
nt
le
\
_J
¥
to ith
ing
atil
the the i
right to lien on all goods. The seller may exercise the right of lien notwithstanding that
he is in possession of the goods as an agent or bailee for the buyer.
Termination of lien
The unpaid seller of goods loses his lien thereon:
(a) when he delivers the goods to a carrier or other bailee for the purpose of
transmission to the
buyer without reserving the right of disposal of the goods;
(b) when the buyer or his agent lawfully obtains possession of the goods;
(c) by waiver of lien.
However, the lien is not lost just because the seller obtains a decree for the price of the
goods. Right of stoppage in transit
When the buyer becomes insolvent, the unpaid seller who has parted with the possession
of the goods has the right of stopping them in transit. He may retain them until payment
of the price.
Duration of transit
Goods are deemed to be in course of transit from the time when they are delivered to a
carrier or other bailee for the purpose of tr ansmission to the buyer and the transit ends,
when the buyerinortransit

How stoppage his agent takes delivery of them from such carrier or other bailee.
is affected?
The unpaid seller may exercise his right of stoppage in transit either by taking actual
possession of the goods, or by giving notice of his claim to the carrier or other bailee in
whose possession the goods are.
Effect of sub-sale or pledge by buyer
The unpaid seller's right of lien or stoppage in transit is not affected by a further sale or
by other disposition of the goods, which the buyer may have made (unless the seller has
given his permission). Exception to this is when any person in good faith and for
consideration takes documents of title to goods from a buyer; or transfer of goods is by
way of pledge, where right of unpaid seller may get defeated.
If the goods are of a perishable nature, or if the unpaid seller, who has exercised his right
of lien or stoppage in transit gives notice to the buyer of his intention to re-sell, the
unpaid seller may, if the buyer does not within a reasonable time pay the price, resell the
goods.
He can also recover from the original buyer, damages for any loss occasioned by his
breach of contract. The buyer is not entitled to any profit which may occur on the resale.
If the unpaid seller does not give, a prior notice of sale to the buyer, then the unpaid
seller is not entitled to recover damages from the buyer. On the contrary, the buyer
becomes entitled to the profit on a resale.
If the unpaid seller who has exercised his right of lien or stoppage in transit re-sells the
goods, the, 'new' buyer acquires a good title to the goods as against the original buyer,
even if no notice of the resale was given to the original buyer.
Unpaid seller's rights against the buyer personally
- CAIIB DISCUSSION
These rights arise out of breach of contract and the seller can file a suit to claim
damages, claim the price of goods with interest and he can also repudiate the contract.
49.3 LET US SUM UP
An unpaid seller has the following rights:
(a) a lien on the goods for the price while he is in possession of them;
376
(b) in case of insolvency of the buyer, a right of stopping the goods in transit after
he has parted with
the possession of them;
(c) a right of resale;
(d) right to withhold delivery of goods.
GO (iii)
1.
2.
Fill in the gaps from the available options given in the brackets.
has not been paid
(i) The seller of goods is deemed to be an unpaid seller when the
(price/interest/damages/penalty)
There is no as to the quality or fitness of goods for any particular purpose.
(implied condition/implied warranty/express condition/express warranty)
When the is in possession of goods, a lien can be exercised, (seller/buyer/agent
of the buyer/carrier)
is terminated when the buyer gets the possession of the goods.
(Lien/Agreement/
(iv)
Condition/Warranty)
Identify whether the following statements are True or False. (i) When property in the
goods has not passed to the buyer and the buyer becomes insolvent
before the price is paid, the seller can withhold the delivery of goods.
(ii) A seller who has accepted a negotiable security as an absolute payment is no longer
an unpaid seller.
55
51

1. (i) price; (ii) implied condition; (iii) seller; (iv) lien.
UNIT
50
DEFINITION, MEANING AND NATURE OF PARTNERSHIP
- CAIIB DISCUSSION
STRUCTURE
50.0 Objective
50.1 Introduction
50.2 Meaning and Nature of Partnership
50.3 types of Partnership
50.4 Let Us Sum Up
378
50.0 OBJECTIVE
The objective of this unit is to give the candidates a broad view of the legal aspects
involved in a partnership business and the determination of the rights and liabilities
arising out of partnership business.
50.1 INTRODUCTION
The Partnership Act lays down the important provisions relating to partnership contracts.
However, the general principles of the Contract Act also continue to apply to the
partnership contracts. A business can be carried on by a single individual by using his
own funds or by two or more persons together in which case some of them would bring
in money and some of them would use their business skills. These persons agree to share
the profits and losses of their venture and it amounts to a contract. The rights and
liabilities arising out of such a mode of carrying on business are governed by the
Partnership Act.
50.2 MEANING AND NATURE OF PARTNERSHIP
Partnership is the relation between persons who have agreed to share the profits of a
business carried on by all or any of them acting for all. Persons, who have entered into
partnership with one another are called individually 'partners' and collectively a 'firm'
and the name under which their business is carried on is called the firm's name.
It must always be remembered that a partnership is not a separate legal entity like a
company formed under the Companies Act, 1956. Let us try to understand the concept of
afor'separate legal entity'

the difference betweenlittlea more clearly
company andwhich is very important as this forms the basis
a partnership.
In the case of a company formed by the members, who contribute the capital and start
the business of the company, the wrongful acts of the company are not the wrongful acts
of the individual members of the company. A person who is cheated by the company
cannot file a case against each and every mem¬ber or even a single member of the
company saying that the members of the company have cheated him. A company has its
own separate existence and the person who is cheated can claim damages from the funds
of the company and not from the pockets of the members forming the company.
A partnership is formed by the persons who have come together to carry on a business
and share profits. However, if a particular partner cheats a customer and runs away with,
say Rs. 1 lakh, then the other partners have to pay for his misdeed (and in fact the
customer can catch any single partner and demand him to shell out the entire funds). If
the partnership firm is left with no funds, the individual partners will have to pay the
funds from their own pockets.
Hence, from the above it can be seen that there is a difference between the company and
the members forming the company, while the partnership is seen clearly to be a group of
persons who have joined together to do business. The partnership firm and the partners
are not separate from each other.
The sharing of profits or r eturns arising from property by persons holding a common
interest in that property does not mean that the persons have formed a partnership firm to
carry on such business.
If a payment to a person is dependent upon the earning of profits or varying with the
profits earned by a business, or he is given a share of the profits of the business then
- CAIIB DISCUSSION
simply this fact does not make the person receiving such payment as a partner in the
business.
Example: The receipt of a payment or share in profits of the business by a servant or
agent as remuneration. Hence, to summarise the essentials of a partnership.
Partnership is the result of an agreement between the persons joining together to do some
lawful business.
379
• The contract between the partners may be oral or written.
• The partnership must be formed to carry on some lawful business.
• The business must be carried on to earn and share the profits and returns of the
business.
• There must be a mutual relation of 'agency' between the partners. This means
that any partner can
by his acts bind all the partners of the firm. This is the meaning of 'business carried on
by all or any
of them acting for all' in the definition of partnership.
Illustrations
(a) A and B buy ten boxes of mangoes agreeing to equally share the mangoes for
personal consumption
and pay the purchase price thereof. This is not a partnership. However, if they further
agree to
sell some mangoes and share the profits from the sale, it is a partnership.
(b) A and B are joint owners of a car. It is not a partnership. However, if they
decide to give it on hire
and share the rentals it is a partnership between the two.
50.3 TYPES OF PARTNERSHIP
1. Partnership at will
Where no provision is made by a contract between the partners for the duration of their
partnership or for the determination (i.e. the termination or end) of the partnership - the
partnership is known
any partner by giving as 'partnership
notice at will'.
in writing to all A
thepartnership at will
other partners canintention
of his be dissolved
to by
dissolve the firm. The firm gets dissolved from the date mentioned in the notice as the
date of dissolution and if no date is mentioned, the/firm gets dissolved from the date of
the commencement of the notice.
2. Partnership for a fixed period
When two or more persons enter into a partnership agreement for a fixed period of time,
it is known as a partnership for a fixed term. In such a case, when the fixed period of
partnership is over, it comes to an end. However, the partners can continue to carry on
the business after the fixed period. In that case, the mutual rights and duties remain
absolutely unaffected and the partnership is automatically transformed into a partnership
at will.
3. Particular partnership
Such partnership is entered into, for completing a particular job or assignment taken up
by two or more persons jointly and to share the profits arising there from. Hence, a
person may become a partner with another person in particular adventures or
undertakings.
50.4 LET US SUM UP
Partnership is the relation between persons who have agreed to share the profits of a
lawful business, carried on by all or any of them acting for all. There is a mutual relation
of 'agency' between the partners. Any partner can, by his acts, bind all the partners of the
firm. This is the meaning of 'business carried on by all or any of them acting for all'. The
three different types of partnership are: partnership at will, partnership for a fixed period
and particular partnership.
- CAIIB DISCUSSION

1. Indicate whether the following statements are True or False.
(i) If one partner cheats a customer of the partnership firm then all the partners of the
partnership firm are liable to compensate the customer.
HI:
380
(ii) Registration of firms is compulsory under the Partnership Act. (iii) It is compulsory
to enter into a partnership deed, (iv) The partners are free to decide their mutual rights
and liabilities.
(v) A partnership deed can even provide that a particular partner would not take part in
the day-to-day business decisions of the partnership firm, (vi) Consent of all the partners
is necessary to change the nature of business carried on by the
firm, (vii) A partnership at will can be dissolved by notice.
1. (i) True; (ii) False; (iii) False; (iv) True; (v) True; (vi) True; (vii) True.
.11:
RELATIONS OF PARTNERS TO ONE ANOTHER
STRUCTURE
51.0 Objective
51.1 Introduction
51.2 General Duties of Partners
51.3 Duty to Indemnify the Loss caused by Fraud
51.4 Determination of Rights and Duties of Partners by Contract between the
Partners
51.5
51.6 The Conduct
Mutual Rightsofand
theLiabilities
Business
51.7 The Property of the Firm
51.8 Profits Earned by Partners
51.9 Rights and Duties of Partners
51.10 Let Us Sum Up
382
51.0 OBJECTIVE
The objective of this unit is to understand the relationship of partners amongst
themselves and their mutual rights and duties.
51.1 INTRODUCTION
Partners are bound to carry on the business of the firm to the greatest common
advantage. The partners are responsible to each other for the conduct of the business of
the firm.
51.2 GENERAL DUTIES OF PARTNERS
The partners should not make secret profits. They have to be just and faithful to each
other. They must render true accounts of the business and full information of all things
affecting the firm to all the partners or their legal representatives.
- CAIIB DISCUSSION
51.3 DUTY TO INDEMNIFY THE LOSS CAUSED BY FRAUD

Every partner is bound to indemnify the firm for any loss caused to the partnership firm
by his fraud, in the conduct of the business of the firm. For example, if a partner
commits a fraud upon a customer of the partnership firm for which the firm is held liable
then the partnership firm, is entitled to recover from the partner the damages that the
firm is required to pay. This liability of the partner cannot be waived off by the partners
as it would be opposed to public policy in the sense that it would amount to exempting a
person from his own frauds.
51.4
DETERMINATION OF RIGHTS AND DUTIES OF PARTNERS BY CONTRACT

BETWEEN THE PARTNERS
The partners of a firm can decide their mutual rights and duties and change them from
time to time with the consent of all the partners. This may be implied (i.e. understood by
the dealings between them/ with outsiders) or may be expressed (i.e. specifically
discussed and made clear). These should however, be not against the provisions of the
Partnership Act. Such contracts (defining their rights and duties) may even provide that a
partner shall not carry on any business other than that of the firm while he is a partner.
51.5 THE CONDUCT OF THE BUSINESS
Subject to a contract between the partners (i.e. the agreement and understanding arrived
between themselves)
(a) every partner has a right to take part in the conduct of the business;
(b) every partner is bound to attend diligently to his duties in the conduct of the
business;
(c) any difference arising as to ordinary matters connected with the business can be
decided by a
majority of the partners and every partner has a right to express his opinion before the
matter is decided. However, no change can be made in the nature of the business without
the
(d) consent of all
every the partners.
partner has a right to have access to and to inspect and copy any of the
books of the firm.
The above rights may be given to some partners only and the others may not be allowed
to have a say in the day-to-day management of the business or even in critical decisions.
The bifurcation of powers can be decided by the partners themselves based on the
agreement and understanding arrived between
383
themselves (except in cases where consent of all partners is required as stated above).
However, if they have no specific understanding on these matters, the above applies to
them.
51.6 MUTUAL RIGHTS AND LIABILITIES
Subject to a contract between the partners (i.e., the agreement and understanding arrived
between themselves),
(a) a partner is not entitled to receive remuneration for taking part in the conduct of
the business;
(b) the partners are entitled to share equally in the profits earned and liable to
contribute equally to the
losses made by the firm;
(c) where a partner is entitled to interest on the capital subscribed by him such
interest is to be paid
only out of profits of the firm;
(d) Interest at 6 per cent on extra amount paid by the partner;
- CAIIB DISCUSSION
(e) the firm has to indemnify a partner in respect of payments made and liabilities
incurred by him:
(i) in the ordinary and proper conduct of the business, and
(ii) in doing such act in an emergency, for the purpose of protecting the firm from loss;
(f) similarly, a partner has to indemnify the firm for any loss caused to it by his
wilful neglect in the
conduct of the business of the firm.
On the matters stated above, the partners are free to have an understanding other than in
the manner stated above, e.g. all or some of the partners may be allowed remuneration
by way of salary in addition to share profits. Further, the share in profits may not be
equal and the options can decide that a particular partner would get more share in the
profits than the others. However, if they have no specific understanding on these matters,
the above applies to them.
51.7 THE PROPERTY OF THE FIRM
The property of the firm includes all property/rights in property originally brought into
the firm or later on acquired (by purchase, etc.) by the firm for the purpose of business of
the firm and includes also the goodwill of the business. The property acquired by the
partners from the funds of the partnership business is deemed to be the property of the
firm (unless, e.g. say the partners had decided to purchase a particular property from the
partnership funds and give it to a partner towards his long due remuneration). The
property of the firm has to be held and used by the partners exclusively for the purposes
of the business. However, the partners can decide the use of the property by mutual
consent.
51.8 PROFITS EARNED BY PARTNERS
If a partner derives any profit for himself from any transaction of the firm or from the
use of the property/business connection of the firm/the firm name he is bound to pay it to
the firm. Also, if a partner carries on any business competing with the firm he is bound
to pay to the firm all profits made by him in that business. On the matters stated above,
the partners are free to have an understanding other than in the manner stated above.
However, if they have no specific understanding on these matters, the above applies to
them.
51.9 RIGHTS AND DUTIES OF PARTNERS
(a) After a change in the partners of a firm the mutual rights and duties of the
partners in the
reconstituted firm remain the same as they were immediately before the change.
(b) Similarly, after the expiry of the term of the firm, if a firm constituted for a
fixed term, continues
to carry on business, the mutual rights and duties of the partners remain the same as they
were
before the expiry.
384
(c) Mutual rights and duties remain same for additional undertaking/adventure
carried out.
(d) On the matters stated above, the partners are free to have an understanding
other than in the
manner stated above. However, if they have no specific understanding on these matters,
the
above applies to them.
51.10 LET US SUM UP
Every partner is bound to indemnify the firm for any loss caused to the partnership firm
by his fraud in the conduct of the business of the firm. The partners of a firm can decide
their mutual rights and duties and change them from time to time with the consent of all
the partners. The property of the firm has to be held and used by the partners exclusively
- CAIIB DISCUSSION
for the purposes of the business. The partners can decide the use of the property by
mutual consent.
1. State whether the following statements are True or False, (i) Every partner has a right
to receive remuneration, (ii) It is necessary that all the partners in the partnership firm
must receive equal share of profits in
the partnership firm, (iii) No partner is entitled to use the partnership property for his
private purposes.
1. (i) False; (ii) False; (iii) True.
RELATIONS OF PARTNERS TO THIRD PARTIES
STRUCTURE
52.0 Objective
52.1 Introduction
52.2 Partner is an Agent of the Firm
52.3 Implied Authority of Partner as Agent of the Firm
52.4 Extension and Restriction of Partner's Implied Authority
52.5 Partner's Authority in an Emergency
52.6 Mode of Doing Act to Bind Firm
52.7 Liability of a Partner for Acts of the Firm
52.8 Liability of the Firm for Wrongful Acts of a Partner
52.9 Liability of Firm for Misapplication by Partners
52.10 Holding Out
52.11 Rights of Transferee or a Partner's Interest
52.12 Let Us Sum Up
386
52.0 OBJECTIVE
The objective of this unit is to understand the rights and liabilities of the partners with
respect to contracts entered into with third parties.
52.1 INTRODUCTION
A partner is the agent of the firm for the purpose of the business of the firm. Every
partner plays a dual role in a partnership. One is the role of a principal, i.e. on his own
behalf and the other the role of an agent for every other partner. It must be noted that
every partner is an agent of every other partner only in the business of the firm.
52.2 PARTNER IS AN AGENT OF THE FIRM
A partner can make the firm liable by his acts, if done in the name of the firm and in the
ordinary course of business of the firm. A partner, who contracts in his own name, incurs
only a personal liability and not the collective liability of the firm.
52.3 IMPLIED AUTHORITY OF PARTNER AS AGENT OF THE FIRM
An act done by a partner to carry on the kind of business done by the firm (in the usual
way) binds the firm. This authority of a partner to bind the firm is called his 'implied
authority'.
The implied authority of a partner does not empower him to
(a) submit a dispute relating to the business of the firm to arbitration (i.e. for
settlement by an
independent person other than the parties to the dispute);
(b) open a banking account on behalf of the firm in his own name;
(c) compromise or relinquish (give up) any claim by the firm;
- CAIIB DISCUSSION
(d) withdraw a suit or proceeding filed on behalf of the firm;

