ATUL DEPAK

Law Student, New Delhi

BANKING LAW & NEGOTIABLE INSTRUMENTS

Photo Credit: Ethan McArthur, Unsplash

Two Limbs of Banking Law

  1. Negotiable Instrument Act (NIA)
  2. Banking Law

Different Systems-

  1. Payment System
  2. Central Banking System
  3. Banking Regulations
  4. Bank Investments
  5. Enforcement Action
  6. Banker Customer Relationship 

Mid-Term Syllabus-NIA in Full 

Relevant Books

For NIA- 

  1. Khirgamwala 
  2. Bhasham 
  3. Avtar Singh 

For Banking Law

  1. Paget on Bankings 
  2. Alinger on Modern Banking Law

Wrt Bank Investment 

  1. Goode on Legal problems, credit and security (first 3 chapters)

INTRODUCTION TO BANKING LAW

Banking law like Admin law is an applied topic. There is no specific statute. 80% understanding of Banking relate to understanding of property. (Read Transfer of Property Act on mortgages and equity) 90% litigations relate to property matter. 

Principles of Equity, Trust and Property matters here too.

MONEY-

  1. Storehouse of Value-To do away with the barter system
  2. Unit of Account-For people to maintain how much they owe to each other
  3. Medium of Exchange-Money came to used as a medium of exchange for buying and selling of commodities. 

With time units of bullion developed as money. In essence, money is a property. It can be inherited, transferred. Because it is a medium of exchange, many civilisations like Islam prohibited usury. The rationale was that you cannot earn money on money. Because it is a medium of exchange, much of it has to look same for others to believe its genuineness and do transactions immediately. Certain properties of properties do not apply to money. The rule ‘No one can give to another person better title than what he himself possess’ (nemo dat quod non habet) does not apply to money because it is a medium of exchange and the person taking it is not expected to verify the ownership of the giver. 

Legal Tender issued by State 

State used to earn seignorage on money. Bullion (metal coins) was inconvenient for the purpose of exchange. So Alternatives were sought.  A means of promise to pay was evolved so that instead of paying through coins people could acknowledge the debt and promise to pay as and when required. Such promissory notes were first issued in China. Payment through coins would involve transportation over long distances and hence was inefficient in many cases. 

Muhammad bin Tughlaq also tried to introduce token currency but it failed due to forgery. But in China it went for a quite a long time. 

In Europe, the rulers did not intervene but nobility used to keep the coins with goldsmith and in return for that goldsmith would issue-‘I owe you’ or IOU (Eg-IOU 10K Pounds)to whosoever deposited the coins with them. At the initial stage, the goldsmiths charged fees on these IOUs, but soon they realised that what was deposited was rarely called upon to be paid because IOU itself would circulate as money. But with time, this mere acknowledgement of debt and promise to pay developed as money itself. UK Parliament declared it to be money and doctrine of nemo debt was applicable on it. These Promissory notes are a kind of Negotiable instruments

Important-NI means that instrument concerned can be transferred to someone else by mere delivery. 

If I sign a debt bond which gets lost, that would not affect the original debt. The debt merges in that debt bond. If that debt bond is transferred to some else, I would still have to pay him. It means that debts are assignable.

The debt bond is not evidence of debt but debt itself. What if someone else finds that paper and goes and pays for his coffee with it? The coffee shop owner would have full right over it. The piece of paper gives rise to the possibility that someone else has a better title to it than the person owning it, this gives rise to negotiable instruments. 

Initially the goldsmith would charge a fee for that IOU. Over a period of time, he realises that people rarely made claim for the gold and paid with IOUs only. That IOU would start circulating as money. So goldsmiths started making money by lending the golds deposited to them. 

BILLS OF EXCHANGE (BoE)

Rich people and merchants deposited their money with trustworthy goldsmiths and bankers in their town or locality.  These merchants moved extensively to other nations for trade and mercantile purposes and sometimes they would require money in those locations.  In such cases it used to be difficult for the goldsmith of their hometown to pay personally, so the goldsmiths concerned developed credit systems, networking, linkages and patronages in other nations. So when their clients required money in other states, they would simply write to their patrons, debtors or fellow goldsmiths in other nations to pay to their respective clients. This type of instrument came to be called “Bills of exchange” The whole system was based on ‘Trust’ and ‘Honour’

BOE became very popular in Europe.  Fares were organised where goods were exchanged and people would make payment in terms of Bills of Exchange drawn in favour of some other person. When the fare would come to end, people would collect the net amount payable from the person concerned on whose behalf the payment was made. 

This is how banks evolved. BOEs were also treated as money.

PROMISSORY NOTES (PN)

Originally Promissory notes were issued by goldsmiths who later converted them into banks. These notes were payable on demand and payable to the bearers. By issuance of bank notes, banks earned profits. The value of bank notes depended on the trust and reputation of the banker. Trust would be inversely proportional to the distance. It was easier to make profit, if the banker had a monopoly in that area. To create a monopoly, rival issuers would buy up the notes of a banker and then suddenly would make a demand of payment. If the banker was unable to pay, it would become bankrupt. So bank failures became common sight. In this manner, economic would take a hit. Some measures of collaboration were found out. It was thought that note-issuing monopoly be given to an entity. 

HISTORICAL DEVELOPMENTS

United Kingdom

In UK, after the glorious revolution, banknote issuing monopoly was given to Bank of England (BOE) around the city of London. In lieu of it, the Bank gave the King loans to bankroll his war efforts. Since London was an important mercantile centre, the notes issued by BOE slowly over-powered other banks all over England. Because it was lending to the King, there was more confidence in it. Later on denominations of notes were decreased and its locality increased. London experiment was copied by other Nations including the United States. The US was the last to copy this because states did not want to give this power to the federal government. 

United States

In the 1880s, the US established the Federal Reserve Board. Economy normally follows a cycle. Over the few cycles, there is a financial cycle. When People become confident about future, they take loans and invest. Over a period of time, something occurs, and they shrink their spending. It becomes difficult to pay the loan. When lender is unable to recover the money, he is unable to pay-back to the entity from which it borrowed. 

There is an element of opacity to lender’s business-Whether the borrower would be able to repay or not? If one lender is unable to pay, it generates a fear in everyone else. People will then not give money to those lenders. When borrower does not pay, banks become afraid and they stop lending.  So at this time, someone who has got deep-pockets is needed. 

In 1907, a crisis occurred in New York wrt many Bank Trusts who were failing due to financial crisis. JP Morgan raised money to rescue the crisis. He then mooted the idea that there should be a central bank to issue money.

So just before the 1st world war, Federal Reserve was established in the US to act as a central bank. 

In 1929 the great depression occurred, and one of the recommendations was that all countries should have entity which has monopoly over issuing notes. Till this depression, the amount of notes issued were equivalent to gold reserved. As economy progressed, the demand of money increases but gold reserved does not increase at same level.

If the money is limited, there will be deflation. Prices of commodities start to reduce. So someone is needed who can issue notes in proportion to the gold reserved and which would honour each notes it issues. 

RBI was created in India after the great depression. 

The best asset that can back a note is either gold reserved or the currency of another state or the debt of the government/government securities

Post World War II

Post WW2 there were only 2 countries where currency notes were backed by gold or bullion-US and Switzerland. After banks lost their note issuing capability, they had to find out some methods to stay in business. So they started issuing ‘Promissory Notes’ and ‘Bills of Exchange’ BoE.

Illustration-‘I will pay the bearer 100 rupees on demand.’

Bills of exchange (BOE) was essentially done by traders. That’s how cheque evolved. 

A Check is a Bill of Exchange with 3 differences-

  1. It can be drawn only from a bank and not from any other person. 
  2. It’s payable only on demand.
  3. There is a time limit.

Banks gave its customers the facility to issue checks upon it. Business evolved. Cheques cannot be indefinitely in circulation. If your AC balance is 10K and you have issued cheque of 20K? 

Two systems developed wrt Cheques-

  1. To pay the cheque drawn upon it.
  2. To collect the cheque of its customers deposited for collection. 

Bank is the debtor of its customer. Customer is the lender. But it differs from a traditional creditor-lender relationship. In any debtor-lender relationship, the debtor goes to lender for payment. But in banking, it is the lender that approaches the bank for payment during working hours. 