(e) admit (accept) any liability in a suit or proceeding against the firm;
(f) acquire immoveable property on behalf of the firm;
(g) transfer immoveable property belonging to the firm; or
(h) enter into partnership on behalf of the firm.
52.4 EXTENSION AND RESTRICTION OF PARTNER'S IMPLIED
AUTHORITY
The partners in a firm may by mutual agreement amongst themselves, extend or restrict
the implied authority of any partner. Any act done by a partner on behalf of the firm
within his implied authority binds the firm unless the person with whom he is dealing
knows the restriction.
52.5 PARTNER'S AUTHORITY IN AN EMERGENCY
Whatever may be the powers given to a particular partner, in case of an emergency, a
partner has authority to do all acts to protect the firm from loss, as would be done by a
person of ordinary prudence in his own case. The firm is bound by such acts.
52.6 MODE OF ACTION TO BIND FIRM
In order to bind a firm, the partner must do the activities in the name of the firm and
execute the documents on behalf of the firm or in any other manner expressing or
implying an intention to bind the firm. A person cannot simply sign an agreement in his
own name to purchase goods for the firm and
387
say that since he is the partner in a firm XYZ it is implied that the partners are bound to
pay for the goods. For example, he should sign as 'For and on behalf of XYZ'.
52.7 LIABILITY OF A PARTNER FOR ACTS OF THE FIRM
Every partner is liable jointly with all the other partners and also severally for all acts of
the firm done while he is a partner. This is a core principle of partnership business.
52.8 LIABILITY OF THE FIRM FOR WRONGFUL ACTS OF A PARTNER
If a partner commits some wrongful act or omits doing of something in the ordinary
course of the business of the firm with or without the authority of other partners and
consequently
same extent asa the
losspartner.
or injury is caused to any third party, the firm is liable thereof to the
52.9 LIABILITY OF FIRM FOR MISAPPLICATION BY PARTNERS
The firm is liable to make good the loss of money or property from a third party in the
following cases:
If any partner had received the funds within his obvious and clear authority but had
misapplied the funds.
The firm received the funds in the course of its business and the same was misapplied by
any of the partners while it is in the custody of the firm.
52.10 HOLDING OUT
Anyone who by words spoken or written or by conduct represents himself or knowingly
permits himself to be represented to be a partner in a firm is as liable as a partner in that
firm to any who has on the faith of any such representation given credit to the firm
whether the person representing himself or represented to be a partner does or does not
know that the representation has reached the person so giving credit.
This is known as doctrine of holding out. This means that when a person who is not at all
a partner in a firm, either represents himself, or knowingly permits himself to be
represented, as a partner in a firm and as a result of this, he induces others to give credit
to the firm then he is known as a partner holding out. Such a stranger is liable
individually and personally for the debts of the firm as if he was a partner in the firm on
the principle of holding out. However, legal heirs or estate of the deceased partner is not
liable to the firm, who uses his name, after his death.
52.11 RIGHTS OF TRANSFEREE OR A PARTNER'S INTEREST
A transfer by a partner of his interest in the firm does not entitle the person to whom the
- CAIIB DISCUSSION
interest is transferred (transferee) to interfere in the conduct of the business but entitles
the transferee only to receive the share of profits of the transferring partner and the
transferee has to accept the account of profits agreed to by the partners. On dissolution of
firm or cessation of the partner, the transferee is entitled to a share in assets of the firm
and verification of accounts to ascertain his share.
52.12 LET US SUM UP
In order to bind a firm, the partner must do the activities under the name of the firm and
execute the documents on behalf of the firm or in any other manner expressing or
implying an intention to bind the firm. Every partner is liable jointly with all other
partners and also severally for all acts of the firm done while he is a partner. This is a
core principle of partnership business.
L.R.A.B-26
388
1. State whether the following statements are True or False.
(i) A single partner can be authorised to carry on business and sign documents on behalf
of the
firm.
(ii) Every partner is liable jointly with all other partners and also severally for all acts of
the firm done while he is a partner.
MINOR ADMITTED TO THE BENEFITS OF PARTNERSHIP
STRUCTURE
53.0 Objective
53.1 Introduction
53.2
53.3 A Minor
Legal cannotafter
Position be athe
Partner
Minor Attains Majority
53.4 Retirement of a Partner
53.5 Insolvency of a Partner
53.6 Let Us Sum Up

390
53.0 OBJECTIVE
The objective of this unit is to understand whether or not a minor can be a partner in a
partnership firm and what are his rights and liabilities in a firm. Further the
consequences of retirement of a partner and adjudication of a partner as insolvent are
also discussed.
53.1 INTRODUCTION
As mentioned in the Indian Contract Act, 1872 a minor is not competent to enter into a
contract. Hence, he is not eligible to enter into a contract of partnership. A person who is
a minor cannot be a partner in a firm but with the consent of all the partners, he may be
admitted to the benefits of partnership. In no circumstances, the minor can be made a
party to the liabilities of the firm.
- CAIIB DISCUSSION
exercise of good faith of powers conferred by contract between the parties. The expelled
partner is in the same position as that of the retiring partner.
53.5 INSOLVENCY OF PARTNER
If partner of a firm is adjudicated as an insolvent, he ceases to be partner from the date
on which the order of adjudication is made. An order of adjudication of a partner may or
may not dissolve the firm. If the firm is not dissolved pursuant to a contract upon
adjudication of a partner, the estate of a partner so adjudicated is not liable for any act of
the firm and firm is not liable for any act of the insolvent, done after the date on which
the order of adjudication is made.
53.6 LET US SUM UP
A minor cannot be a partner but he can be admitted to the benefits of the partnership.
1. State whether the following statements are True or False, (i) A minor can be a
partner in a partnership firm, (ii) A minor can be admitted to the benefits of a partnership
firm, (iii) A minor is personally liable like other partners to pay the debts of the firm, (iv)
A minor who is admitted to the benefits of a partnership firm, has a choice when he
attains majority as to whether he wants to continue as a partner or not.
1. (i) False; (ii) True; (iii) False; (iv) True.
UNIT
54
DISSOLUTION OF A FIRM
STRUCTURE
54.0 Objective
54.1 Introduction
54.2 Dissolution by Agreement
54.3 Compulsory Dissolution
54.4
54.5 Dissolution
Dissolution on the Happening
by the Court of Certain Contingencies
54.6 Liability for Acts of Partners Done after Dissolution
54.7 Let Us Sum Up
394
54.0 OBJECTIVE
To understand as to when and how a partnership firm may be dissolved and if so, what
are the rights and liabilities of partners on the dissolution of the firm.
54.1 INTRODUCTION
A partnership firm can be dissolved. This means that the partners can decide to stop
carrying on the business for which it is formed and the partners can decide their share in
the profits or losses as on the date of dissolution after payment of debts and liabilities.
This unit discusses the various modes of dissolution of a partnership firm.
54.2 DISSOLUTION BY AGREEMENT
A firm can be dissolved with the consent of all the partners or in accordance with a
contract between the partners.
54.3 COMPULSORY DISSOLUTION
A firm is dissolved:
(a) if all the partners (except one) are adjudicated insolvent; or
(b) by the happening of any event which makes it unlawful for the business itself to
be carried on or
- CAIIB DISCUSSION
the event makes the business unlawful if it carried on in partnership.

However, if the partnership firm is carrying on more than one separate businesses, the
illegality of one or more does not cause the dissolution of the firm. The firm can
continue to carry on its lawful adventures and undertakings.
54.4 DISSOLUTION ON THE HAPPENING OF CERTAIN CONTINGENCIES
A firm is dissolved in the following circumstances. To avoid dissolution in these cases,
the partners should expressly agree that the firm shall not be dissolved in these
circumstances:
(a) if the partnership is constituted for a fixed term, then by the expiry of that term;
(b) if the partnership is constituted to carry out one or more adventures or
undertaking, then by the
completion thereof;
(c) by the death of a partner; and
(d) by the adjudication of a partner as an insolvent.
54.5 DISSOLUTION BY THE COURT
At the suit of a partner the court may dissolve a firm on any of the following grounds:
(a) that a partner has become of unsound mind;
(b) that a partner (other than the partner suing for dissolution) has become
permanently incapable of
performing his duties as partner;
(c) that a partner (other than the partner suing) is guilty of conduct which is likely
to affect prejudicially
the carrying on of the business;
(d) that a partner (other than the partner suing) wilfully or persistently commits
breach of agreements
in relation to the management of the affairs of the firm or the conduct of its business or it
is not
reasonably practicable for the other partners to carry on the business in partnership with
him
I because of his conduct with respect to the business;
395
(e) that a partner (other than the partner suing) has transferred the whole of his
interest in the firm to
a third party;
(f) that the business of the firm cannot be carried on except at a loss; or
(g) on any other ground which renders it just and equitable that the firm should be
dissolved.
54.6 LIABILITY FOR ACTS OF PARTNERS DONE AFTER DISSOLUTION
Any partner of the firm must give a public notice to the effect that the firm is dissolved.
This is because even after the dissolution of a firm, the partners continue to be liable to
third parties for any act done by any of them, until such public notice is given.
54.7 LET US SUM UP
A firm can be dissolved by agreement between the partners or by the court or it gets
compulsorily dissolved in certain cases.
1. State whether the following statements are True or False, (i) The partners can
mutually agree and dissolve the firm, (ii) On the death of a partner the partnership firm is
compulsorily dissolved.
1. (i) True; (ii) False
EFFECT OF NON-REGISTRATION
- CAIIB DISCUSSION
STRUCTURE
55.0 Objective
55.1 Introduction
55.2 Registration
398
55.0 OBJECTIVE
The objective of this unit, is to understand as to whether a partnership firm is required to
be registered with any governmental authorities and what are the benefits of registration
and the consequences of non-registration of a partnership firm.
55.1 INTRODUCTION
A company is compulsorily required to be incorporated and registered with the Registrar
of Companies under the Companies Act, 1956. However, a partnership firm is not
required to be compulsorily registered with the Registrar of Partnership Firms.
55.2 REGISTRATION
The partner's may or may not enter into a partnership deed and may decide to have an
oral partnership if they have a strong understanding amongst themselves. Further, even if
a partnership deed is entered into by the partners they may not opt for registration of the
partnership firm. However, the Partnership Act casts certain disabilities on a partnership
firm that is not registered with the Registrar of Partnership Firms. Due to this provision
which is stated in the Section 69, a majority of the partnership firms decide to register
the firm to avoid future hassles and complexities on solving issues amongst the partners
as well as with third parties. The provisions of the Section 69 are briefly stated
hereunder:
A partner of an unregistered firm cannot enforce by way of a suit, any right available to
him under the Partnership Act or a right conferred by a contract amongst the partners
against the partnership firm or any partner thereof.
Similarly an unregistered
contract against any third firm
party.cannot enforce by way of a suit, any right arising by a
However the enforcement of any right to sue, for matters relating to the dissolution of a
firm is not affected and can be brought before the Court of Law.
1. State whether the following statement is True or False.
(i) A partner of an unregistered firm can file a suit against other partners to get his share
of profits.
1. (i) False.
d >f
UNIT
56
DEFINITION AND FEATURES OF A COMPANY
:s :d
IP :d
is
tie or
- CAIIB DISCUSSION
STRUCTURE
56.0 Objective
56.1 Introduction
56.2 Definition of a Company
56.3 Features of a Company
56.4 Distinction between a Company and Partnership
56.5 Let Us Sum Up
ist
lOt
ts.
400
56.0 OBJECTIVE
In this unit, an attempt is made to explain the nature of a company and the fundamental
legal aspects of the form of organisation of a company as evolved by courts and as
enshrined under the Companies Act, 1956.
56.1 INTRODUCTION
In today's trade world, companies are the rivers of commercial prosperity of the country.
The form of organisation of a company is relatively more advantageous than other forms
of business organisations. The features of limited liability, perpetual existence and
separate entity serve as advantages to set up a company.
56.2 DEFINITION OF A COMPANY
Section 3 of the Companies Act, 1956 defines a company as 'a company formed and
registered under this Act, or an existing company'. An existing company means a
company formed and registered under any of the former Companies Acts.
56.3 FEATURES OF A COMPANY
(a) Registration
A
(b)company has to be
Artificial compulsorily
Legal Person registered under the Companies Act, 1956.
A company is an artificial legal person which is created by law and can be dissolved by
the law alone. It is invisible, intangible and exists only in the eyes of the law. It enjoys
many rights of a natural person. A company may enter into contracts in its own name,
and it can acquire and dispose property and can be fined under the provisions of the law
for violation of law. However a company is not a natural citizen like an individua l and
courts have held that neither the provisions of the Constitution of India nor the
provisions of the Citizenship Act apply to a company. Thus, even though a company has
a nationality and domicile it has no citizenship.
(c) Independent corporate personality
A partnership firm has no legal existence apart from its members. In other words, a
partnership firm is nothing but the aggregate of the partners. A company on the other
hand, after incorporation is in law a single person, it has a distinct legal per sonality. By
incorporation under the Companies Act, 1956 the company is vested with a corporate
personality which is independent of and different from the members who compose it.
The decision of House of Lords in England in the case of Salomon vs A. Salomon and
Company Limited (1897) AC 22 at 57: (1895-9) All ER Rep 33 is the leading case as the
bedrock of the existence of a company.
Salomon, an individual was a boot and shoe manufacturer. He incorporated a company
named Salomon and Company Limited and the company took over and carried on his
personal business. The seven subscribers to the memorandum of association were
Salomon himself, his wife, four sons and a daughter each taking one share. The
company's board of directors was composed of Salomon as the managing director and
- CAIIB DISCUSSION
his four sons. Through this board, the personal business of Salomon was transferred to
the company for 40,000 pounds. In payment thereof Salomon was allotted 20,050 shares
of one pound each and debentures worth 10,000 pounds. These debentures certified that
the
401
company owed Salomon 10,000 pounds and created a charge on the company's assets.
One share was given to each remaining member of the family. Within a year, the
company went into liquidation and the state of affairs was broadly like this - assets 6,000
pounds liabilities - Salomon's debentures at 10,000 pounds and ordinary insecured
creditors at 7,000 pounds. Thus, after paying off the debenture holder (Salomon) nothing
would be left for the insecured creditors. The insecured creditors filed a case against the
company and contended that though incorporated under the Companies Act, 1956 the
company never had an independent existence at all. It was Salomon himself trading
under another name and that he cannot pay off himself first for the debentures from his
own funds by creating a charge on the assets. The insecured creditors should be paid
first. The House of Lords held that Salomon and the company were different and the
company had a separate existence of its own.
(d) Limited liability
Limitation of liability is an advantage of incorporation of a company. Since under
company law, the existence of a company is different from its own members and
directors and a company leads its own business existence and since it is itself the owner
of its assets and has its own liabilities, the members of the company are not bound to
contribute anything more than the nominal value of the shares held by them and their
liability ends there even though there may be creditors who may be claiming crore of
rupees from the company In a partnership firm, on the other hand, the liability of the
partners for the debts of the firm is unlimited and the partners are required to meet all the
liabilities of the partnership firm from their own pocket.
(e) Perpetual succession
An incorporated company never dies. It is a legal entity with perpetual succession. The
insolvency
In spite of aortotal
death of members
change does not of
in the members affect the continued
the company, existence will
the company of the company.
remain the
same entity. Members may come and members may go but the company goes on forever.
(f) Separate property
On incorporation the company becomes the owner of its capital and assets. The company
is capable of holding property in its own name.
(g) Transfer of shares
The Companies Act, 1956 states that shares or other interest of any member in a
company shall be moveable property, transferable in the manner provided by the articles
of association. A shareholder may sell his shares in the open market and get back his
money without changing the capital of the company.
(h) Common Seal
As a company is an artificial legal person, it is not capable of signing documents for
itself. It acts through natural persons who are the directors appointed by the shareholders
of the company. However since it is a legal person it can be held responsible for only
those documents that bear its signature. Hence the law provides for a common seal with
the name of the company engraved on it as a substitute for its signature. Any document
bearing the common seal of the company is legally binding on the company. However a
common seal cannot be affixed by any director. It has to be affixed in the manner stated
in the articles of association, e.g., in the presence of two directors who shall sign on the
document where the common seal is affixed in their presence.
(i) Corporate veil
Although a company is a separate legal entity distinct from shareholders in reality it is an
association of persons who are the beneficial owners of all the corporate property. Hence
- CAIIB DISCUSSION
it may sometime become
402
necessary to look at the persons who are behind the corporate veil. The corporate veil is
said to be lifted or pierced when the Court ignores the separate entity of the company
and directly concerns itself with the members or directors of the company. There is no
specific law as to when this should be done. The Court decides this as applicable on a
case to case basis.
56.4 DISTINCTION BETWEEN A COMPANY AND PARTNERSHIP
(a) Registration
Registration of a company is compulsory under the Companies Act, 1956. Registration
of a partnership is not compulsory under the Indian Partnership Act, 1932.
(b) Number of members/partners
Minimum of two and maximum of fifty in case of a private company and a minimum of
seven and no limit on maximum number of members in case of public company.
Minimum number of two persons is required to form a partnership. The maximum
number is ten for banking business and twenty for any other business.
(c) Legal status
A company has a legal existence separate from its own members and is viewed as a
separate legal person from its members. A firm does not have, a separate legal existence
different from its own partners.
(d) Ownership of property
The property of the company is owned by the company itself and not its members as the
company has a separate legal existence. The property of the firm is owned by the
partners themselves and not by the firm as a firm does not have a separate legal existence
different from its own partners.
(e) Management
The company is managed by a board of directors elected by the shareholders. A
partnership is managed by the partners except the dormant and sleeping partners.
(f) Perpetual existence
A
A company has
partnership a perpetual
does not haveexistence.
a perpetual existence.
(g) Contracts
A member of the company can contract with the company. A partner cannot contract
with the partnership firm.
(h) Liability
Except in case of a company with unlimited liability, the liability of the members of the
company is limited. The liability of partners in a partnership is unlimited.
(i) Transfer
A transferee of shares in a company becomes a member of the company and the consent
of all members is not required to become a member. A person can become a partner in a
partnership firm with the consent of all the partners.
0) Death
The death of any or all members of the company does not determine (end) the existence
of the company. Death of a partner dissolves the partnership unless the partnership deed
provides otherwise.
403
(k) Agency
The members of a company are not the agents of each other or of the company. Every
partner of a firm is an agent of the other.
56.5 LET US SUM UP
A company is an artificial legal person which is created by law and can be dissolved by
law alone. It is invisible, intangible and exists only in the eyes of law. A company can
- CAIIB DISCUSSION
enter into contracts in its own name, and it can acquire and dispose property and can be
fined under the provisions of the law for a violation of the law. It is a distinct entity from
the members forming it. Since a company is a distinct legal person, it has its own
signature, i.e., a common seal with the name of the company engraved in it.
1. Indicate whether the following statements are True or False, (i) Directors are the
actual owners of a company.
(ii) A company has to be compulsorily registered under the Companies Act, 1956. (iii) A
company cannot enter into contracts in its own name, (iv) If all the members of a
company die, then the company has to be wound up (i.e., dissolved).
1. (i) False; (ii) True; (iii) False; (iv) False.
UNIT
57
TYPES OF COMPANIES
STRUCTURE
57.0 Objective
57.1 Introduction
57.2 Classifications of Companies on the Basis of Mode of Incorporation
57.3 Classifications of Companies on the Basis of Liability
57.4 Classifications of Companies on the Basis of Public Interest
57.5 Holding and Subsidiary Companies
57.6 Let Us Sum Up
406
57.0 OBJECTIVE
The objective of this unit is to enable the candidates to understand the various types of
companies that can be formed under the Companies Act, 1956 and their peculiar
features.
57.1 INTRODUCTION
There are various types of companies that can be formed under the Companies Act, 1956
and they can be classified as per the mode of incorporation, on the basis of liability, on
the basis of public interest, as holding and subsidiary companies, etc. This unit examines
these in brief.
57.2 CLASSIFICATIONS OF COMPANIES
THE BASIS MODE OF INCORPORATION
1. Statutory Company
2. Registered under the Companies Act, 1956
57.2.1 Statutory Company