There cannot be any specific performance of a contract to take debt or lend. The customer can lend to the bank as much as he want to lend and duty upon the bank to collect the money which the customer deposits or gives to it. 

The Cheque issuance facility-This denotes the liability of the bank to pay upon it.

Actionable claim-Cannot be split if the cause of action is one. Similarly cheque cannot be split.  We did what a bank does.

3 Essential Components of a Bank

  1. Banks in order to be called bank has to accept deposit to be payable on demand
  2. It has to provide chequing facilities
  3. It has to collect cheques on behalf of its customers.

Statutes do not convey all the components 

Post offices are not banks because there is a limit on the amount which can be deposited in post office bank. Banking regulation also defines bank. To be called a bank an entity has to provide cheque facility. Many entities like Payment Banks use the word ‘Bank’ in their name but do not include all its feature.There is a limit on deposit amount. No Cheque collection facility. Initially, Cheque writing and cheque collection was rogue. Bank took customers only if they were confident that he will payback. But as time progressed, common people also became the customers of Bank. Because Banks were collecting cheques more frequently, people had fewer interactions so certain duties and privileges had to be accorded to the bank.

BANKER CUSTOMER RELATIONSHIP

  1. If bank collects cheque and the customer is at fault, the bank is to be given a certain degree of protection. 
  2. Cheque is not money, its a movable property. 
  3. So if a thief has collected payment on a stolen cheque, he is guilty of tort of conversion. Bank is guilty as an agent of thief
  4. The only remedy is the bank itself. 
  5. They are governed by the terms of the contract between bank and customers
  6. Banks act as customers agent when doing transactions
  7. Confidentiality Agreements
  8. Bank concerned is the single debtor of the customer. 
  9. Right to combine the credit and debt account. 
  10. Right of lien over the property that comes across in the course banking business. 
  11. Lien is that the thing will not be returned, neither will it be sold. 
  12. The rights that the bank has, is with regard to the customer. 
  13. For banking law purpose, the person is a customer only if he/she has an account with it. Earlier it was the rule that, a person has to habitually deal with the bank. Now, a person is a customer when it is certain that will open the account, Provided he opens the account
  14. In banking business a person is entitled to withdraw the money on demand. 
  15. All the debt which the bank owes are short termed. It has to cover its cost of operation and also generate profit. So they have lend loan for fix duration loan. It liabilities are short in duration, assets are long in duration. 
  16. Banking business is most convenient but inherently unstable. 

Banks lend loans for a fixed duration. Banks are unstable because if there is sudden surge in demand then Banks will not be able to repay the loan. It is a means by which people transact. Rules for its insolvency are much stricter than institutions

If a person is unable to pay loan, court will not order insolvency of that person. 

A Bank is immediately admitted for insolvency proceedings the moment it is unable to pay on demand. So it becomes very imp to regulate bank more than any other sector of the economy.

In addition there are always difficulties wrt financial sector itself. In any particular business other than bank, most of the assets can be observed ie most of them are tangible. 

Its a bundle of rights and liabilities. In banking business, if other person goes off, your assets will also go off. 

In the normal course if I lend money, I will take something as a security. There is an opacity wrt to bank. You have to essentially rely on trust. 

FRACTIONAL BANKING SYSTEM

The fractional banking system not only deal in money but also create money. Switzerland had a referendum whether Banks should create money. 

Eg-Promissory notes issued on gold coins. I issue a 1K Promissory notes and you acknowledge liability of 1K. So 2K is created. So money is not gold coin but a fiction which people believe that they will be paid. 

You deposit 1K rupees. The deposited 1K is called reserved money. Bank will credit that to your account. The Bank will lend the 900 Rupee if chance of your withdrawal is 10%. Other person deposits 900 as part of loan payment. Bank by fiction creates 9000 out of 1000 Rupees. System will work as long as people are confident that the bank will survive. The moment confidence erodes, the system will collapse. 90% of the money does not exist in realty

Every bank is dependent on other banks. If one fails, people are afraid to lend to others. You deposited the cheque in PNB. It is collected by SBI. Will PNB give 10K to SBI? No, It will just credit 10K to SBI.