A statutory company is created or incorporated by a special Act passed by either the
Central or the State Legislature. It enjoys powers, rights and privileges as laid down in
the Act. Hence, the statutory companies are not required to have Memorandum of
Association. Although each statutory company is governed by the provisions of the
special Act, the Companies Act, 1956 is also applicable to them insofar as the provisions
- CAIIB DISCUSSION
of the Companies Act, 1956 are not inconsistent with the provisions of the special Act
under which the company is incorporated. Examples of statutory companies - Reserve
Bank of India incorporated under the Reserve Bank of India Act, 1934; Food
Corporation of India.
57.2.2 Registered under the Companies Act, 1956
Such companies are incorporated and registered under the prevailing Companies Act,
e.g. Tata Iron and Steel Company Limited is incorporated and registered under the
Companies Act prevailing before the enactment of the Companies Act, 1956, i.e. the
Companies Act, 1913.
57.3 CLASSIFICATIONS OF COMPANIES ON THE BASIS OF LIABILITY
1. Company limited by shares

3. Company with unlimited liability
2. Company limited by guarantee
Company Limited by Shares

In such companies there is a share capital and each share has a fixed nominal value also
known as the face value which the shareholder is bound to pay either at a time or in
instalments. The member is not bound to pay anything more than the fixed amount on
the share, whatever may be the liabilities of the Company. In other words, the liability of
the members of such a company is limited to the extent of amount unpaid on the shares.
It may be a private company or a public company. Such companies are the most
commonly found companies.
Company Limited by Guarantee
Where the liability of the members of the company is limited by the memorandum of
association to such an amount a s the members undertake to contribute to the assets of the
company in the event of the liquidation of the company, the company is known as a
company limited by guarantee. In other words, in such a company each member
promises to pay a fixed sum of money in case of its winding up. The amount is called the
guarantee. A guarantee
company must company
have articles may or may
of association. not have
If such a share has
a company capital. A guarantee
a share capital then
each
40/
member is required to pay the amount of the fixed share capital as in the case of a
company limited by shares in addition to the guarantee. Thus the liability is restricted to
the amount of the share capital plus the amount of guarantee. Such a company may also
be a private company or a public company.
57.3.3 Company with Unlimited Liability
Where the liability of the members of a company is unlimited it is known as an unlimited
company. Every member of such a company is liable without any limit for its debts as in
the case of a partnership firm in proportion to his interest in the company. If such a
company has a share capital, it may be a public company or private company. An
unlimited company must have articles of association and it must state the number of
members and the share capital (if any) with which it is proposed to be registered.
57.4 CLASSIFICATIONS OF COMPANIES ON THE BASIS OF PUBLIC INTEREST
On the basis of public interest companies can be classified as under:
1. Private company 2. Public company
3. Government company 4. Foreign company
Private Company
A private company is defined under the Section 3 of the Companies Act, 1956 as a
company which under its articles of association contains the following restrictions:
(a) Transfer of Shares
- CAIIB DISCUSSION
If a private company has a share capital it imposes restriction on the right to transfer
shares in a manner which restricts the number of members to fifty.
(b) Restricts the number of members to fifty
The maximum number of members of a private company is limited to fifty excluding the
members who were past employees or are the present employees of the company.
(c) Issue of Prospectus
A private company cannot issue a prospectus and cannot invite the public to subscribe
for any shares or debentures of the company.
(d) Deposits
A private company prohibits any invitation or acceptance of deposits from persons other
than its members, directors or their relatives.
A private company should have a minimum paid-up capital of Rs. 1 lakh.
Public Company
A public company is one which is not a private company. In a public company the
number of its members is unlimited. Any seven or more persons can form a public
company. Generally the shares of a public company are listed on the stock exchange and
therefore the marketability of the shares is more. A public company should have a
minimum paid-up capital of Rs. 5 lakh.
There are certain provisions under the Companies Act, 1956 which are applicable only to
a public company and not to a private company and by which a private company is
benefited. However, if a private company defaults in complying with the aforesaid four
restrictions then it shall cease to enjoy these exemptions and all these provisions shall
apply as if it is a public company.
Some of the advantages of a private company over a public company (exemptions and
benefits to a private company under the Companies Act, 1956). This also forms a
distinction between a private
408
(i) A private company can have only two members and two directors. A public company
has to
have
obtaina aminimum ofof
certificate seven members and
commencement ofthree directors,
business (ii)Registrar
from the A private company need not
of Companies which a public company has to obtain and it has to only get the certificate
of
incorporation, (iii) A private company need not hold a statutory meeting and submit a
statutory report to the
Registrar of Companies while a public company has to do so. (iv) Certain provisions of
the Companies Act, 1956 with respect to requirements of appointment and
remuneration payable to the directors applicable to a public company are not applicable
to a
private company, (v) Certain provisions of the Companies Act, 1956 with respect to
general meetings of a company
are not applicable to a private company, (vi) Restrictions on the powers of the Board of
Directors under the Section 293 of the Companies
Act, 1956 which stipulate that certain powers cannot be exercised by the Board of
Directors
except without the consent of the company in a general meeting are not applicable to a
private
company.
Government Company
The Companies Act, 1956 defines a government company as any company in which not
less than fifty-one per cent of the paid-up share capital is held by
• the Central Government or
• by any State Government or Governments or
- CAIIB DISCUSSION
• partly by the Central Government and partly by one or more of State

Governments
and includes a company which is subsidiary of a government company, e.g. Bharat
Heavy Electricals Limited, Bokaro Steel Limited, etc.
Foreign Company
The Companies Act, 1956 defines a foreign company as a company which is
incorporated outside India but has a place of business in India.
57.5 HOLDING AND SUBSIDIARY COMPANIES
A company is deemed to be a subsidiary of another if:
• That other company controls the majority composition of its board of directors
with the sole object
of controlling its management.
• That other company holds the majority of its shares.
• The holding company's subsidiary has its own subsidiary; it becomes the
subsidiary of the first
mentioned company (i.e. the first holding company). Thus, for example, company B is a
subsidiary
of company A and company C is a subsidiary of company B then company C is a
subsidiary of
company A.
57.6 LET US SUM UP
There are various types of companies that can be incorporated, e.g. statutory company,
company limited by shares, company limited by guarantee, company with unlimited
liability, private company, public company, etc. A private company enjoys certain
relaxations of legal compliance under the Companies Act, 1956 as compared to a public
company.
409
(i) In case of a company limited by shares the creditors of the company can recover the
money
from the members if the company is not making profits, (ii) A member cannot transfer
shares in a public company without the consent of other members.
2. Fill in the blanks from the options given in the brackets.
(i) The minimum number of members required in a private company is . (3/7/12/2)
(ii) The minimum number of members required in a public company is (3/7/12/2)
(iii) The maximum number of members in a private company can be (7/12/50/2)
(iv) The maximum number of members in a public company can be . (any number/
12/50/15)
(v) A private company should have a minimum paid-up capital of Rupees . (five
crore/five lakh/one crore/one lakh)
(vi) A public company should have a minimum paid-up capital of Rupees . (five
crore/five lakh/one crore/one lakh)
(vii) In a government company the government holds at least per cent of the paid-up
capital. (12/15/50/51)
1. (i) False; (ii) False.
2. (i) 2; (ii) 7; (iii) 50; (iv) any number; (v) one lakh; (vi) five lakh; (vii) 51.
UNIT
58
MEMORANDUM OF ASSOCIATION AND ARTICLES OF ASSOCIATION

- CAIIB DISCUSSION
STRUCTURE
58.0 Objective
58.1 Introduction
58.2 Memorandum of Association
58.3 Articles of Association
58.4 Distinction between the Memorandum of Association
and Articles of Association
58.5 Let Us Sum Up
58.7 Answer to 'Check Your Progress'
412
58.0 OBJECTIVE
To understand the concept and importance of the constitutional documents which form
the basis of incorporation and administration of a company.
58.1 INTRODUCTION
The basic documents that are necessary to incorporate a company are the 'Memorandum
of Association' and the "Articles of Association'. The business of the company is carried
on the basis of the objectives laid down in the memorandum of association while the
internal management and procedures are regulated by the articles of association.
58.2 MEMORANDUM OF ASSOCIATION
The first step in the formation of a company is the preparation of the memorandum of
association. It is a document of great significance as it embodies the fundamental rules
regarding the constitution and scope of activities of a company. The purpose of
memorandum of association among others is to enable the member's creditors and those
who deal with the company to know the permitted scope of its activities.
Contents of the various clauses of the memorandum of association are stated herein
together with a brief of a provision pertaining to that clause.
A.
A company Name
is aclause
legal person and hence it must have a name to be identified. A company
cannot have a name which in the opinion of Central Government is undesirable. A name
is undesirable when it is identical with or too nearly resembles the name of another
company.
If the company is with limited liability the last word of the name should be limited and
in case of a private company the last words should be private limited. However, the
Central Government has powers to permit by licence a company not to use the words
private limited or limited as the case may be, if the company is formed for promotion of
arts, commerce, science, religion, charity or any other useful objective and the company
intends to apply its income, if any, in promoting its objects and to prohibit the payment
of any dividend to its members.
B. Registered office clause
This clause must mention the name of the state in which the registered office of the
company is situated. It is to be noted that the address of the registered office is not to be
mentioned. Only the name of the state is required to be mentioned. A company shall
from the date on which it commences business or within thirty days after the date of
incorporation, whichever is earlier, have a registered office to which all the
communications and notices may be addressed. Notice of the situation of the r egistered
office and of every change therein is to be given within thirty days after the date of
incorporation of the company or after the date of the change as the case may be to the
registrar of companies who shall record the same.
C. Objectives Clause
This is a very important clause and must be drafted very carefully and i t should clearly
- CAIIB DISCUSSION
state the objectives for which the company is established (incorporated) and the nature of
business it can undertake/carry on. Choice of the objectives is left with the subscribers to
the memorandum of association who incorporate the company. Although the ownership
of the corporate capital is vested in the company itself, in reality the capital is
contributed by the shareholders. It is therefore very essential that the objectives of the
proposed company must be intimated to the shareholders so that they can decide in
413
which business areas they want to invest their mo.iey. A company can have any lawful
objectives. This means that a company cannot have objectives contrary to law to carry
on activities prohibited under the law.
The objectives clause, of the memorandum of association of a company are to be
classified and stated under two sub-clauses as 'main clause' and 'other objectives'.
The Main Objectives clause must contain the main objectives which are to be pursued by
the company immediately on incorporation and objectives which are incidental or
ancillary to the attainment of the main objectives of the company.
The Other Objectives clause must contain other objectives which are not included in the
above clause.
D. Liability clause
If the company is to be incorporated with limited liability the liability clause must state
that the liability of the members shall be limited by the unpaid amount on shares.
E. Capital clause
In case of companies having a share capital this clause must state that the amount of
share capital which the company will be authorised to raise and the number and the
value of shares into which it is divided.
F. Association or subscription clause
The memorandum of association concludes with a declaration of the subscription that the
persons who have subscribed their signatures intend to form themselves into an
association
58.3 ARTICLESin accordance with the Memorandum of Association.
OF ASSOCIATION
Articles of Association is the second important document of a company. It consists of a
set of rules/ regulations and bye laws made by the company for internal management of
the company and for carrying out the objects of the company embodied in its
memorandum of association.
The Companies Act, 1956 requires that the articles of association must be filed together
with the memorandum of association by the following kind of companies:
• Unlimited company • Company limited by guarantee
• Private company limited by shares
Schedule I of the Companies Act, 1956 sets out the tables or model forms of articles of
association for different companies. Table A is applicable to public companies limited
by shares. Hence a public company limited by shares may either frame its own articles of
association or adopt the regulations contained in Table A which will then automatically
apply to the extent to which it is not excluded.
The main advantage of adopting Table A lies in the fact that its provisions are legally
beyond all doubt.
In the case of an unlimited company the articles of association must state the number of
members with which the company is to be registered and the amount of share capital of
the company (if the company has a share capital).
In the case of a company limited by guarantee the articles of association must state the
number of members with which the company is to be registered.
In the case of a private company the articles of association must contain the restrictive
conditions peculiar to a private company (i.e. with respect to prospectus, deposits,
- CAIIB DISCUSSION
number of members and transfer of shares).
414
58.4 DISTINCTION BETWEEN THE MEMORANDUM OF ASSOCIATION
AND
ARTICLES OF ASSOCIATION
The memorandum of association contains the fundamental conditions (objects) upon
which the company is incorporated. The conditions are introduced for the benefit of the
creditors, the shareholders, and the outside public.
The articles of association are the internal regulations of the company and they provide
the manner in which the proceedings of the company are to be carried on.
The memorandum of association is a dominant instrument as it states the purposes of the
company and the reasons for which it has come into existence.
The articles of association are always held to be subordinate to the memorandum of
association because the articles of association are merely the internal regulations of the
company while the memorandum of association states the objects of the company
beyond which the company cannot go.
Clauses in the memorandum of association (e.g. change of registered office in another
state or the objects clause) can be altered only by a special resolution passed by the
company and with the sanction of the Company Law Board.
Any terms of the articles of association can be altered by a special resolution and no
approvals are required from the Company Law Board or any other authority.
If a company commits an act in contravention of the memorandum of association (e.g. a
company having objects only to manufacture biscuits starts activities of bottling of milk
without proper amendments in the objects clause) then the acts done and liabilities
arising there from are not binding on the company and the same cannot be ratified by the
company.
If a company does something in contravention of the provisions of its articles of
association, it is only a procedural irregularity and the same can be ratified by the
shareholders at a general meeting and thus rectified.
58.5 LET US SUM

The memorandum UP
of association and articles of association are the basic constitutional
documents of the company, which define the ambit of the operations of the company.
1. Indicate whether the following statement is True or False.
(i) In case of conflict between the memorandum of association and articles of
association, the articles of association prevail.
58.7 ANSWER TO CHECK YOUR PROGRESS'
1. (i) False.
UNIT
59
DOCTRINES OF ULTRA VIRES/ CONSTRUCTIVE NOTICE/INDOOR

MANAGEMENT
STRUCTURE
59.0 Objective
59.1 Introduction
59.2 Doctrine of Ultra Vires
59.3 Effects of Ultra Vires Transaction
59.4 Constructive Notice of Memorandum of Association and Articles of
Association
59.5 Effect of the Doctrine of Constructive Notice
- CAIIB DISCUSSION
59.6 Doctrine of Indoor Management

59.7 Let Us Sum Up
59.9 Answers to 'Check Your Progress' s
416
59.0 OBJECTIVE
The objective of this unit is to understand the implications of the doctrines of ultra
vires/constructive notice/indoor management which govern the interpretation of the
memorandum and articles of association.
59.1 INTRODUCTION
These three doctrines deal with the rights and duties of the company with respect to the
members, amongst the members, and of the company with the outsiders. We now dwell
upon the doctrines in detail as under:
59.2 DOCTRINE OF ULTRA VIRES
When a company exercises its powers to promote and/or realise any of its objectives
stated in the memorandum of association, it is intra;vires (i.e. within the powers of) the
company. However, any other act of the company which is outside the scope of the
objects clause of the memorandum of association is known as ultra vires (i.e. beyond the
powers of) the company.
The rule of law on the question of the doctrine of ultra vires has been clearly and
emphatically laid down by House of Lords in Ashbury Railway Carriage and Iron
Company vs Riche (1875) LR 7 HL 653, 671. The facts of the case are as under:
Ashbury Company was incorporated with the objectives to manufacture and sell railway
carriages, etc., and to act as mechanical engineers and general contractors. The directors
of the company had contracted with Riche to finance the construction of railway line in
Belgium. Subsequently, the directors repudiated the contract on the ground that it was
ultra vires to the company and Riche brought an action for damages for breach of
contract.
The House of Lords held that the contract was ultra vires and therefore null and void. It
was laid down

objectives that the
as stated company
in the came
objectives into existence
clause. for the achievement
These objectives ofstate
affirmatively the the
activities that the company can undertake/carry and its states negatively that nothing
shall be done beyond the ambit of the objectives for which the company is established.
The term general contractors was meant to be read as making such type of contracts
generally that are connected with the business of mechanical engineers and if it is not so
interpreted then it would authorise the making of contracts of every nature and
description. Hence, it was entirely beyond the powers of the company to enter into the
contract.
59.3 EFFECTS OF ULTRA VIRES TRANSACTION
An ultra vires transaction is void ab initio and therefore cannot become intra vires by
reason of ratification. No company can be held liable for obligations arising out of such a
contact. If lending done by the company is ultra vires then the company is entitled to
recover the money from the debtors because the debtors cannot say that the company had
no power to lend. If the rendering of a particular service by the company is ultra vires the
company is entitled to recover the charges for such services. If the property of the
company is delivered to an outsider through an ultra vires act, the company can get back
the property if such property can be traced.
Effects of Ultra Vires Acquired Property
If a company's money has been spent ultra vires in purchasing any property the company
is entitled to the ownership of such a property because that asset though wrongly
acquired represents the capital of the company.
417
- CAIIB DISCUSSION
Personal Liability of Directors