REGULATION OF BANKS

How banks are regulated?

We discussed that note issuing entity is given the power to disperse loans as a last resort. That’s why  known as lender of last resort. When it gives loan, it will take some security. Because it lends money for the purpose of being paid back. It has to have the confidence it will be paid back. That confident will be there only if it can tell the loan taker to abide by the terms and condition and how he will do his business. RBI does the same. BOR and Federal Reserve example. 

All banks meet for the clearances of cheque. The clearing house will always have regulatory role. 

Re-Financing agencies also have a regulatory role. Cooperative banks have got regulatory role. 

NABARD is the re-financing agency for all rural banks.

WHAT ARE THE IMPORTANT ASPECTS OF REGULATIONS?

The ownership

Who has controlling stake in the bank. Ownership of a bank gives you access to liquidity which he may use for other business. That business becomes more important than servicing the customers of the bank. Therefore banks should not do other business other than banking directly or indirectly. Bank of Bengal failed because of these reasons. 

Management

Control over management becomes very important. Most of bank frauds occurred due to the same person has been on the desk for ages. Banking regulation therefore provides for oversight and regular change in the board. 

Capital

One needs to have initial capital for the purpose of doing banking. There is a ratio of capital which bank will give as loan. Management is not answerable to customers but to shareholders. Management’s instinct will be to maximise returns. The risk taken should be proportional to the capital. 

1973New York Crisis 

The Heritage Fiasco-A German bank failed. Because of this many other banks also failed. So countries came up with BASEL Accord. Now we have BASEL3. It was essentially for developed countries who were members of Bank of Intl Settlement. Amount of capital will determine the risk you can take. Risk also depend on type of activities for which loan is given. RBI had prohibited many PSBs from lending to any private individual but only to government because of less risk. In India, Banks should have 9 rupees of their own for every 100 rupee they lend. Internationally it is 8%. 

Purpose

  1. To control shareholder’s instinct of pushing management to take more risk
  2. Standby for loss

Banking business is inherently unstable. Its liabilities are liquid but its assets are illiquid.

Two measures of insolvency-

  1. Assets are less than liability
  2. When liabilities arise, you are not able to pay. 

Therefore for some of Bank’s assets should be liquid which can be sold off when need be. In India we have Cash Reserve Ratio-Cash with the RBI. 

Statutory Liquidity Ratio-Money invested in govt. securities. You will always get a buyer of gold. 

They are a kind firewall.

Prudential practices in lending-

  1. RBI Directives/Guidelines
  2. Market Practices
  3. Bank’s Own norms

Banks do not lend all their money for the purpose of buying land and buying shares. There has to be a diversity in lending. You cannot lend only in one sector. 

You cannot have exposure to one person or entity more than 15% of the capital. 

What is the margin (difference b/w the value of the security and loan) and security while lending? 

Banks also make money by quasi-lending. It means lending the name and not the money. It has been Provided in the BALI ACCORD

Issuance of letter of credit or Bank Guarantees-The bank will take a certain commission. Because there is more certainty of payment due the robust practices and the law, the Bank will take certain cuts on it. 

Banks also make money through Negotiable Instruments by being an accommodating party. It charges a certain commission. Bill discounting is very common means by Bank to invest their short term surplus. Banks buys bills of exchange. BOEs have payment period of 45 days. For eg-GOI owes you 1 lac payable in 60 days. You sell the instrument to Bank and collect payment now. Bank will charge 5% will give you 95K and will collect the payment from GOI after 60 days. 

When a person borrows, he is the first security (including his reputation and track record). He can’t be a guarantor to his own loan. Anything extra given as a security is known as collateral security

Property which he gives as security-This is a very imp area. 

We use the term ‘security’ very loosely. 

Eg-You deposit certain amount to landlord as security. But in reality it is not security. 

Any security given to company has to be registered. 

What is security interest? When it is created? When it attaches? Perfection of a security interests

In law, perfection relates to the additional steps required to be taken in relation to a security interest in order to make it effective against third parties or to retain its effectiveness in the event of default by the grantor of the security interest.

Methods of perfection

There are three principal modes by which a security interest may be perfected (which method of perfection is applicable depends upon the nature of the security interest and the laws of the relevant country).

  1. Possession of the collateral;
  2. Statutory registration or filing, and
  3. Notice to the debtor or a fund-holder.

NEGOTIABLE INSTRUMENTS ACT

Lays down laws regarding 3 Instruments-

  1. Promissory Notes
  2. Bills of Exchange
  3. Cheque

Instrument in oriental language-‘Hundis’ are not covered by it. But General Principles of NI Act are applicable to Hundis as well. 

Eg-Law of Mortgages-Whether the mortgage will be valid if it is not registered? This a specific rule. 

NIA is not an outdated Act. It lays down the mercantile law generally applicable in most jurisdiction. Its Lex Mercatoria and they are utilised for International trade and finance. Most bonds are in the form of promissory notes. Now we use cards but earlier people used to carry cheques. 

In UK, BOEs are commonly used. Banks take it as a collateral security. It can be easily sold off to anyone else. 

They are regarded as equal to money and denoted right to money. There had to be certain attributes in them to be regarded as negotiable. 

CERTAINTIES 

There had to be certain certainties regarding NI-

  1. Negotiable Instruments are transferrable
  2. Every right and duty wrt the instrument have to be evident on the instrument itself.

Certainties regarding-

  1. Who has to pay?
    1. It can be paid by person promising to pay unconditionally. Then it is Promissory notes. Or it can order someone else to pay ie cheque. 
    2. When you order someone else to pay, it is Bills of Exchange. BOE payable on demand is Cheque
    3. Person who orders is called Drawer on Instrument.
    4. The person who has been ordered to pay is Drawee of the Instrument. (ie in a cheque Bank is the Drawee) Drawee is not liable. Its his option whether or not to pay. But once he accepts his liability, he becomes an acceptor
    5. In Cheque, there is not concept of acceptance as it is paid across the counter even if the drawee bank concerned has written something on the cheque. It can only verify the genuineness of the signature. 
    6. There is also a concept of acceptor for honour. He is the one who is not mentioned as drawee but accepts it for the honour of that person (generally drawer)
    7. The person who has been ordered to pay, if he has been named, he is payee. Payee when further endorses the BoE, he is called the endorsee. Endorsee might again endorse it. Sometimes the endorsement can become blank. When the endorsement is endorsement in blank, then it becomes payable to bearer. He will just enter his name on the blank space and collect the payment
    8. Unconditional acknowledgement that he will pay. 
    9. See S.4 and 5 of NI Act. 
  2. Payment to whom?
    1. Payment might be to the bearer or it might to be to whosoever.
  3. How much has to be paid?
    1. It has to be only in terms of money or anything which public regards as money
  4. When it has to be paid. 
    1. Payable on demand or payable after certain time which is certain to happen.

MEANING OF NEGOTIABLE

Negotiable means the receiver will get it free from defects of the title.

S.13 of the RBI Act provides that no one other than central govt. can issue any PN, BOE or Hundis which is payable on demand to the bearer. Only RBI can issue bank notes. The raison d’être is that they are nearer to currency. Currency issuing power is only with RBI in India. Exceptions are made wrt cheque or drafts upon one’s own bank or Shroff. 

Long time ago they used to issue Indira Vikas Patra

PN is something which is nearer to currency

If you bypass the restriction ‘Payable on Demand’ and put the date of issuance and payment as same.  

Now-days ‘PN payable to the bearer’ is used to bypass money laundering. 

BOE (order to pay) if it is drawn on myself or in favour of a fictitious person who does not exists or agent upon the principle or one branch upon other branch. They on the face of it looks like BOI but in reality it is a PN. Where there an ambiguity wrt to nature of the instrument, the person concerned has an option of how he treat it as. 

In case of PN, the maker is primarily liable and everyone who endorses it unconditionally is a guarantor upon that instrument. The more signatures (indorsers) there are on a PN, the more the value of the PN. The value also depends upon who the guarantor is. If the guarantor is a bank, then its value increases. The rule of Sale of Goods apply. 