If a director of a company makes an ultra vires payment he is personally liable to the
company and he can be compelled to refund the money. In the case of deliberate
misapplication, criminal action can also be taken for fraud.
Breach of Authority
Directors are the agents of the company. Hence, they must act within the limits of the
powers of the company. If they induce (however innocently) an outsider to contract with
the company in a matter in which the company does not have power to act, they will be
personally liable to such an outsider for his loss provided that the outsider had no
knowledge of the fact that the act was ultra vires the company.
59.4 CONSTRUCTIVE NOTICE OF MEMORANDUM ASSOCIATION AND
ARTICLES OF ASSOCIATION
What is meant by constructive notice of the memorandum of association and articles of
association? The memorandum of association and articles of association of a company
are registered with the registrar of companies at the time of incorporation. As the office
of the registrar of companies is a public office, the memorandum of association and
articles of association become public documents. Hence, the act expressly guarantees the
right of inspection of these documents to all. It is therefore the duty of every person who
deals with a company to inspect its public documents, i.e. its memorandum of
association and articles of association and make sure that his contract is in accordance
with their provisions. However, whether a person has actually read them or not he shall
be in the same position as if he had read them.
In other words, he will be presumed to have knowledge of the contents of these
documents and to have understood them according to their proper meaning. This kind of
presumed notice is known as constructive notice. This is known as the doctrine of
constructive notice.
59.5 EFFECT OF THE DOCTRINE OF CONSTRUCTIVE NOTICE
The following are the practical effects of the doctrine of constructive notice:
(a) He who deals with the company is deemed to have notice of the public
documents whether he has
actually
(b) seen themeffect
Another or not.
is that a person dealing with the company is not only deemed to
have notice but is
also presumed to have read those documents and to have understood not only the
company's
powers but also of its officers.
(c) The doctrine of constructive notice is of a negative nature in the sense that it
stops a person from
contending (arguing) that he had no notice of the contents of the documents.
59.6 DOCTRINE OF INDOOR MANAGEMENT
The principle of constructive notice seeks to protect the company against the outsiders
whereas the doctrine of indoor management seeks to protect outsiders against the
company. The doctrine of indoor management may be stated briefly as under:
A person who deals with the company is deemed to have read and understood the
registered public documents such as the memorandum of association and articles of
association, etc., to see that his contract with the company is not inconsistent with them.
But he is not bound to inquire into the regularity of the company's internal functioning or
the internal management of the company. Hence if his contract is consistent with the
public documents, the company is bound. He will not be affected by
418
any irregularity in the internal management of the company. This is known as the
doctrine of indoor management.
The doctrine of indoor management was first illustrated in the case of Royal British
- CAIIB DISCUSSION
Bank vs Turquand
(1856) 6 E & B 327: (1843-60) All ER Rep 435. The facts of the case are as under:
The directors of a company (Royal British Bank) borrowed a sum of money from
Turquand, and issued a bond to him. The articles of association of the company provided
that the directors might borrow on bonds such sums as may be from time to time be
expressly authorised by the resolution of the shareholders. The shareholders claimed that
there had been no such resolution authorising the loan.
The company, however, was held bound by the loan because Turquand had the right to
assume that the necessary resolution must have been passed.
Exception
The doctrine of indoor management has the following exception:
Knowledge of internal irregularity
Where a person dealing with the company has actual knowledge of the internal
irregularity of the company he is not entitled to claim protection of this doctrine because
he could have taken measures for self-protection.
Acts outside apparent authority of an officer of company
Finally, if an officer of the company makes a contract with an outsider and if the act of
the officer falls outside the apparent authority of an officer, then the company is not
bound by such a contract.
59.7 LET US SUM UP
Doctrine of ultra vires lays down that a company cannot carry on the objects not
permitted by its memorandum of association. Doctrine of constructive notice states that
every outsider is assumed to have read the memorandum of association and articles of
association. Doctrine of indoor management lays down that the outsiders are not
required to see the compliance of internal regulations of the company.
(i) Doctrine of ultra vires lays down that every outsider is assumed to have read the
memorandum
of association and articles of association, (ii) Doctrine of constructive notice states that
the outsiders
of internal are not required
regulations to see the compliance
of the company.
(iii) Doctrine of indoor management lays down that a company cannot carry on the
objects not permitted by its memorandum of association.
1. (i) False; (ii) False; (iii) False.
MEMBERSHIP
STRUCTURE
60.0 Objective
60.1 Introduction
60.2 Who is a Member of a Company?
60.3 Various Modes of Becoming Member of a Company
60.4 Who can be Members of a Company?
60.5 Cessation of Membership in a Company
60.6 Register of Members
60.7 Place of Keeping and Inspection of Register of Members
60.8 Rights and Duties (Liabilities) of Members of a Company
60.9 Rights of Embers
60.10 Let Us Sum Up
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420
60.0 OBJECTIVE
The objectives of this unit, are to understand the concept of membership in a company,
who can be a member in a company and what are the rights of a member of a company.
60.1 INTRODUCTION
The words member and shareholder have been used interchangeably in the Companies
Act, 1956 and generally speaking, except for a few cases they are synonymous, e.g. in
the case of companies having no share capital there are members but not shareholders.
60.2 WHO IS A MEMBER OF A COMPANY?
According to the Companies Act, 1956 the term member of a company means:
• The subscribers of the memorandum of association.
• Every other person who agrees in writing to become a member of a company
and whose name is
entered in its register of members.
• Every person holding equity share capital of a company and whose name is
entered as beneficial
owner in the records of the depository shall be deemed to be a member of the concerned
company.
60.3 VARIOUS MODES OF BECOMING A MEMBER OF A COMPANY
(a) By Subscribing to Memorandum of Association: The Companies Act, 1956
provides that a
subscriber of the memorandum of association shall be deemed to have agreed to become
a member
of the company. Hence on r egistration of the company he shall be entered as m ember of
the
company in its register of members. It may noted that a subscriber of the memorandum
of association
is deemed to have agreed to become a member of the company and neither application
form nor
allotment
(b) of shares is necessary.
Membership by Allotment of Shares: A person may become a shareholder if he
agrees to take
shares in the company by allotment. What is allotment? Broadly speaking the term
allotment means
an appropriation by directors of shares to a particular person.
(c) Transfer of Shares: If a person buys shares of a company in the open market
and then applies to
the company to register him as a member he becomes a member on registration of his
name.
(d) Transmission of Shares: On a death of a member, if the member has not made a
nomination for
the shares then the surviving joint holder (if any) or his legal representatives have the
right to
register themselves as members.
(e) Membership by Acquiescence: A person is deemed to become a member of a
company if he
allows his name to be put on the register of the members or otherwise holds himself out
as a
member even if there is no agreement to become a member.
(f) Joint Membership: When two or more persons hold shares in a company in
their joint names, it
is called a joint membership. In such a case the name of the member appearing first is
considered
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to be the main member for the purpose of sending notices, dividend, etc. However, they
all shall be
treated as a single member.
60.4 WHO CAN BE MEMBERS OF A COMPANY?
(a) Any Person competent to contract: The Companies Act, 1956 has not prescribed any
qualifications for acquiring membership of a company. Hence, every person who is
competent to contract can become a member of a company. It therefore follows that a
person who is incapable of entering into a contract cannot be a member.
—_„ 421
(b) Minor and persons of unsound mind: Under the Indian Contract Act, 1872
minors and persons
of unsound mind are incompetent at law to contract. Hence such persons cannot become
members
of a company.
A minor therefore cannot apply for and be a member of a company. However, if a minor
has by mistake been recorded as a member of the company, the company and the minor
have a right to r escind the transaction and remove the name from the register of
members. However, if a minor has been allotted shares and his name is entered into the
register of members he incurs no liability during minority.
(c) Company as a member: As a company is a legal person it can become a
member of another
company provided it is so authorised by its memorandum of association. A company
cannot buy
its own shares and become a member of itself.
(d) Partnership firm: Since a partnership firm is not a legal person it cannot buy any
shares in its
own name and thus become a member of a company. The shares have to bought only in
the name
of the individual partners of the partnership firm even though such shares constitute a
part ofof
assets the
the partnership firm.
(e) Registered society: A society registered under the Societies Registration Act,
1860 can hold
shares in a company.
(f) Non-residents: A non-resident cannot become a member of a company without
complying with
the requirements of the Foreign Exchange Management Act, 1999 and the regulations
made there
under that inter-alia stipulate the permission of the Reserve Bank of India.
(g) Fictitious Persons: The Companies Act, 1956 provides that any person who:
(a) makes in a fictitious name an application to a company for acquiring or

subscribing shares
therein, or
(b) otherwise induces a company to allot, or register any transfer of shares to him
or any other
person in a fictitious name, shall be punishable with imprisonment for a term which may
extend to five years.
60.5 CESSATION OF MEMBERSHIP IN A COMPANY
The membership in a company ceases in case of any of the following:
1. If a member transfers his shares to another person.
2. If a member's shares are forfeited.
3. If the shares are sold pursuant to a decree of a Court.
- CAIIB DISCUSSION
4. If the member surrenders his shares to the company where such surrender is
permitted.
5. If he rescinds the contract to take the shares, e.g. on the ground of
misrepresentation in the
prospectus.
6. If a member is adjudicated insolvent (shares and other properties of an insolvent
vest in the Official
Receiver or Assignee).
7. On the death of a member: However, the estate of the deceased member,
remains liable until the
shares are registered in the name of his legal representative.
8. If redeemable preference shares are redeemed.
9. If the company is being wound up. In such a case a member remains liable as a
contributor and is
also entitled to share in the surplus assets, if any.
60.6 REGISTER OF MEMBERS
The Companies Act, 1956 provides that every company shall keep a register of its
members and enter
422
(a) the name and address, and the occupation, if any, of each member;
(b) in the case of a company having a share capital, the shares held by each
member, distinguishing
each share by its number except where such shares are held with a depository and the
amount
paid or agreed to be considered as paid on those shares;
(c) the date at which each person was entered in the register as a member; and
(d) the date at which any person ceased to be a member.
A company may, after giving not less than seven days previous notice by advertisement
in some newspaper circulating in the district in which the r egistered office of the
company is situated,
for any period close theinregister
not exceeding of members
the aggregate or thedays
forty-five r egister of debenture
in each holders
year, but not
exceeding thirty days at any one time.
60.7 PLACE OF KEEPING AND INSPECTION OF REGISTER OF MEMBERS
The register of members is to be kept at the registered office of the company. It may be
kept at any other place within the city, town or village in which the registered office is
situated, if
(i) such other place has been approved for this purpose by a special resolution passed by
the
company in general meeting, and (ii) the Registrar of Companies has been given in
advance a copy of the proposed special resolution.
The registers are to be open during business hours to the inspection of any member or
debenture
holder without fee. Any other person has to pay a fee. Any such member, debenture
holder or
other person may make extracts from any register.
60.8 RIGHTS AND DUTIES (LIABILITIES) OF MEMBERS OF A COMPANY
The liability of a member of a company depends upon the nature of the company.
(a) Unlimited Liability Company: The member is liable in full for all the debts of
the company
contracted during the period of his membership.
(b) Company Limited by Guarantee: The member is liable to contribute a sum of
money agreed
and specified in the liability clause of memorandum of association in the event of being
- CAIIB DISCUSSION
wound up.
(c) Company Limited by Shares: The member is liable to pay the full nominal
value of the shares
and the liability of the member ends there. However, if the member has paid only a part
of the
amount of the shares then his liability is limited to the unpaid amount on the shares in
respect of
which he is a member.
60.9 RIGHTS OF MEMBERS
(a) Statutory Rights: These are the rights conferred by the Companies Act, 1956. These
rights cannot be taken away or modified by the memorandum of association or the
articles of association. Some of the statutory rights available to members under the
Companies Act, 1956 are as under:
1. Priority to have new shares offered, in case the company proposes to increase
capital.
2. To receive notice of meetings, attend and vote at meetings.
3. Transfer shares.
4. Receive copies of annual accounts of the company.
5. To inspect the register of members, register of debenture holders and copies of
annual returns.
6. To apply to the CLB to call annual general meeting if the board of directors
fails to call such a
meeting.
7. To convene an extraordinary general meeting of the company.
8. Appoint the directors and auditors at the general meetings of the company.
423
9. To approach the CLB to order an investigation into the affairs of the company. 10. To
file a petition to the High Court to order the winding up of the company.
(b) Documentary Rights: These rights are conferred upon the members by the
memorandum
association andofthe articles of association of the company.
(c) Proprietary Rights:
(a) To be registered as a member in the company's register of members, (subject to

a valid
membership obtained by transfer, allotment, etc.)
(b) No personal liability of a company's debts.
(c) To receive dividends (if declared by the board of directors and approved by the
members at
AGM).
(d) To participate in the distribution of assets in case of liquidation of the company.
60.10 LET US SUM UP
Any person competent to contract can be a member of a company. There are various
modes by which a person can acquire membership in a company.
(i) A minor can be a member of a private company but not of a public company, (ii) A
member can inspect the register of members.
1. (i) False; (ii) True.
PROSPECTUS
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STRUCTURE
61.0 Objective
61.1 Introduction
61.2 What is a Prospectus?
61.3 Compliance with Respect to Prospectus
61.4 Misstatements in a Prospectus and Remedies
61.5 Let Us Sum Up
426
61.0 OBJECTIVE
The objective of this unit is to understand the meaning and implications of misstatements
in the prospectus and the liabilities of the company, the promoters and the directors for
such misstatements.
61.1 INTRODUCTION
As explained in the previous units, a public company can raise funds for its business
from the public by issuing a document known as the prospectus. This document has to
contain all the material disclosures as required under the Companies Act, 1956.
61.2 WHAT IS A PROSPECTUS?
The Companies Act, 1956 defines a prospectus as any document described or issued as a
prospectus and includes any notice, circular, advertisement or other document inviting
deposits from the public or inviting offers from the public for the subscription or
purchase of any shares in, or debentures of a body corporate.
Hence, put in plain words, prospectus means a document by which a company solicits
funds from the public for its capital either by way of shares, debentures or deposits.
It is very clear that private companies cannot issue a prospectus to raise funds from the
public. It iscompanies
the public prohibitedwho
under thethe
issue articles of association of the company. It is necessarily
prospectus.
In the following cases even though shares are offered to the public, issue of prospectus is
not required:
(a) When a person is invited to enter into an underwriting agreement/arrangement
to purchase/subscribe
the shares.
(b) When the shares are offered only to the existing shareholders or debenture-
holders of the company.
(c) When the shares or debentures offered are in all respect uniform with the shares
or debentures
previously issued and listed on a recognised stock exchange.
61.3 COMPLIANCE WITH RESPECT TO PROSPECTUS
(a) Time of issue of Prospectus: A prospectus can be issued only after the
incorporation of the
company.
(b) Contents of the Prospectus: Section 56 read with Schedule II of the Companies
Act, 1956
stipulates the mandatory provisions that are to be stated in the prospectus.
(c) Date of publication: Section 55 states that a prospectus must be dated and this
ensures a prima
facie evidence of the date of its publication.
(d) Signature of every director on the Prospectus: A prospectus must be signed by
every person
- CAIIB DISCUSSION
mentioned therein as a director or proposed to be a director.

(d) Application form with a Prospectus: Every application form for shares must be
accompanied by a copy of the prospectus except for the application forms issued to
underwriters and existing shareholders and debenture holders.
(f) Statements by expert in Prospectus: A prospectus including a statement purporting to
be made by an expert cannot be issued unless he has given his written consent to the
issue thereof and he has not withdrawn such consent before the delivery of a copy of the
prospectus for registration to the Registrar of Companies and a statement that he has
given and has not withdrawn his consent as aforesaid appears in the prospectus. The
expert must not be engaged or interested in the formation, promotion or in the
management of the company.
427
(g) Registration of the Prospectus: Before the issue of a prospectus the same must be
delivered to the Registrar of Companies for registration with the documents which are
stipulated under the Companies Act, 1956, e.g. the consent of the expert, copy of
contracts relating to appointment and remuneration of the managerial personnel, etc.
61.4 MISSTATEMENTS IN A PROSPECTUS AND REMEDIES
A person who has been induced to subscribe for shares or debentures on the faith of a
statement in a prospectus which is untrue has a two fold remedy:
1. Remedy against the company
2. Remedy against the promoters and experts who were responsible for (or
associated with) the issue
of the prospectus. The liability can be civil or criminal.
Civil Liability
Remedies against the Company
If there are untrue statements or mis-statements or omissions in a prospectus which have
induced any shareholder or debenture holder to buy shares or debentures respectively,
the
1. person has two
rescind thefold remedies:
contract
2. claim damages from the company whether the statement is a fraudulent one or
innocent one.
Remedies against the promoters and experts, who were responsible for or associated
with the issue of the prospectus.
A suit for damages can be filed for misstatements in the prospectus against the promoters
and experts who were responsible for or associated with the issue of the prospectus.
Criminal Liability
Section 56 requires certain matters and reports must be stated in the prospectus. Failure
to do so will render the director or any other person responsible for the issue of such
prospectus to be punished with fine.
Section 63 provides that if prospectus contains an untrue statement, every person who is
responsible for the untrue statement in the prospectus shall be punishable with a fine or
imprisonment or with both.
61.5 LET US SUM UP
A public company raises funds from the public by issuing a prospectus. The company,
the promoters and the directors of the company have certain liabilities for any wrongful
statements that may be included in the prospectus on the basis of which the public
invests funds into the company by way of subscribing to the shares and/or debentures of
the company.
1. Indicate whether the following statement is True or False.
(i) There are no remedies available for misstatements in prospectus by directors.
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1. (i) False
UNIT
62
DIRECTORS
STRUCTURE
62.0 Objective
62.1 Introduction
62.2 Minimum Number of Directors
62.3 Subscribers of Memorandum Deemed to be Directors
62.4 Appointment of Directors and Proportion of Those who are to Retire by
Rotation
62.5 Ascertainment of Directors Retiring by Rotation and Filing of Vacancies
62.6 Right of Persons Other than Retiring Directors to Stand for Directorship
62.7 Maximum Number of Directors
62.8 Additional Directors
62.9 Filling of Casual Vacancies among Directors
62.10 Separate Resolutions are required to Appoint Every Director in a Meeting
62.11 Consent to the Company
62.12 Consent to Registrar of Companies
62.13 Whole-time Director
62.14 Qualification Shares
62.15 Maximum Number of Directorships
62.16 Vacation of Office by Directors
62.17 Certain Powers can be exercised Only at Meetings of the Board
62.18 Restrictions on Powers of Board
62.19 Loan to Director
62.20
62.21 Contracts in which Directors are Interested
Alternate Director
62.22 Compensation for Loss of Office
62.23 Let Us Sum Up
62.24 Keywords
430
62.0 OBJECTIVE
To have an overview of the legal provisions of the Companies Act, 1956 relating to the
requirement, appointment and removal of directors in a company.
62.1 INTRODUCTION
The ownership of a company is with the shareholders who are scattered all over and due
to free transferability of shares, the shareholders keep on changing quite frequently. In
such a scenario, the management of the company needs to be entrusted with a
professional body, i.e., the board of directors. The ownership and management of the
company is thus bifurcated. The board of directors control the day-to-day working and
management of the company as well the long-term strategic planning of the company.
No body corporate, association or firm can be appointed as director of a company, and
only an individual can be appointed. The important provisions of the Companies Act,
1956 pertaining to directors are discussed hereunder.
62.2 MINIMUM NUMBER OF DIRECTORS
Every public company must have at least three directors. A public company having
- CAIIB DISCUSSION
(a) a paid-up capital of Rs. 5 crore or more;

(b) one thousand or more small shareholders can elect a director from small
shareholders. Small
shareholders mean a shareholder holding shares of nominal value of Rs. twenty thousand
rupees
or less. A private company must have at least two directors. As per the latest directives
of SEBI,
all listed companies should have at least 50 per cent of their Directors as independent
directors.
Further the boards should follow the criteria of 'fit and proper' while appointing the
Directors.
62.3 SUBSCRIBERS OF MEMORANDUM DEEMED TO BE DIRECTORS
Subscribers of the memorandum, who are individuals, are deemed to be the directors of
the company, until the directors are duly appointed in accordance with the Act.
62.4 APPOINTMENT OF DIRECTORS AND PROPORTION OF THOSE WHO
ARE TO RETIRE BY ROTATION
Unless the articles provide for the retirement of all directors at every annual general
meeting, at least two-thirds of the total number of directors of a public company, or of a
private company which is a subsidiary of a public company, have to be
(a) Persons whose period of office is liable to determination by retirement by
rotation;
(b) Appointment by the company in general meeting.
The remaining directors are to be appointed in the general meeting subject to the
provisions of the articles of association.
62.5 ASCERTAINMENT OF DIRECTORS RETIRING BY ROTATION AND
FILLING OF VACANCIES
The directors who are to retire by r otation at every annual general meeting are those who
have been longest in office since their last appointment, but as between persons who
became directors on the same day, those who are to retire is to be determined by lots
(unless there is an agreement between them that who would retire). The retiring director
can also be reappointed.

431
62.6 RIGHT OF PERSONS OTHER THAN FOR DIRECTORSHIP
RETIRING DIRECTORS TO STAND
Any person is eligible for appointment to the office of director at any general meeting, if
not less than fourteen days before the meeting he himself or some other member intends
to propose that person as a director gives a signed notice in writing to the company
signifying that person's candidature for the office of director along with a deposit of Rs.
five hundred.
The deposit is refunded to such a person or to the member (whoever had given the notice
and paid the deposit) if that person is elected as a director.
62.7 MAXIMUM NUMBER OF DIRECTORS
A company can have a maximum number of twelve directors and to increase this
number, the approval of Central Government is required.
62.8 ADDITIONAL DIRECTORS
The board of directors can appoint directors by passing a resolution if such a power
exists in the articles. Such directors are known as additional directors and they hold
office only up to the date of the next annual general meeting of the company.
62.9 FILLING OF CASUAL VACANCIES AMONG DIRECTORS
In the case of a public company or a private company, which is a subsidiary of a public
- CAIIB DISCUSSION
company, if there arises any vacancy in office of any director (other than by expiry of
term of office) then subject to the articles, the board of directors can fill the vacancy at a
meeting of the board. Such a director can hold office only up to the date up to which the
director in whose place he is appointed would have held office if he had continued as a
director.
62.10 SEPARATE RESOLUTIONS ARE REQUIRED TO APPOINT EVERY
DIRECTOR IN A MEETING
One single resolution can appoint one director only and not two or more, e .g., to appoint
as directors A and B in the same meeting, two different resolutions are to be passed.
62.11 CONSENT TO THE COMPANY
In case of every public company and every private company which is subsidiary
company of a public company.
Every person proposed as a candidate for the office of a director must sign, and furnish
to the company, his consent in writing to act as a director. This does not apply to a
director retiring by rotation or otherwise or a person who has left at the office of the
company a notice under Section 257 signifying his candidature for the office of a
director.
62.12 CONSENT TO REGISTRAR OF COMPANIES
A person cannot act as a director unless he/she, within thirty days of his appointment,
signs and files with the Registrar his consent to act as a director. This does not apply to
the following directors:
(a) A director reappointed (after retirement by rotation) or (immediately on the expiry
of his term of office).
432
(b) An additional or alternate director, or a person filling a casual vacancy
reappointed as director, on
the expiry of his term of office).
(c) A person named as a director of the company under its articles as first
registered.
62.13 WHOLE-TIME
Every public company, orDIRECTOR
a private company which is a subsidiary of a public company,
having a paid-up share capital of Rupees five crore must have a Managing or Whole-
time Director or a Manager, (under the entire Companies Act, 1956 the term manager
does not mean a manager as we understand it normally like assistant manager/deputy
manager/senior manager/chief manager). Manager under the Companies Act, 1956
means a person having substantial powers of the management of the company and one
who is in control of the entire affairs of the company under the supervision of the board.
62.14 QUALIFICATION SHARES
A director is required to hold certain shares as qualification shares if such requirement is
there in the articles of association of the company. This requirement is not applicable to
a private company, unless it is a subsidiary of a public company.
There are certain disqualifications under which a person shall not be capable of being
appointed director of a company; e.g., he has been found to be of unsound mind by a
Court or he is an undischarged insolvent or he has been convicted by a Court of any
offence involving moral turpitude and sentenced in respect thereof to imprisonment, he
has not paid the call money on his shares.
62.15 MAXIMUM NUMBER OF DIRECTORSHIPS
A person cannot be a director of more than fifteen companies (excluding a private
company, an unlimited company, an association not carrying on business for profit or
which prohibits the payment of a dividend, alternate directorships).
62.16 VACATION OF OFFICE BY DIRECTORS
The office of a director becomes automatically vacant (i.e., his directorship ceases) if
(a) he fails to obtain qualification shares within six months of his becoming a
- CAIIB DISCUSSION
director in the Company,

if qualification shares were essential as per the articles of association.
(b) he is found to be of unsound mind by a Court;
(c) he applies to be adjudicated an insolvent;
(d) he is adjudged an insolvent;
(e) he is convicted by a Court of any offence involving moral turpitude and
sentenced to imprisonment;
(f) he fails to pay any call in respect of shares;
(g) he absents himself from three consecutive meetings of the board of directors, or
from all meetings
of the board for a continuous period of three months, whichever is longer, without
obtaining leave
of absence from the board;
(h) he acts in contravention of Section 295 (loan to directors) or Section 299
(disclosures of interest
by directors); (i) he is removed by the shareholders by resolution passed in a general
meeting.
A company can remove a director even before the expiry of his period of office (not
being a director appointed by the Central Government) by passing ordinary resolution.
433
62.17 CERTAIN POWERS CAN BE EXERCISED ONLY AT
MEETINGS OF THE BOARD
The board of directors have the general powers to do all the acts on behalf of the
company but certain powers can be exercised only at meetings of the board and not by
circulating papers amongst the directors and passing the resolution by such circulation.
These are some significant matters which need deliberations and discussions. These are
the powers to
(a) make calls on shareholders in respect of money unpaid on their shares;
(b) issue debentures;
(c)
(d) borrow moneys
invest the funds otherwise than on debentures;
of the company;
(e) make loans; and
(f) authorise a particular buyback as stated in Section 77 A.
62.18 RESTRICTIONS ON POWERS OF BOARD
The board of directors of a public company, or of a private company which is a
subsidiary of a public company can exercise the following powers only after a resolution
is passed to that effect by th e shareholders of the company in general meeting:
(a) dispose of any undertaking of the company;
(b) remit, or give time for the repayment of, any debt due by a director (except in
the case of renewal
or continuance of an advance made by a banking company to its director in the ordinary
course of
business);
(c) invest, otherwise than in trust securities, the amount of compensation received
by the company in
respect of the compulsory acquisition;
(d) borrow moneys in excess of aggregate of the paid-up capital of the company
and its free reserves;
(e) contribute to charitable and other funds not directly relating to the business of
the company or the
welfare of its employees an amount more than Rs. fifty thousand or five per cent of its
average net
profits during the three immediately preceding, financial years whichever is greater.
- CAIIB DISCUSSION
62.19 LOAN TO DIRECTOR

A public company requires the previous approval of the Central Government to give any
loan to its director (and certain other related partnership firms and private companies) or
to give any guarantee or security to any person for any loan given to the director or the
related parties. This is to ensure that the board of directors of a public company does not
misuse the funds of the company for the benefit of its directors.
62.20 CONTRACTS IN WHICH DIRECTORS ARE INTERESTED
Also when any company enters into contracts relating to the business of the company
with the directors (or) private companies in which the directors are members/directors
(or) partnership firms in which the directors are partners, the consent of the board of
directors is required by way of a resolution. If the paid-up capital of the company is Rs.
one crore or more then the approval of Central Government is also required. Every
director of a company who is interested in a contract to be entered into by the company
has to disclose the nature of his concern or interest at a meeting of the board of directors.
Interest means say for example that the company is going to purchase its raw materials
from a partnership firm in which he is a partner. Hence he becomes interested in the
contract as a director of the company
434
and he can influence the price to be paid to the partnership firm. Such interested director
cannot participate or vote for decision by r esolution and in the discussions on such
matters in which he is interested.
62.21 ALTERNATE DIRECTOR
The board of directors can appoint an alternate director to act for a director ('the original
director') during the original director's absence for a period of not less than three months
from the state in which meetings of the board are ordinarily held if the articles or a
shareholders resolution have authorised the directors to make such appointments. The
alternate director vacates the office when the original director returns or when the term
of office of the original director expires (whichever is earlier).
62.22 COMPENSATION FOR LOSS OF OFFICE
Managing
compensationor whole-time directors
for loss of office or directors
if they who are
are removed frommanagers and eligible
directorships except for
in cases
like when they were guilty of fraud, etc., or the removal is consequent to some
amalgamations of the company, etc. No compensation is payable on a take over of
management under the Securitisation Act. Similarly there is no compensation under
Section 10A of Banking Regulation Act.
For the academic interests of the students, we have summarised a case law, which
highlights the jurisdiction of a Company Law Court vis-a-vis a Debt Recovery Tribunal
(DRT).
A. Adjudication under the DRT Act is exclusive and jurisdiction of Civil Court
and Company Court is
ousted.
B. DRT proceedings cannot be stayed by the Company Court nor proceedings can
be transferred to
the Company Court.
C. DRT Act overrides the Company act.
D. In respect of money realised under DRT Act for distribution between Bank/FIs
and other creditors,
when no winding up order is passed against the company, priorities to be decided subject
to the
principles underlying the Section 73 of CPC and principles of natural justice. (Section 73
of CPC
mentions about the rateable distribution of sale proceeds of execution among the decree
holders.)
- CAIIB DISCUSSION
E. Moneys realised under the DRT Act, distribution between bank and other
secured creditors, when
winding up proceedings are pending in the Company Court, priority of secured creditors
is subject
to provisions of the Section 529A of Companies Act (the said section mentions about the
priority
of secured creditors and workman over other dues and distribution inter se between
secured
creditors and workman should be pari passu).
F. DRT is a special law, it overrides the Company Law. Levee of Company Court
under the Section
446 is not necessary nor could the suit be transferred to the Company Court under the
Section
446.
62.23 LET US SUM UP
The ownership of a company is diversified from the management of the company. The
ownership of a company is with the members of the company. The management of the
company is with the board of directors elected by the members of the company.
62.24 KEYWORDS >
Liquidation; Perpetual; Ultra Vires; Intra Vires; Ratification; Approval of the
Underwriter; Underwriting Agreement, —
435
10t : is
r') ch he or
or of m >n

_. (3/7/12/15)
. (3/7/12/15)
_. (3/7/12/2)
(3/7/12/2)
(i) The maximum number of directors in a private company can be (ii) The maximum
number of directors in a public company can be _
(iii) The minimum number of directors required in a public company is
(iv) The minimum number of directors required in a private company is
(v) At least of the total number of directors of a public company are to be persons
whose period of office is liable to determination by retirement by rotation. (2/3/7/two-
third) (vi) Every public company, or a private company which is a subsidiary of a public
company,
having a paid-up share capital of Rupees must have a managing or whole-time
director or a manager, (five crore/five lakh/one crore/one lakh)
(vii) Additional directors are appointed by the (board of directors/promoters/
underwriters/shareholders)
(viii) Alternate directors are appointed by the (board of directors/promoters/
underwriters/shareholders)
(ix) Casual vacancies in the board of directors is filled in by the (board of
directors/
promoters/underwriters/shareholders)
1. (i) 12; (ii) 12; (iii) 3; (iv) 2; (v) two-third; (vi) five crore; (vii) board of directors;
(viii) board of directors; (ix) board of directors
- CAIIB DISCUSSION
FOREIGN EXCHANGE MANAGEMENT ACT, 1999
STRUCTURE
63.0 Objective
63.1 Introduction
63.2 Meaning of Certain Important Terms Used in FEMA
63.3 Regulation and Management of Foreign Exchange
63.4 Powers of RBI with Respect to Authorised Persons
63.5 Contravention, Penalties, Adjudication and Appeals
63.6 Directorate of Enforcement
438
63.0 OBJECTIVE
This unit aims to show the broad structure of the Foreign Exchange Management Act,
1999 which is enacted to regulate foreign exchange transactions in India. By a reading of
this unit, it would be clear that the FEMA does not specify the details of each and every
procedure and matter concerning the regulation of foreign exchange. The RBI and the
Central Government frame various rules, regulations and issue directions and orders
under the FEMA for the actual implementation of the check on foreign exchange
transactions.
63.1 INTRODUCTION
The main objective of the Foreign Exchange Regulation Act, 1973 (FERA), was to
consolidate and amend the law; regulate certain payments; dealings in foreign exchange
and securities; transactions, indirectly affecting foreign exchange; the import and export
of currency, for the conservation of the foreign exchange resources of the country; and
finally, the proper utilisation of this foreign exchange so as to promote the economic
development
The object of of the country.
enacting The FERA
the Foreign has since
Exchange been repealed.
Management Act, 1999 (FEMA) is to
consolidate and amend the law relating to foreign exchange with the objective of
facilitating external trade and payments and for promoting the orderly development and
maintenance of foreign exchange market in India.
The provisions of the FEMA extends to all over India and also applies to all branches,
offices and agencies outside India owned or controlled by a person resident in India and
also to any contravention committed outside India by any such person to whom this Act
applies.
63.2 MEANING OF CERTAIN IMPORTANT TERMS USED IN FEMA
'Authorised person' means any bank or other person including authorised money changer
or dealer, authorised under the FEMA to deal in foreign exchange or securities.
'Capital account transaction' means a transaction by which there may be a change (either
an increase or decrease) in the assets or liabilities outside India of persons resident in
India or assets or liabilities in India of persons resident outside India.
'Current account transaction' means a transaction other than a capital account transaction.
For example,
(i) payments due with respect to the foreign trade done, other business, services, and
short-term
banking and credit facilities in the ordinary course of business; (ii) payments due as
interest on loans and as income from investments; (iii) remittances for living expenses of
parents, spouse and children residing abroad; and (iv) expenses in connection with
foreign travel, education and medical care of parents, spouse and children.
'Currency' is defined under the FEMA not only to include all currency notes but also
- CAIIB DISCUSSION
postal notes, postal orders, money orders, cheques, drafts, travellers' cheques, letters of
credit, bills of exchange and promissory notes, credit cards or such other similar
instruments as may be notified by the RBI.
'Foreign currency' is defined to mean any currency other than Indian currency.
•The term 'foreign exchange' is much wider than the term foreign currency. In addition
to the foreign currency, it includes the following:
(i) amounts payable in any foreign currency;
(ii) drafts, travellers' cheques, letters of credit or bills of exchange, expressed or drawn in
Indian currency but payable in any foreign currency;
439
(iii) drafts, travellers cheques, letters of credit or bills of exchange drawn by banks,
institutions or persons outside India, but payable in Indian currency.
Under the FEMA 'security' is defined to include shares, stocks, bonds and debentures,
Government securities, savings certificates, deposit receipts and units of any mutual fund
etc. However, it does not include bills of exchange or promissory notes other than
Government promissory notes or any other instruments which may be notified by the
RBI.
Under the FEMA, the term 'foreign security' means any security as stated above. Under
the FEMA a 'person' is defined to include the following entities:
(i) an individual;
(ii) a Hindu Undivided Family;
(iii) a company;
(iv) a firm;
(v) an association of persons or a body of individuals, whether incorporated or not;
(vi) every artificial juridical person; and
(vii) any agency, office or branch owned or controlled by such person.
'Person resident in India' means the following:
(i) a person residing in India for more than one hundred and eighty-two days in the
preceding financial year but does not include
(A)
(a) aforperson
takingwho has gone outoutside
up employment of IndiaIndia,
or whoor stays outside India:
(b) for carrying on a business or vocation outside India, or
(c) for any other purpose, in such circumstances as would indicate his intention to
stay
outside India for an uncertain period;
(B) a person who has come to India or stay in India, otherwise than:
(a) for taking up employment in India, or
(b) for carrying on a business or vocation in India; or
(c) for any other purpose, in such circumstances as would indicate his intention to
stay in
India for an uncertain period;
(ii) any person or body corporate registered or incorporated in India;
(iii) an office, branch or agency in India owned or controlled by a person resident outside
India;
(iv) an office, branch or agency outside India owned or controlled by a person resident in
India.
Accordingly, a 'person resident outside India' means a person who is not resident in India
as above.
'Repatriate to India' means bringing into India, foreign exchange and selling it to an
authorised person in India in exchange for rupees.
63.3 REGULATION AND MANAGEMENT OF FOREIGN EXCHANGE
Any person who wants to carry out the following activities has to do so in accordance
with the provisions of the FEMA. At times if the FEMA prescribes approval of the RBI,
- CAIIB DISCUSSION
it has to be obtained.
(a) deal/transfer any foreign exchange or foreign security to any person other than
an authorised
person;
(b) make any payment to any person resident outside India;
(c) receive (otherwise through an authorised person) any payment on behalf of any
person resident
outside India.
(d) enter into any financial transaction in India in relation to a right to acquire any
asset outside India
by any person.
440
A person resident in India can hold, own, transfer or invest in foreign currency, foreign
security or any immoveable property situated outside India if it was acquired, held or
owned by such person when he was resident outside India,
There is no bar on a person resident outside India to hold, own, transfer or invest in
foreign currency, foreign security or any immoveable property situated outside India.
Every exporter of goods and services has to furnish the necessary data by way of a
declaration to the RBI. Such export proceeds cannot be held in foreign countries and has
to be repatriated to India. Non-repatriation is a violation of the provisions of the FEMA.
63.4 POWERS OF RBI WITH RESPECT TO AUTHORISED PERSONS
RBI has the following powers under FEMA:
1. To appoint authorised persons: The said authorised persons are authorised to
deal in foreign
exchange. The person so appointed shall work under the direction of the RBI and shall
have to
comply with the rules and regulations so framed or formulated by the RBI from time to
time for
this purpose.
2.
compliesTo inspect
with all the authorised persons: So appointed to ensure that the said person
the rules and regulations so formulated by the RBI from time to time.
63.5 CONTRAVENTION, PENALTIES, ADJUDICATION AND APPEALS
Under the FEMA any violation of the provisions of the said Act will attract penal
provisions including the right of arrest and detention.
Like any other statutes there exists the right of appeal. The first of such appeals shall be
with the special director (Appeals). Thereafter if someone is aggrieved by the said
appellate order they can prefer an appeal against the order before the appellate tribunals
established for this purpose. Wherein questions of law are involved and need to be
interpreted, an appeal lies to the High Court. Only questions of law are referred to the
High Courts and thereafter to the Supreme Court.
Penalty can be levied up to thrice the sum involved in such contravention where such
amount is quantifiable, or up to Rs. two lakh where the amount is not quantifiable, and
where such contravention is a continuing one, further penalty which may extend to Rs.
five thousand for every day after the first day during which the contravention continues.
63.6 DIRECTORATE OF ENFORCEMENT
The Central Government establishes a directorate of enforcement with a director and
other officers, called officers of enforcement.
Power of Search, Seizure, etc.
The director of enforcement and other officers of enforcement, not below the rank of an
assistant director can investigate contraventions.
The Central Government can also authorise any class of officers in the Central
Government, State Government or the RBI to investigate contraventions.
- CAIIB DISCUSSION
Empowering Other Officers

The Central Government can (subject to conditions and limitations), authorise any
customs officer/ central excise officer/any police officer/any other officer of the Central
Government or a State
441
Government to exercise the powers and discharge the duties of the director of
enforcement or any other officer of enforcement.
(i) Authorised person is an individual appointed by the RBI to deal in foreign exchange.
(ii) A current account transaction alters the assets or liabilities outside India of persons
resident
in India, (iii) A capital account transaction includes payments due in connection with
foreign trade in the
ordinary course of business, (iv) Foreign exchange includes traveller's cheques, (v) RBI
can revoke any authorisation given to an authorised person, (vi) Civil Court has the
jurisdiction to entertain any suit or proceeding in respect of any matter
under the FEMA.
1. (i) False; (ii) False; (iii) False; (iv) True; (v) True; (vi) False;
UNIT
64
TRANSFER OF PROPERTY ACT, 1882
STRUCTURE
64.0 Objective
64.1 Introduction
64.2
64.3 Sale of Immoveable
Mortgage Property
of Immoveable Property
64.4 Types of Mortgage
64.5 Sale without Court Intervention
64.6 Enforcement of Mortgages through Court
64.7 Leases of Immoveable Property
64.8 Enforcement of Mortgages through Court
64.9 Actionable Claims
444
IKING
64.0 OBJECTIVE
We have seen that the transactions relating to moveable goods and the rights and
liabilities of the parties in a contract for the sale of moveable goods are stated in the Sale
of Goods Act. Sale of Goods Act does not cover transactions of immoveable property.
The objective of this unit is to learn briefly the aspects of the transactions of immoveable
property as contained in the Transfer of Property Act which concerns a banker, i.e., sale,
mortgage, lease and actionable claims.
64.1 INTRODUCTION
Transfer of property means an act by which a living person conveys property, in present
- CAIIB DISCUSSION
or in future, to one or more other living persons, or to himself and one or more other
living persons. (Living person includes a company or any such association whether
incorporated or not.)
Every person competent to contract and entitled to transferable property is competent to
transfer property.
64.2 SALE OF IMMOVEABLE PROPERTY
Sale is a transfer of ownership in exchange for a price paid or promised or part-paid and
part-promised. The sale of tangible immoveable property for a consideration exceeding
Rs. 100/- can be made only by a registered instrument. Delivery of tangible immoveable
property takes place when the seller places the buyer (or such person as directed by the
buyer) in possession of the property.
64.3 MORTGAGE OF IMMOVEABLE PROPERTY
A mortgage is the transfer of an interest in specific immoveable property to secure the
payment of money given by way of loan or to secure the performance of an engagement
which may give rise to a pecuniary (monetary) liability.
The transferor is called a mortgagor. The transferee is called a mortgagee. The principal
money and interest secured is called the mortgage-money. The instrument (if any) by
which the transfer is effected is called a mortgage-deed.
Mortgagor can be
(i) An absolute owner of property (including ownership by purchase or by partition or
inheritance or by gift or by lease)
(ii) One of two or more co-owners; (iii) KartaofHUF;
(iv) Guardian of minor's property with sanction of Court under the Guardians and Wards
Act, 1890; (v) Executor or administrator.
Mortgage is a transfer of an interest in specific immoveable property as a security for the
repayment of a monetary liability. This liability could be arising out of money already
advanced or to be advanced; it could be a future debt or it could be pecuniary liability
arising out of the non-performance of any engagement.
The mortgage referred in the Transfer of Property Act, 1882 is a mortgage of
immoveable property and it has no application to moveable property. Security by way of
moveable property is called hypothecation or pledge or pawn.