When one issues a cheque, following things are implied-

  1. The bank exists
  2. The account exists 
  3. The balance exists
  4. The liability exists 

Accommodation Instrument

Where someone puts his name on the instrument so as to help someone else in selling that particular instrument or making it more credible. Eg-I have deposited in bank 10K for the purpose of BOE and order the bank to pay. If I don’t have any balance now, the bank takes a risk on me that I will put the money in my account on  or before the given date when the BOE has to be paid the bearer. Even the money is not deposited, the Bank will still honour the BOI to the bearer but not the person who issued it. 

PN/BOECheque comes into existence only after it has been given to the 3rd person. If I have drawn PN but have not given it to 3rd person, it will not come into existence. Even if the 3rd party has got that, the issuer can refuse to pay Provided he can prove that he didn’t give it. In the case of PN, it is looked whether you has intention to pay or not. Merely because I promised to pay does not mean that I had intention to make a PN. Intention depends upon facts and circumstances

INTENTION

One of the requirement of PN is that the maker should have intention to write PN. Intention to create any legal relationship is not required. Many a time intention is also contested by the holder of PN.

PN and BOE as per Indian Stamp Act in order to be admissible as evidence must be stamped. Similarly Mortgages need to be registered. This limitation might not be there wrt to foreign courts.

It has to stamped during the inception itself. If it is not adequately stamped at the inception, it cannot be stamped later

The stamp Act distinguishes b/w stamping of PN and a Bond. Consequences are different. An inadequately stamped bond will be inadmissible as evidence but court may allow it to be produced as an evidence if a penalty is paid upon it. But in the case of PN and BOE no such concession is Provided for. If it is inadmissible as evidence once, it will remain inadmissible. 

Rationale-Policy Concerns ie people will not stamp it. 

In case of inadequately stamped PN, writer or holder will generally say that it was never issued in the first place. Holder will say, that maker didn’t intend to pay, he just acknowledged his debt through this inadequately stamped PN and therefore it should admissible as evidence of debt and maker should be made to pay. 

All factors will be taken into account to ascertain the intention.

Eg-In Nawab Mohammad Akbar Khan case, PC held that debtor acknowledged the debt in his account book and said that he was willing to pay the debt with interest and it was also stamped. PN is written in 1-2 pages and is transferable. So if it is written in account book, it shows there was no intention to transfer even if it was stamped. This case was a property dispute in family. The person who got bigger share wrote the PN that he will compensate the one who got lesser share. 

In PN you as writer of PN lose your right of set-off. 

Totality of facts & circumstances will determine the intention. 

If PN is inadmissible in evidence due to inadequate stamping, then other party try to claim it upon the dept. PN is generally evidence of debt. 

Muang Chit v Roshan Kareem Omer 

The Rangoon HC laid down in detail law regarding this. When you make the payment in terms of NI, generally the NI is supposed to be a conditional payment. You still retain your right wrt debt. If it is dissatisfied. If someone issues a 15K to you to settle a loan which he took from you. This is a conditional payment ie if the cheque is honoured by the bank then debt is settled but if it cannot be encashed, then the debt remains. The holder of cheque may come back due to some concerns ie it is difficult for him to encash the cheque. Similarly PN is a conditional payment towards the debt generally. If PN is held to inadmissible, one can ask for the payment on the original debt. 

But in certain circumstances, one loses it-When the debt and NI merges. It can be by the intention of the parties or their conduct subsequently which can show that debt has merged in the NI and there cannot exist a debt which is separate from the NI. Eg-Where the parties to the debt negotiated and all terms are reflected in the PN. If the PN is contemporaneous with the debt and every detail is listed in the PN, then it is indication that parties intended that debt and PN should merge. 

By the Act of the parties-The parties have done something which shows that debt has merged with PN. Eg-Bank has given you loan and you have given a PN as a collateral security after negotiations. Later Bank gives it to other Bank. This shows that both have merge and PN was not intended to be just a collateral security. 

There is no requirement of stamp in the case of cheque. 