445
64.4 TYPES OF MORTGAGE
(A) Essentials of a simple mortgage:
(i) The mortgagor does not deliver possession of the mortgaged property to the
mortgagee, (ii) The mortgagor binds himself personally to pay the mortgage-money, (iii)
The mortgagor agrees that in the event of his failing to pay according to his contract, the
mortgagee shall have a right to get the mortgaged property sold and recover his dues.
(B) Essentials of a mortgage by conditional sale:
(i) the mortgagor apparently sells the mortgaged property to the mortgagee; (ii) the
condition of sale is that on default of payment of the mortgage-money on a certain date
the sale shall become absolute; or (iii) on such payment being made the sale shall
become void, or the buyer (mortgagee) shall
transfer the property to the seller (mortgagor).
(C) Essentials of a usufructuary mortgage:
(i) The mortgagor delivers possession of the mortgaged property to the mortgagee, (ii)
The mortgagor authorises the mortgagee to retain such possession until payment of the
mortgage-money.
(iii) To receive the rents and profits arising from the property, (iv) Appropriate the same
towards the payment of interest or mortgage-money or both.
(D) Essentials of an English mortgage:
(i) The mortgagor binds himself to repay the mortgage-money on a certain date, and
transfers
- CAIIB DISCUSSION
the mortgaged property absolutely to the mortgagee, (ii) subject to a condition that he
will re-transfer it to the mortgagor upon payment of the
mortgage-money.
(E) Essentials of a mortgage by deposit of title deeds (Equitable Mortgage):
(i) The mortgagor delivers to a creditor or his agent documents of title to
immoveable property,
(ii) With intent to create a security thereon.
(iii) The delivery of documents of title is done in a town specified by the State
Government,
(iv) The property given as a mortgage may or may not be situated in the notified
towns.
A mortgage other than a mortgage by deposit of title deeds can be effected only in terms
of a mortgage deed duly signed by the mortgagor and attested by at least two witnesses.
A mortgage by deposit of title deeds does not require any writing. As such a mortgage
by deposit of title deeds being an oral transaction is not affected by the law of
registration. All other mortgages in writing must be registered.
In simple words, the procedure followed in banks for the creation of an equitable
mortgage is as under:
(i) Title clearance certificate is to be obtained from an advocate that the property
proposed to be mortgaged is free from all encumbrances and readily marketable and a
search of the land records should be taken for at least thirty years prior to the date of
certificate.
(ii) There shall be a deposit of the original title deeds in the notified towns personally by
the true and legal owner of the immoveable property or his/its duly authorised agent.
(iii) A record of equitable mortgage popularly called as memorandum of entry is to be
prepared by the concerned branch. The stamp duty is payable on the said memorandum
of entry as per local laws of the state and no registration is required. It is a sort of
evidence/record to file in the Court if required for the recovery of the bank dues.
446
(iv) In the case

the director/ of limited
officer companies,
to deposit thefor
the deeds company
raising has to pass
a loan a resolution
and after authorising
memorandum of
entry is recorded, charge is required to be filed with registrar of charges.
64.5 SALE WITHOUT COURT INTERVENTION
One of the important provision of the Transfer of Property Act, which permits the
mortgagee (i.e., the lender) to sell the mortgaged property without the intervention of the
Court is as explained hereunder.
Section 69 of the Transfer of Property Act is as under-Power of sale when valid
1. A mortgagee or any person acting on his behalf has power to sell the mortgaged
property or any
part thereof, in default of payment of the mortgage-money, without the intervention of
the Court,
in the following cases namely
(a) where the mortgage is an English mortgage, and neither the mortgagor nor the
mortgagee is a
Hindu, Mohammedan or Buddhist or a member of any other race, sect, tribe or class
from
time to time specified in this behalf by the State Government, in the official gazette;
(b) where a power of sale without the intervention of the Court is expressly
conferred on the
mortgagee by the mortgage-deed and the mortgagee is the Government;
(c) where a power of sale without the intervention of the Court is expressly
conferred on the
mortgagee by the mortgage-deed and the mortgaged property or any part thereof was, on
- CAIIB DISCUSSION
the
date of the execution of the mortgage-deed, situated within the towns of Kolkata,
Chennai,
Mumbai, or in any other town or area which the State Government may, by notification
in the
official gazette, specify in this behalf.
2. No such power shall be exercised unless and until
(a) notice in writing requiring payment of the principal money has been served on
the mortgagor,
or on one of several mortgagors, and default has been made in payment of the principal
money, or of part thereof, for three months after such service; or
(b) some interest under the mortgage amounting at least to Rs. five hundred is in
arrear and
unpaid for three months after becoming due.
3. When a sale has been made in the professed exercise of such a power, the title
of the purchaser
shall not be impeachable on the ground that no case had arisen to authorise the sale, or
that due
notice was not given, or that the power was otherwise improperly or irregularly
exercised; but any
person indemnified by an unauthorised or improper or irregular exercise of the power
shall have his
remedy in damages against the person exercising the power.
4. The money which is received by the mortgagee, arising from the sale, after
discharge of prior
encumbrances, if any, to which the sale is not made subject, or after payment into the
Court under
the Section 57 of a sum to meet any prior encumbrance, shall, in the absence of a
contract to the
contrary, be held by him in trust to be applied by him, first, in payment of all costs,
charges and
expenses properly incurred by him as incident to the sale or any attempted sale; and,
secondly, in
discharge of the mortgage-money and costs and other money, if any, due under the
mortgage; and
the residue of the money so received shall be paid to the person entitled to the mortgaged
property,
or authorised to give receipts for the proceeds of the sale thereof.
64.6 ENFORCEMENT OF MORTGAGES THROUGH COURT
After the enactment of the Recovery of Debts due to Banks and Financial Institutions
Act, 1993, recovery of debts due to banks and financial institutions in excess of Rs. ten
lakh only can be commenced
447
in the Debts Recovery Tribunals. Since the banks and financial institutions advance
loans/facility below Rs. ten lakh, and if they were secured by a mortgage on the
borrower's immovable properties, the lender has to file a civil suit for the recovery of his
dues by enforcement of the mortgage. While filing the civil suit the following aspects
may have to be kept in view:-
1. The suit shall be instituted in the court of the lowest jurisdiction where it can
lie.
2. The suit shall be instituted in the jurisdiction of the court where the mortgaged
properties are
Facebook Groups
- CAIIB DISCUSSION
situated.
3. All puisne mortgagees (subsequent mortgagees) shall be impleaded as
defendants.
4. If there is more than one mortgage in favour of the lender filing the suit, he
shall sue on all debts
unless a leave of the court is obtained for filing separate suits.
5. If personal covenant of the mortgage is to be enforced, it must be ensured that
the claim is within
limitation.
6. In Civil Courts the decree on mortgage is two fold; namely a preliminary decree
and a final decree.
The preliminary decree sets out a time limit for the mortgagor to pay the decretal
amount. If the
mortgagor fails to pay the decretal amount by the time stipulated in the preliminary
decree, the
mortgagee is entitled to make an application to the Court for passing the final decree.
The execution
proceedings shall be commenced only after the final decree is passed in the mortgage
suit.
7. While executing the mortgage decree, the decree holder can bring the properties
mortgaged to sale
without first seeking an order of attachment from the Court.
64.7 LEASES OF IMMOVEABLE PROPERTY
A lease is a transfer of a right to enjoy the property for a certain time (express or
implied) or in perpetuity (that is forever), in consideration of a price paid or promised or
any other thing of value, to be given periodically to the transferor by the transferee. The
transferor is called 'the lessor', the transferee is called the 'lessee', the price is called the
premium, and the money or any other thing to be given is called the rent.
A sale is an absolute transfer of property. A lease is a partial or limited transfer of
property. In a lease, there is a transfer of the right to enjoy such property. Thus, in case
of a lease,ofthere
Duration is a Leases
Certain separation betweenof
in Absence ownership and possession.
Written Contract or Local Usage: A lease for
an agricultural or manufacturing purpose is deemed to be a lease from year to year. It
can be terminated by the lessor or lessee by giving six months notice to one another.
A lease for any other purpose is deemed to be a lease from month to month. It can be
terminated by the lessor or lessee by giving fifteen days notice to one another.
Important Case Law
Chapsibhai Dhanjibhai Danad, Appellant vs. Purushottam, Respondent AIR 1971 SC
1878
(1883): The facts of the case in brief are as under:
By a deed of Jqase, dated 5 May 1906, the predecessor-in-title of the respondent let out
to the appellant's father an open portion of land measuring 26 ft x 225 ft out of a larger
plot. The lease was for constructing buildings arid for a period of thirty years certain at
the annual rate of Rs. 130. The lease contained, inter alia, the following: ,
'Even after the prescribed time-limit, I shall have a right to keep my structure on the
leased-out land, so long as I like, and I shall be paying to you the rent every year as
stated above. You will have no right to increase the rent and I shall also not pay it,
myself and my heirs shall use this land in whatever manner
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- CAIIB DISCUSSION
448
vacate your land. In case we remove our structure before the stipulated period, we shall
be liable to pay to you, the rent for all the 30 years, as agreed to above. ... In case I were
to sell away the buildings, which I shall be constructing on the above land, to anyone
else, then, the purchaser shall be bound by all the terms in this lease-deed.'
The trouble between the parties started when the respondent commenced construction on
the rest of the land in a fashion so as to be in close vicinity to the western boundary of
the leased land to house an industry, called Sudha Industries.
The appellant filed the suit in 1958, out of which this appeal arises, urging that the said
lease was a permanent lease. The Trial Court partially decreed the appellant's suit.
The District Court dismissed the appellant's appeal and allowed the cross-objections with
the result that the appellant's suit was dismissed. A second appeal filed by the appellant
in the High Court was heard by a single Judge who held that the said lease was a
permanent lease.
Aggrieved by the judgement and decree passed by the learned single Judge, the
respondent filed a letters patent appeal wherein the principal question was canvassed
whether the said lease was a permanent lease or not. The Letters Patent Bench answered
the question against the appellant holding that the said lease being a lease for building
purposes and transferable, was a lease for an indefinite period.
On appeal the Supreme Court held that the lease was undoubtedly for an indefinite
period which only means that it was to ensure for the lessee's lifetime. The lease in
question was held to be of the former class and not inheritable and permanent.
On arriving at such a decision the Supreme Court relied on the following principles:
Whether a lease was permanent or for the lifetime only of the lessee, even where it was
for building structures and was transferable, depended upon the terms of the lease and
the Court must, therefore, look at the substance of it to ascertain whether the parties
intended it to be a permanent lease. The mere fact, however, that a lease provides for the
interests there under to pass on to the heirs of the lessee would not always mean that it is
a permanent lease. Such a provision can be made in two ways resulting in two different
consequences.
the event of theAlessee
lease dying
may provide a fixed
before the period
expiry and period,
of such then include a provision
his heirs would bethat in
entitled
to have the benefit of the lease for the remainder of the period. In such a case, although
the lease may provide for the heirs to succeed to the interests in the leased land, it would
only mean that such heirs succeed to the rights up to the expiry of the lease period. If the
lease, on the other- hand, were for an indefinite period, and contains a provision for the
rights there under being inheritable, then, such a lease, though ordinarily for the lifetime
of the lessee, would be construed as permanent. The lease in question was held to be of
the former class and not inheritable and permanent. If any accession is made to the
leased property during the continuance of a lease, such accession is deemed to be
comprised in the lease. If the accession is by encroachment by the lessee, and the lessee
acquires title thereto by prescription, he must surrender such accession together with the
leased land to the lessor at the expiry of the term. The presumption is that the land so
encroached upon is added to the tenure and forms part thereof for the benefit of the
tenant so long as the lease continues and afterwards for the benefit of the landlord.
How are leases made?
A lease from year to year or for any term exceeding one year can be made only by a
registered instrument. All other leases can be made either by a registered instrument or
by oral agreement accompanied by delivery of possession.
The practical procedure followed for mortgage of lease hold rights is: (i) Original lease
agreement can constitute the title deeds if the lease is perpetual.
449
(ii) The Lease agreement should be duly stamped and registered.
- CAIIB DISCUSSION
(iii) The unexpired lease period must be sufficiently longer and must cover, the period
allowed for repayment for bank's advance.
(iv) A tripartite agreement may also be entered into between the lender bank, the lessor
and the lessee (the borrower).
(v) The lease deed must contain a clause permitting/authorising the lessee to create
mortgage, or alternatively the lessor should give a specific letter of authority-cum-no-
objection authorising the lessee to create the mortgage in favour of the lender bank and
undertaking not to exercise the right of forfeiture of the lease so long as lender bank's
dues are outstanding.
64.8 ENFORCEMENT OF MORTGAGES THROUGH COURT
After the enactment of the Recovery of Debts due to Banks and Financial Institutions
Act, 1993, recovery of debts due to banks and financial institutions in excess of Rs. ten
lakh only can be commenced in the Debt Recovery Tribunals. Since banks and financial
institutions advance loans/facility below Rs. ten lakh, and if they were secured by a
mortgage on the borrower's immovable properties, the lender has to fi-le a civil suit for
the recovery of his dues by enforcement of the mortgage. While filing the civil suit the
following aspects may have to be kept in view:-
1. The suit shall be instituted in the court of the lowest jurisdiction where it can
lie.
2. The suit shall be instituted in the jurisdiction of the court where the mortgaged
properties are
situated.
3. All puisne mortgagees (subsequent mortgagees) shall be impleaded as
defendants.
4. If there is more than one mortgage in favour of the lender filing the suit, he
shall sue on all debts
unless leave of the court is obtained for filing separate suits.
5. If a personal covenant of the mortgagor is to be enforced, it must be ensured
that the claim is
within limitation.
6.
decree andIn aCivil
finalCourts
decree.the decree on mortgage is two-fold, namely a preliminary
The preliminary decree sets out a time limit for the mortgagor to pay the decretal
amount. If the
mortgagor fails to pay the decretal amount by the time stipulated in the preliminary
decree, the
mortgagee is entitled to make an application to the court for passing the final decree. The
execution
proceedings shall be commenced only after the final decree is passed in the mortgage
suit.
7. While executing the mortgage decree, the decree-holder can bring the
properties mortgaged to sale
without first seeking an order of attachment from the court.
64.9 ACTIONABLE CLAIMS
'Actionable claim' means a claim to any debt (other than a debt secured by mortgage,
hypothecation or pledge).
Transfer of actionable claim
The transfer of an actionable claim whether with or without consideration, can be done
only by the execution of an instrument in writing signed by the transferrer. There is no
mandatory requirement of giving notice to the debtor before the transfer of the
actionable claim. The transferee of an actionable claim can sue the debtor in his own
name without obtaining the transferrer's consent and without making him a party to the
suit.
Illustration
- CAIIB DISCUSSION
(i) A owes money to B. B transfers the debt to C. A is not aware of the same. B then
demands the debt from A. A pays B. The payment is valid, and C cannot sue A for the
debt.
.-^"■"T.1*:-^,"*:.;-1
For the academic interests of the students, a summary of a couple of case laws are stated
hereunder: Dena Bank vs Bhikhabhai Prabhudas Parekh and Co. and others 2000 AIR
(SC) 3654
This judgement is regarding issue of priority of dues of Government vis-a-vis the bank
dues. The Honourable Supreme Court held that crown debts gets priority over others
debts. In this case the Court has examined the various provisions of the Sales Tax Act,
the Land Revenue Act and the precedents prevailing in India as well as in England and
finally come to the conclusion that the debts of the crown (Government) prevail over the
others provided there are statutory provisions to that effect in the r espective statutes.
Sirpur Paper Mills Ltd v/s The Collector of Central Excise. AIR 1998 SC 1489.
In this case the Honourable Supreme Court held that just because plant and machinery
had to be installed in earth for better functioning it does not automatically become
immoveable property. Property liable to excise duty. In this case, the issue was whether
plant and machinery installed in the earth can be treated as immoveable property
whereby the tax burden (excise duty) on such plant and machinery may be avoided. The
Court examined the definition of the word immoveable property in the Transfer of
Property Act and the other Acts and accordingly gave such verdict.
(i) Transfer of Property Act basically contains provisions relating to transfer of moveable
property and goods, (ii) Mortgage is a transfer of an interest in specific immoveable
property to secure the payment
of money given by way of loan, (iii) In a simple mortgage the mortgagor does not
deliver possession of the mortgaged property
to the mortgagee, (iv) In a mortgage by conditional sale the property is transferred the
condition
default of of sale is of
payment that onmortgage-money on a certain date the sale shall become
the
absolute. (v) In a usufructuary mortgage the mortgagor delivers possession of the
mortgaged property
to the mortgagee, (vi) In an English mortgage the property is transferred absolutely by
the mortgagor to the
mortgagee with a condition for retransfer. (vii) In a mortgage by deposit of title-deeds
the property given as a mortgage has to be situated
in notified towns, (viii) A lease of from year to year or for any term exceeding one year
can be made by transfer of
possession, (ix) The debtor has to be given a notice of transfer of actionable claim.
(i) A lease for agricultural or manufacturing purpose can be terminated by the lessor or
lessee
by giving notice to one another, (six months/15 days)
(ii) A memorandum recording mortgage by deposit of title deeds does not require

(registration/stamping)
(iii) The essentials of valid equitable mortgage are debt, deposit of title deeds and

(intention as security/intention of safe deposit) (iv) In case of accession to the mortgaged
property, where the mortgagee is in possession of
the mortgaged property, the mortgagee is of the accession, (entitled/not entitled)
(v) A mortgagor, while lawfully in possession of the mortgaged property, shall have
- CAIIB DISCUSSION
to make leases thereof, (power/no power)
451
3. Multiple Choice Questions. Select the alternative as applicable.
(i) The power of sale without intervention of the Court is given to the mortgagee in the
case of:
(a) Equitable mortgage (b) English mortgage
(c) Simple mortgage (d) Usufructuary mortgage
(ii) A lease for an agricultural or manufacturing purpose is deemed to be a lease for:
(a) year to year (b) month to month
(c) week to week (d) with infinite period
1. (i) False; (ii) True; (iii) True; (iv) True; (v) True; (vi) True; (vii) False; (viii)
False; (ix) False.
2. (i) 6 months; (ii) registration; (iii) intention of security; (iv) entitled; (v) power
3. (i) English mortgage; (ii) year to year
UNIT
65
THE RIGHT TO INFORMATION ACT, 2005
STRUCTURE
65.0 Objective
65.1 Introduction
65.2 Applicability
65.3 Definitions
65.4 Let Us Sum Up
65.5 Keywords
65.6
65.7 Check Your
Answers Progress
to 'Check Your Progress'
454
65.0 OBJECTIVE
The objective of this unit is to provide salient features of the Right to Information Act,
2005. The Act has application to most of the banks and financial institutions that will
come under the purview of public authority as defined in the Act.
65.1 INTRODUCTION
The Right to Information Act, 2005 was enacted with intent to provide for setting out the
practical regime of right to information for citizens to secure access to information under
the control of public authorities, in order to promote transparency and accountability in
the working of every public authority. The Act aims at containing corruption and holding
the Governments and their instrumentalities accountable to the governed by providing
access to information. The Act also creates machinery for ensuring effective
implementation of the Act.
65.2 APPLICABILITY
This Act extends to whole of India except the State of Jammu & Kashmir. While the
provisions of the Act relating to the obligations of public authorities, designation of
public information officers and assistant public information officers, constitution of
Central information commission, constitution of State information commission, non
applicability of the Act to certain organisations and power to make rules came into force
- CAIIB DISCUSSION
on 15 June 2005, the remaining provisions were made effective 120 days after the
aforesaid date. They came into force on 12 October 2005. On coming into force of this
Act (i.e., 12.10.2005) the Freedom of Information Act, 2002 has been repealed.
65.3 DEFINITIONS
It is relevant to understand the meaning of some of the terms defined in the Act for the
proper understanding of the Act. These are discussed below:
The term 'Appropriate Government' has to be understood in the context of the definition
of public authority. It can be either the Central Government or the State Government.
Central Government is the appropriate authority if the concerned public authority is
established, constituted, owned, controlled or substantially financed by funds provided
directly or indirectly by that Government or the Union Territory Administration. It is the
State Government, if the concerned public authority is established, constituted, owned,
controlled or substantially financed by funds provided directly or indirectly by that
Government.
'Central Information Commission' means the Central Information Commission
constituted by the Central Government.
'Central Public Information Officer' means the Central Public Information Officer
designated by the public authority and includes a Central Assistant Public Information
Officer.
'Information' means any material in any form, including records, documents, memos, e-
mails, opinions, advices, press releases, circulars, orders, logbooks, contracts, reports,
papers, samples, models, data material held in any electronic form and information
relating to any private body which can be accessed by a public authority under any law
for the time being in force.
'Public authority' means any authority or body or institution of self Government
established:
(a) by or under the Constitution;
(b) by any other law made by Parliament;
(c) by any other law made by the State Legislature;
I
455
(d) by notification issued or order made by the appropriate Government and includes any
(i) body owned, controlled or substantially financed; (ii) non-Government organisation
substantially financed, directly or indirectly by funds provided
by the appropriate Government.
'Right to information' has been defined in an inclusive manner. It means the right to
information accessible under this Act which is held by or under the control of any public
authority and includes the right to:
(i) inspection of work, documents, records;
(ii) taking notes, extracts or certified copies of documents or records; (iii) taking certified
samples of material; (iv) obtaining information in the form of diskettes, floppies, tapes,
video cassettes or in any other
electronic mode or through printouts where such information is stored in computers or in
other device.
'State Information Commission' means the State Information Commission constituted by
the State Government under this Act.
65.4 LET US SUM UP
The Right to Information Act, 2005 secures access to information under the control of
public authorities to the citizens. The Act aims at promoting transparency and
accountability in the working of every public authority and containing corruption. The
Act was brought in to force in stages on 15 June 2005 and 12 October 2005. The chief
public information officers and Central assistant public information officers are
- CAIIB DISCUSSION
66.7 Penalties
66.8 Let Us Sum Up
458
66.0 OBJECTIVE
This unit explains the obligations of public authorities, the procedure for obtaining
information and the information exempt from disclosure etc.
66.1 INTRODUCTION
Every public authority shall maintain all its records duly catalogued and indexed which
facilitates the right to information and ensure that all records that are appropriate to be
computerised are, within a reasonable time and subject to availability of resources,
computerised and connected through a network all over the country on different systems
so that access to such records is facilitated.
66.2 OBLIGATIONS OF PUBLIC AUTHORITIES
PIOs (Public Information Officers) are officers designated by the public authorities in all
administrative units or offices under it to provide information to the citizens that request
for information under the Act. Any officer, whose assistance has been sought by the PIO
for the proper discharge of his or her duties, shall render all assistance, whenever
demanded.
66.3 PROCEDURE FOR OBTAINING INFORMATION
PIO shall deal with requests from persons seeking information and where the request
cannot be made in writing, to render reasonable assistance to the person to reduce the
same in writing.
If the information requested for is held by or its subject matter is closely connected with
the function of another public authority, the PIO shall transfer, within five days, the
request to that other public authority and inform the applicant immediately.
PIO may seek the assistance of any other officer for the proper discharge of his/her
duties.
PIO, on receipt of a r equest, shall as expeditiously as possible, and in any case within
thirty days of the receipt of the request, either provide the information on payment of
such fee as may be prescribed or reject the request for any of the reasons specified in 8.8
or 8.9 of the Act.
Where the information requested for concerns the life or liberty of a person, the same
shall be provided within forty-eight hours of the r eceipt of the request.
66.4 DISPOSAL OF REQUEST
(a) If the PIO fails to give a decision on the request within the period specified, he shall
be deemed to have refused the request.
Where a request has been rejected, the PIO shall communicate to the requester -
(i) the reasons for such rejection,
(ii) the period within which an appeal against such rejection may be preferred, (iii) the
particulars of the appellate authority.
PIO shall provide the information in the form in which it is sought unless it would
disproportionately divert the resources of the public authority or would be detrimental to
the safety or preservation of the record in question.
If allowing partial access, the PIO shall give a notice to the applicant, informing:
(a) that only part of th e record requested, after severance of the record containing
information which is exempt from disclosure, is being provided;
I
- CAIIB DISCUSSION
includes a public authority. Where a Central Public Information Officer intends to

disclose any informatiorT or record or part thereof which relates to or has been supplied
by a third party and has been
460
treated as confidential by that third party, the Central Public Information Officer shall
within five days from the date of receipt of the request give a written notice to such third
party that he intends to disclose the information. The third party may make his
submissions in writing or orally within ten days from the date of receipt of such notice,
which shall be taken in to account by the Central Public Information Officer.
Except in the case of trade or commercial secrets protected by law, disclosure of third
party information may be allowed if the public interest in disclosure outweighs in
importance any possible harm or injury to the interests of such third party.
The notice given to the third party must state that the third party is entitled to prefer an
appeal against the decision to disclose the information.
(e) Rejection of the request
The request for Information may be rejected where such a request for providing access
would involve an infringement of copyright subsisting in a person other than the State.
Where a request has been rejected, the Central Public Information Officer shall
communicate to the person making the request the reasons for such rejection, the
particulars of the appellate authority and the period within which an appeal against such
rejection may be preferred.
(f) Information exempt from disclosure
The Act lists certain categories of information that is exempt from disclosure. These
include:
(a) information, the disclosure of which would prejudicially affect the sovereignty
and integrity
of India;
(b) disclosure of information expressly forbidden by law or may constitute
contempt of court;
(c) disclosure of which would cause a breach of privilege of Parliament or of the

State Legislature;
(d) information relating to commercial confidence, trade secrets or intellectual
property;
(e) information available to a person in his fiduciary relationship;
(f) information received in confidence from foreign government;
(g) information, the disclosure of which would endanger the life or physical safety
of any person;
(h) information which would impede the process of investigation or apprehension or
prosecution
of offenders;
(i) cabinet papers including records of deliberations of the Council of Ministers,
Secretaries and other officers.
In respect of items listed at (a), (c), and (i), the information if relating to any event which
occurred or happened twenty years before the date on which the request is made shall be
provided to the person making a request.
66.5 APPEAL
The Central Government has the powers to constitute a body known as the Central
information commission. The State Governments have the power to constitute for the
State a body known as the State Information Commission to administer the provisions of
the Act where the State Government is the appropriate authority.
The Central Information Commission (also the State Information Commission wherever
it has the jurisdiction) has been empowered to receive and inquire into a complaint from
any person-
- CAIIB DISCUSSION
(a) who has been unable tojmbmiLarequesUaaCentral Public Information Officer; or his
application for information or appeal was refused to be received by the Central Assistant
Public Information Officer;
461
(b) who has been refused access to any information requested under this Act;
(c) who has not been given a response to a request for information;
(d) who has been required to pay a fee which he considers unreasonable;
(e) who believes he has been given incomplete, misleading or false information;
and
(f) in respect of any other matter under this Act.
Any person who does not receive a decision within the time specified (normally thirty
days) or is aggrieved by a decision of the Central Public Information Officer may within
thirty days from the expiry of such period or from the receipt of such decision, prefer an
appeal to the officer who is senior in rank to the Central Public Information Officer in
each public authority. The appellate authority has the power to condone the delay in
filing the appeal if he is satisfied that the appellant was prevented by sufficient reasons
from filing the appeal in time.
If the appeal is against the third party information, the appeal by the concerned third
party shall be made within thirty days from the date of the order.
A second appeal will lie against the decision of the appellate authority before the Central
Information Commission (or the State Information Commission) and the same shall have
to be preferred within ninety days from the date on which the decision should have been
made or was actually received.
The appeal shall be disposed of within thirty days of the receipt of the appeal or within
such extended time not exceeding a total of forty-five days from the date of filing
thereof. The decision of the Central Information Commission is binding on the parties.
66.6 ORDERS IN APPEAL
In deciding the appeal, the Central Information Commission may pass the following
orders:
(a) require the public authority to take any steps necessary to secure compliance
with the provisions
of this Act including -
(i) by providing access to information in a particular form; (ii) by appointing a Central
Public Information Officer; etc.;
(b) require the public authority to compensate the complainant for any loss or other
detriment suffered;
(c) impose any of the penalties provided under this Act;
(d) reject the appeal.
66.7 PENALTIES
The Central Information Commission has the power to impose a penalty of two hundred
and fifty rupees for each day till the information is furnished subject to a maximum of
twenty-five thousand rupees. The Commission shall give an opportunity to the parties of
being heard before imposing any penalty. The Commission has the power to recommend
taking disciplinary action against the Central Public Information Officer under the
service rules applicable to him when he is satisfied that the Central Public Information
Officer
(i) without reasonable cause persistently failed to receive an application for
information; or
(ii) has not furnished the information within the time specified; or
(iii) with malafied intent denied the request for information; or
(iv) knowingly given incorrect, incomplete or misleading information; or
(v) destroyed information which was the subject of request; or
(vi) obstructed in furnishing the information.
- CAIIB DISCUSSION
462
66.8 LET US SUM UP
The Right to Information Act, 2005 gives right to every citizen to seek information from
any public authority under the Act. He need not give reasons for requesting the
information. Every public authority is required to display specified information about the
organisation, its employees, etc., and continue to update the information periodically.
Every public authority is required to designate one or more of its officials as Central
public information officer and at branch, district levels Central assistant Public
Information Officers. The central assistant public information officers are required to
receive the request for information and forward the same to the Central Public
Information Officer within five days of its receipt. Fees has been prescribed both for the
application and for the cost of furnishing information. Information has to be furnished
within thirty days. Where the request involves disclosure of information furnished by a
third party and the Central Public Information Officer intends to disclose it, he shall
within five days of the receipt of the request communicate in writing to the third party of
his intention to disclose. The third party has a right to make representation. The Act
provides a right of appeal to the officer senior in rank to that of the Central Public
Information Officer against the non disclosure or the decision to disclose the third party
information. Further appeal lies to the Central Information Commission. The appeal has
to be filed within ninety days. The Act prescribes penalties for various offences under
the Act.
1. Every citizen is entitled to seek information under the Right to Information Act
from a public
authority. (True/False)
2. Every public authority is required to display information about their
organisation, employees, etc.,
and update them periodically. (True/False)
3. Central Government appoints Central Public Information Officer in every
public
False) authority. (True/
4. A person seeking information has to disclose the reason for seeking
information. (True/False)
5. Central Assistant Public Information Officer has to forward the request for
information to the
concerned public authority within five days of the receipt of the request if it does not
relate to his
organisation. (True/False)
6. The request for information has to be disposed of ordinarily within thirty days.
(True/False)
7. No third party information can be sought from a public authority. (True/False)
8. If information requested is not provided it will be treated as a deemed refusal.
(True/False)
9. There is no redressal if the Central Public Information Officer refuses to
provide information.
(True/False)
10. Central information commission can recommend taking disciplinary action
against the Central
Public Information Officer if the latter failed to furnish information within the specified
time.
(True/False).
1. True; 2. True; 3. False; 4. False; 5. True; 6. True; 7. False; 8. True; 9. False; 10. True.
- CAIIB DISCUSSION
1C
UNIT
67
THE PREVENTION OF MONEY LAUNDERING ACT, 2002
STRUCTURE
67.0 Objective
67.1 Introduction
67.2 Offence of Money Laundering
67.3 Punishment for Money Laundering
67.4 Obligations of Banking Companies, Financial Institutions and Intermediaries
67.5 Rules Framed
67.6 Records to be Maintained
67.7 Information Contained in the Records
67.8 Procedure for Maintaining Information
67.9 Procedure for Furnishing Information
67.10 Verification of Records of the Identity of Clients
67.11 Maintenance of Records of Identity of Clients
67.12 Let Us Sum Up
464
67.0 OBJECTIVE
The objective of this unit is to familiarise the students with the requirements of the
Prevention
the bankingof Money Laundering
transactions Act, 2002 and the rules made there under in so far as
are concerned.
67.1 INTRODUCTION
The Prevention of Money Laundering Act, 2002 was enacted to prevent money
laundering and to provide for the confiscation of property derived from, or involved in,
money laundering. The banking machinery has been used by the persons indulging in
money laundering. In order to prevent the misuse of the banking machinery, a separate
Chapter, viz., Chapter IV dealing with Obligations of Banking Companies, Financial
Institutions and Intermediaries has been included in the Act. The Central Government in
consultation with the Reserve Bank of India has framed the rules, viz., The Prevention of
Money Laundering, Maintenance of Records of the Nature and Value of Transactions
etc., Rules, 2004.
67.2 OFFENCE OF MONEY LAUNDERING
There is no definition of money laundering in the Act. However, the Section 3 of the Act
states that whosoever directly or indirectly attempts to indulge or knowingly assists or
knowingly is a party or is actually involved in any process or activity connected with the
proceeds of crime and projecting it as untainted property shall be guilty of offence of
money laundering.
67.3 PUNISHMENT FOR MONEY LAUNDERING
Whosoever commits the offence of money laundering shall be punishable with rigorous
imprisonment for a term which shall not be less than three years but may extend to seven
years and also be liable to a fine which may extend to five lakh rupees. If the offence
relates to offences under the Narcotic Drugs and Psychotropic Substances Act, 1985 the
maximum punishment could extend to imprisonment for ten years.
- CAIIB DISCUSSION
67.4 OBLIGATIONS OF BANKING COMPANIES,

FINANCIAL INSTITUTIONS AND INTERMEDIARIES
Every banking company, financial institution and intermediary is required to
(a) maintain a record of all transactions, of the nature and value specified in the
rules whether such
transactions comprise of a single transaction or a series of transactions integrally
connected to
each other, and where such a series of transactions take place within a month;
(b) furnish information of the transactions to the director within the prescribed
time;
(c) verify and maintain records of the identity of all its clients.
The records shall be maintained for ten years from the date of cessation of the
transactions between the clients and the banking company, financial institution or
intermediary. The director appointed by the Central Government, has the right to call for
the records and make such inquiry or cause an enquiry to be made. If he finds that the
banking company, financial institution or intermediary has not complied with the
requirements he may impose a fine on the banking company which shall not be less than
ten thousand rupees but may extend to one lakh rupees. The Act also specifically
provides that the banking companies and their officers shall not be liable to any civil
proceedings against them for furnishing information.
465
67.5 RULES FRAMED
The Central Government in consultation with the Reserve Bank of India has framed 'The
Prevention of Money Laundering Maintenance of Records of the Nature and Value of
Transactions, the Procedure and Manner of Maintaining and Time for Furnishing
Information and Verification and Maintenance of Records of the Identity of the Clients
of the Banking Companies, Financial Institutions and Intermediaries Rules, 2004'.
67.6 RECORDS TO BE MAINTAINED
The Act envisages the following records shall be maintained by every banking company,
financial
(A) institution
all or intermediary,
cash transactions namely:
of the value of more than rupees ten lakh or its equivalent
in foreign currency;
(B) all series of cash transactions integrally connected to each other which have
been valued below
rupees ten lakh or its equivalent in foreign currency where such series of transactions
have taken
place within a month;
(C) all cash transactions where forged or counterfeit currency notes or bank notes
have been used as
genuine and where any forgery of a valuable security has taken place,
(D) all suspicious transactions, whether or not made in cash and by way of:
(i) deposits and credits, withdrawals into or from any accounts in whatsoever name they
are referred to in any currency maintained by way of:
(a) cheques including third party cheques, pay orders, demand drafts, cashiers
cheques or
any other instruments or payment of money including electronic receipts or credits and
electronic payments or debits; or
(b) travellers cheque; or
(c) transfer from one account within the same banking company, financial
institution and
intermediary, as the case may be, including from or to Nostro and Vostro accounts; or
(d) any other mode in whatsoever name it is referred to;
(ii) credits or debits into or from any non-monetary accounts such as a demat account,
- CAIIB DISCUSSION
security
account in any currency maintained by the banking company, financial institution and
intermediary, as the case may be; (iii) money transfer or remittances in favour of own
clients or non-clients from India or abroad
and to third party beneficiaries in India or abroad including transactions on its own
account
in any currency by any of the following:
(a) payment orders, or
(b) cashier cheques; or
(c) demand drafts; or
(d) telegraphic or wire transfer or electronic remittances or transfer; or
(e) interest transfers; or
(f) automated clearing house remittances; or
(g) lock box driven transfers or remittances; or
(h) remittances for credit or loading to electronic cards; or (i) any other mode of money
transfer by whatsoever name it is called;
(iv) loans and advances including credit or loan substitutes, investments and contingent
liability by way of:
(a) subscription to debt instruments such as commercial paper, certificate of
deposits
preferential shares, debentures, securitised participation, inter-bank participation or any
other investments in securities or the like whatever form and name it is referred to; or
(b) purchase and negotiation of bills, cheques and other instruments; or
466
(c.) foreign exchange contracts, currency, interest rate and commodity and any other
derivative
instrument in whatsoever name it is called; or (d) letters of credit, standby letters of
credit, guarantees, comfort letters, solvency certificates
and any other instruments for settlement and/or credit support.
(v) collection
or any service
other mode in any currency
of collection by way of
in whatsoever collection
name of bills,to.cheques, instruments
it is referred
67.7 INFORMATION CONTAINED IN THE RECORDS
The record shall contain the following information:
(a) the nature of the transaction
(b) the amount of the transaction and the currency in which it was denominated
(c) the date on which the transaction was conducted; and
(d) the parties to the transaction.
67.8 PROCEDURE FOR MAINTAINING INFORMATION
The information as to the transactions shall be maintained in hard and soft copies in
accordance with the procedure and manner as may be specified by the RBI or SEBI.
Banking company shall have to evolve a mechanism for maintaining such information in
such form and at such intervals as may be specified by the RBI or SEBI.
It is the duty of the banking company to observe the procedure and manner of
maintaining the information as specified by the RBI or SEBI.
67.9 PROCEDURE FOR FURNISHING INFORMATION
The principal officer of a banking company shall furnish the information in respect of
the transaction every month to the director by the seventh day of the succeeding month.
If the transactions relate to
(a) forged or counterfeit currency notes or bank notes or forgery of valuable security or
(b) all suspicious transactions, whether or not made in cash shall be promptly furnished
in writing or by way of fax or electronic mail to the director not later than three working
days from the date of occurrence of such transactions.
67.10 VERIFICATION OF RECORDS OF THE IDENTITY OF CLIENTS
- CAIIB DISCUSSION
The rules prescribe the type of records to be obtained or verified in respect of various
types of clients. The rules mandate that every banking company shall at the time of
opening an account or executing any transaction with it, verify and maintain the record
of identity and current address or addresses including permanent address of the client,
the nature of business of the client and his financial status. If it is not possible to verify
the identity at the time of opening the account or executing the transaction, the banking
company shall verify the identity of the client within a reasonable time after the account
has been opened or the transaction has been executed.
The documents required to be taken for verification of the identity of clients differ from
the type of client. They are listed below:
(a) Individual
One certified copy of an officially valid document containing details of his permanent
address, current address including in respect of the nature of business and financial
status.
(b) Company
1. Certificate of incorporation
467
2. Memorandum and articles of association
3. Board resolution or the power of attorney
4. Officially valid document in respect of the person, operating the account
(c) Partnership firm
1. Registration certificate;
2. Partnership deed;
3. Officially valid document in respect of the person acting in the transaction.
(d) Trust
1. Registration certificate;
2. Trust deed; and
3. Officially valid document in respect of the person acting in the transaction.
(e) Unincorporated association
1.
2. Resolution of the managing
Power of attorney granted tobody
the person conducting the transaction; and
3. Information as may be required by the banking company to establish the legal
existence of
the association or body of individuals.
67.11 MAINTENANCE OF RECORDS OF IDENTITY OF CLIENTS
The records relating to the identity of clients shall be maintained for a period often years
from the date of cessation of the transactions between the client and the banking
company.
67.12 LET US SUM UP
The Prevention of Money Laundering Act, 2002 was enacted to prevent money
laundering. The Act provides rigorous punishment for the offence of money laundering.
Certain obligations have been cast on banking companies, financial institutions and
intermediaries to maintain record of transactions, identity of clients, etc. A director
appointed by the Central Government has the right to call for records and impose
penalties if he finds that the banking company has failed to comply with the requirement
of the Act. Central Government has, in consultation with the RBI, framed rules. The
rules prescribe what records are to be maintained, retention of records, verification of the
identity of client and furnishing information in respect of the transactions to the director,
etc.
1. The Prevention of Money Laundering Act, 2002 does not apply to banking
transactions. (True/
False)
- CAIIB DISCUSSION
2. The term money laundering has been defined in the Prevention of Money
Laundering Act, 2002.
(True/False)
3. Director under the Act is appointed by the Reserve Bank of India. (True/False)
4. Record of transactions specified under the Act is to be maintained for ten years
(True/False)
5. RBI and SEBI can prescribe the nature of records to be maintained by a
banking company (True/
False)
6. Documents to be verified depend upon the type of the client. (True/False)
7. Bank is not required to enquire the financial status of the client. (True/False)
8. All cash transactions of the value of more than ten lakhs or its equivalent in
foreign currency are
covered by the Act (True/False)
1. False; 2. False; 3. False; 4. True; 5. True; 6. True; 7. False; 8. True.
L.R.A.B-31
INFORMATION TECHNOLOGY ACT, 2000
STRUCTURE
68.1 Introduction
68.2 Definitions
68.3 Electronic Governance
68.4 Certifying Authorities
68.5 Digital Signature Certificates
68.6 Penalties
68.7 Appeal
68.8 Investigations
68.9
68.10 Let Us Sum Up
Keywords
470
68.1 INTRODUCTION
The General Assembly of the United Nations by the resolution A/RES/51/162, dated 30
January, 1997 has adopted the Model Law on Electronic Commerce adopted by the
United Nations Commission on International Trade Law. The said resolution
recommends inter alia that all States give favourable consideration to the said Model
Law when they enact or revise their laws, in view of the need for uniformity of the law
applicable to alternatives to paper-cased methods of communication and storage of
information. It is considered necessary to give effect to the said resolution and to
promote efficient delivery of Government services by means of reliable electronic
records.
Therefore in May 2000, both the houses of the Indian Parliament passed the Information
Technology Bill. The Bill received the assent of the President in August 2000 and came
to be known as the Information Technology Act, 2000. Cyber laws are contained in the
IT Act, 2000.
This Act aims to provide the legal infrastructure for e-commerce in India which involves
the use of alternatives to paper based methods of communication and storage of
information and also to facilitate electronic filing of documents of Government agencies.
Therefore the Act facilitated the amendments to Indian Penal Code, the Indian Evidence
- CAIIB DISCUSSION
Act, 1872, the Bankers' Books Evidence Act, 1891 and the Reserve Bank of India Act,
1934 and for matters connected therewith or incidental thereto. And the cyber laws have
a major impact for e-businesses and the new economy in India. So, it is important to
understand what the various perspectives of the IT Act, 2000 are and what does it offer.
The Information Technology Act, 2000 also aims to provide the legal framework so that
legal sanctity is accorded to all electronic records and other activities carried out by
electronic means. The Act states that unless otherwise agreed, an acceptance of contract
may be expressed by electronic means of communication and the same shall have legal
validity and enforceability. Some highlights of the Act are listed below.
68.2 DEFINITIONS
In this Act, unless the context otherwise requires,
1. 'access' with its grammatical variations and cognate expressions means gaining
entry into,
instructing or communicating with the logical, arithmetical, or memory function
resources of a
computer, computer system or computer network;
2. 'addressee' means a person who is intended by the originator to receive the
electronic record but
does not include any intermediary;
3. 'adjudicating officer' means an adjudicating officer appointed under sub-Section
(1) of Section
46;
4. 'affixing digital signature' with its grammatical variations and cognate
expressions means adoption
of any methodology or procedure by a person for the purpose of authenticating an
electronic
record by means of digital signature;
5. 'appropriate Government' means as respects any matter, -
(i) enumerated in List II of the Seventh Schedule to the Constitution;
(ii) relating to any State law enacted under List III of the Seventh Schedule to the
Constitution,
6. the Statecrypto
'asymmetric Government
system'and in any
means other case,
a system the Central
of a secure Government;
key pair consisting of a
private key for
creating a digital signature and a public key to verify the digital signature;
7. 'certifying authority' means a person who has been granted a licence to issue a
Digital Signature
Certificate under Section 24;
8. 'certification practice statement' means a statement issued by a Certifying
Authority to specify
the practices that the Certifying Authority employs in issuing Digital Signature
Certificates;
471
9. 'computer' means any electronic magnetic, optical or other high-speed data processing
device or system which performs logical, arithmetic, and memory functions by
manipulations of electronic, magnetic or optical impulses, and includes all input, output,
processing, storage, computer software, or communication facilities which are connected
or related to the computer in a computer system or computer network;
10. 'computer network' means the interconnection of one or more computers
through -
(i) the use of satellite, microwave, terrestrial line or other communication media; and (ii)
terminals or a complex consisting of two or more interconnected computers whether or
not the interconnection is continuously maintained;
11. 'computer resource' means computer, computer system, computer network,
- CAIIB DISCUSSION
data, computer
data base or software;
12. 'computer system' means a device or collection of devices, including input and
output support
devices and excluding calculators which are not programmable and capable of being
used in
conjunction with external files, which contain computer programmes, electronic
instructions,
input data and output data, that performs logic, arithmetic, data storage and retrieval,
communication
control and other functions;
13. 'controller' means the Controller of Certifying Authorities appointed under the
sub-Section (1) of
Section 17;
14. 'Cyber Appellate Tribunal' means the Cyber Regulations Appellate Tribunal
established under the
sub-Section (1) of Section 48;
15. 'data' means a representation of information, knowledge, facts, concepts or
instructions which
are being prepared or have been prepared in a formalised manner, and is intended to be
processed,
is being processed or has been, processed in a computer system or computer network,
and may
be in any form (including computer printouts magnetic or optical storage media,
punched cards,
punched tapes) or stored internally in the memory of the computer;
16. 'digital signature' means authentication of any electronic record by a subscriber
by means of an
electronic method or procedure in accordance with the provisions of section 3;
17. 'Digital Signature Certificate' means a Digital Signature Certificate issued under
the
(4) sub-Section
of Section 35;
18. 'electronic form' with reference to information means any information
generated, sent, received
or stored in media, magnetic, optical, computer memory, micro film, computer generated
micro
fiche or similar device;
19. 'Electronic Gazette' means the Official Gazette published in the electronic form;
20. 'electronic record' means data, record or data generated, image or sound stored,
received or sent
in an electronic form or micro film or computer generated micro fiche;
21. 'function', in relation to a computer, includes logic, control arithmetical process,
deletion, storage
and retrieval and communication or telecommunication from or within a computer;
22. 'information' includes data, text, images, sound, voice, codes, computer
programmes, software
and databases or micro film or computer generated micro fiche;
23. 'intermediary' with respect to any particular electronic message means any
person who on behalf
of another person receives, stores or transmits that message or provides any service with
respect
to that message;
24. 'key pair', in an asymmetric crypto system, means a private key and its
mathematically related
- CAIIB DISCUSSION
public key, which are so related that the public key can verify a digital signature created
by the
private key;
25. 'law' includes any Act of Parliament or of a State Legislature, Ordinances
promulgated by the
President or a Governor, as the case may be. Regulations made by the President under
the article
472
240, Bills enacted as President's Act under the sub-Clause (a) of Clause (1) of the Article
357 of the Constitution and includes rules, regulations, bye laws and orders issued or
made there under;
26. 'licence' means a licence granted to a Certifying Authority under the Section 24;
27. 'originator' means a person who sends, generates, stores or transmits any
electronic message or
causes any electronic message to be sent, generated, stored or transmitted to any other
person
but does not include an intermediary;
28. 'prescribed' means prescribed by the rules made under this Act;
29. 'private key' means the key of a key pair used to create a digital signature;
30. 'public key' means the key of a key pair used to verify a digital signature and
listed in the Digital
Signature Certificate;
31. 'secure system' means computer hardware, software, and procedure that
(a) are reasonably secure from unauthorised access and misuse;

(b) provide a reasonable level of reliability and correct operation;
(c) are reasonably suited to performing the intended functions; and
(d) adhere to generally accepted security procedures;
32.
16 by the'security
Central procedure' means the security procedure prescribed under the Section
Government;
33. 'subscriber' means a person in whose name the Digital Signature Certificate is
issued;
34. 'verify' in relation to a digital signature, electronic record or public key, with its
grammatical
variations and cognate expressions means to determine whether —
(a) the initial electronic record was affixed with the digital signature by the use of a
private key
corresponding to the public key of the subscriber;
(b) the initial electronic record is retained intact or has been altered since such an
electronic
record was so affixed with the digital signature.
68.3 ELECTRONIC GOVERNANCE
Chapter III of the Act deals with electronic governance and provides that information or
any other matter shall be in writing or in the typewritten or printed form, then
notwithstanding anything contained in such law, such requirement shall be deemed to
have been satisfied if such information or matter is -
(a) rendered or made available in an electronic form; and
(b) accessible so as to be usable for a subsequent reference. The said chapter also
details recognition
of Digital signatures.
- CAIIB DISCUSSION
The said chapter also details the legal recognition of Digital Signatures.
68.4 CERTIFYING AUTHORITIES
Chapter IV of the said Act gives a scheme for Regulation of Certifying Authorities. The
Act envisages a Controller of Certifying Authorities who shall perform the function of
exercising supervision over the activities of certifying authorities as also laying down
standards and conditions governing the certifying authorities as also specifying the
various forms and content of Digital Signature Certificates. The Act recognises the need
for recognising foreign certifying authorities and it further details the various provisions
for the issue of license to issue Digital Signature Certificates.
68.5 DIGITAL SIGNATURE CERTIFICATES
Chapter VII of the Act deals with the scheme of things relating to Digital Signature
Certificates. The duties of subscribers are also enshrined in the said Act.
473
68.6 PENALTIES
Chapter IX of the said Act talks about penalties and adjudication for various offences.
The penalties for damage to computers, computer system, etc., has been fixed as
damages by way of compensation not exceeding Rs. 1 crore to affected persons. The Act
talks of appointment of any officers not below the rank of a director to the Government
of India or an equivalent officer who shall adjudicate whether any person has made a
contravention of any of the provisions of the Act or rules framed there under. The said
adjudicating officer has been given the powers of a Civil Court.
68.7 APPEAL
Chapter X of the Act talks about the establishment of the Cyber Regulations Appellate
Tribunal which shall be an appellate body where appeals against the orders passed by
Adjudicating Officers will be preferred.
68.8 INVESTIGATION
Chapter XI of the Act talks about various offences and the said offences will be
investigated by the Police Officer not below the rank of Dy. Superintendent of Police.
These offences include the tampering with computer source documents, publishing of
information,
The Act also which is obscene
provides in electronicofform
for the constitution and hacking.
the Cyber Regulation Advisory Committee
which shall advise the Government as regards any rules or for any other purpose
connected with the said Act. The said Act also proposes to amend the Indian Penal Code
1860, The Indian Evidence Act 1872, The Bankers Book Evidence Act 1891, The
Reserve Bank of India Act 1934, to make them in tune with the provisions of the IT Act.
68.9 LET US SUM UP
This Act is very important in the electronic age, where documents are transmitted
through electronic means. Students should be aware of its relevance and provisions,
when e-commerce and e-transactions are on the rise.
68.10 KEYWORDS
Digital Signature; Asymmetric Crypto System; Computer data; Digital Signature;
Information Originator; Secure System; Electronic Commerce
1. The IT Act was introduced on account of the initiatives of
(A) IT industry of India (B) Indian Parliament

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8/18/2019 JAIIB-MACMILLAN EBOOK-LEGAL AND REGULATORY ASPECTS OF BANKING.

LEGAL AND REGULATORY ASPECTS OF BANKING 2nd Edition

LEGAL & REGULATORY ASPECTS OF BANKING

Kulkarni (Module C), B. Gopalakrishnan (Module D) under the guidance of M.L.

in preparing the courseware in a short period of time.

MODULE, A.-REGULATIONS &COMPLIANCE

• Winding Up - Amalgamation and Mergers

- Scope and Application

• Laws Relating to Bill Finance, LC and Deferred Payments

MODULE C - BANKING RELATED LAWS

• The Transfer of Property Act

10. Letters of Credit 119

23. Enforcement of Security Interest

31. Jurisdiction, Powers and Authority of Tribunals

231 241 245 249

MODULE D - COMMERCIAL LAWS WITH REFERENCE TO BANKING

41. Meaning and Essentials of a Contract

341 345 347 353 357 359 365 369

49. Unpaid Seller

63. Foreign Exchange Management Act, 1999

MODULE-A REGULATIONS AND COMPLIANCE

Unit 1 LEGAL FRAMEWORK OF REGULATION

includes the business of a financial institution or whose principal business is acceptance

when such business is of a nature described in Section 6.

1.3 CONSTITUTION OF BANKS

iv. Co-operative Banks: A co-operative bank is a co-operative society registered or

1.4 RESERVE BANK OF INDIA ACT, 1934

1.5 BANK I NG REGULATI ON ACT, 1949

public interest and

Co-operative Societies Acts. The extent of applicability of the regulatory provisions

regulating acceptance of deposits from public)

(iv) Authorities under the Companies Act (v) SEBI.

with commercial banks)

CONTROL OVER ORGANISATION OF BANKS

2.17 Answers to 'Check Your Progress'

unencumbered approved securities or partly in both. Apart from this, an amount of

Rs. 5 lac, plus

with his/her creditors;

\\\r 9 r*riminQl rrmrt r\f 'An

2.14 LET US SUM UP

licence once given

REGULATION OF BANKING BUSINESS

3.13 Maintenance of Liquid Assets

directions to control advances by banking companies. Such directions may be issued to

(i) Deficiency in banking or other services in respect of:

comprehensive adjudication by a court, arbitrator, tribunal or forum with wider powers.

3.17 CHECK YOUR PROGRESS

(iv) (v) (vi)

3.19 TERMINAL QUESTIONS

RETURNS, INSPECTION, WINDING UP

4.8 Acquisition of Undertakings

4.14 Check Your Progress

the law relating to the above matters.

quarterly results as per proforma prescribed by SEBI.

to be the auditor of a banking company.

14B of the Banking Regulation (Companies) Rules.

banking company to make a representation in respect of the report. The Central

special knowledge of accountancy, law, economics, banking, finance and management.

4.9 AMALGAMATION OF BANKS

thereof in the case of amalgamation; (iii) change in or appointment of board of directors;

(b) Theif Reserve

4. Say whether true or false

prepare its annual