HOLDER AND HOLDER IN DUE COURSE

NI Act is one of the worst drafted Acts. Few Reasons- 

  1. It was depended upon Lex Mercatoria which the drafter might not have been aware of. 
  2. They took into account written text.
  3. It was a type of experiment. 
  4. 99% of the NI Act will correspond to UK BOE Act. 

S.8 defines Holder and S.9 defines Holder in Due Course

S.8 Holder-The “holder” of a promissory note, bill of exchange or cheque means any person entitled in his own name to the possession thereof and to receive or recover the amount due thereon from the parties thereto. 

Where the note, bill or cheque is lost or destroyed, its holder is the person so entitled at the time of such loss or destruction

S.9 Holder in due course means any person who for consideration became the possessor of a promissory note, bill of exchange or cheque if payable to bearer, or the payee or indorsee thereof, if payable to order, before the amount mentioned in it became payable, and without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title

Holder is meant to be owner. Holder in Due Course (HDC) is the person who will get the title to the instrument free of defect of the title of previous party. Certain conditions have to be fulfilled. 

Ownership here is legal ownership and not equitable ownership. Person who is entitled to the possession in his own course  and to receive the amount due thereon.

A person may not be a holder but can derive the title.

A person to whom the instrument comes through an offense is not entitled to it. He may receive the payment on the it but he is not entitled to it. The person should be entitled to receive payment on it. If he is not entitled then he is not the holder of the instrument.

Who will be holder of the instrument?

  1. The bearer of the instrument
  2. The Payee or the endorsee

The one who comes across the instrument in succession is holder and owner of the instrument. I endorse the instrument for the purpose of collection to my servant. The servant is the holder of the instrument for a limited time-for collection of payment. If he is unable to collect the payment, he is not entitled to its possession. 

If the instrument is assigned, it is separate from the instrument.

If negotiation happens upon the instrument, you negotiate upon it

PRIVILEGES OF A HOLDER IN DUE COURSE 

The title of the holder in due course of a negotiable instrument as defined in S.9 is free from equities and other defences which could be urged against prior parties. This special privilege is secured to him by means of certain rules and estoppels contained in the Act. These may be briefly summarised as follows-

  1. According to S.20, a person who has signed and delivered to another, a stamped but otherwise inchoate instrument, is precluded from asserting, as against a holder in due course, that the instrument has not been filed in accordance with the authority given by him, the stamp being sufficient to cover the amount. 
  2. According to S.42, where a bill of exchange is accepted payable to the order of the drawer in a fictitious name, and is indorsed in the same hand as the drawer’s signature, the acceptor is not permitted to allege, as against a holder in due course, that such name is fictitious
  3. According to S.46 and 47, if a bill or note is negotiated to a holder in due course, the other parties to the bill or note cannot avoid liability on the ground that the delivery of the instrument was conditional or for a special purpose only. 
  4. According to S.58, the defences on the part of the person liable on a negotiable instrument that the instrument had been lost or obtained from him by means of an offences or fraud or for an unlawful consideration, cannot be set up against a holder in due course. 
  5. According to S.120, no maker of a promissory note and no drawer of a bill of exchange or cheque and no acceptor of a bill of exchange for the honour of the drawer shall, in a suit thereon by a holder in due course, be permitted to deny the validity of the instrument as originally made or drawn. 
  6. According to S.121, no maker of a promissory note and no acceptor of a bill of exchange payable to order shall, in a suit thereon by a holder in due course, be permitted to deny the payee’s capacity at the date of the note or bill to indorse the same.

DIFFERENCE BETWEEN NEGOTIATION AND ASSIGNMENT

The difference between negotiation and assignment is that when you endorse the instrument you become party to that instrument and you also become a guarantor. When you assign the instrument you implicitly say whatever right I have in this instrument, I give it to you. But when you endorse it, you give a guarantee as well. If a person gets the instrument as an assignee, he become the holder of the instrument

BENEFICIAL/EQUITABLE OWNER

This person cannot be regarded as the holder of the instrument. He may have the right of possession of the instrument but is not entitled to that possession. It is the legal owner who is entitled to its possession. He may take the money on behalf of beneficial owner. The person who holds it for someone else’s benefit is the real owner and not the beneficiary. 

Eg-Your father creates a trust in your name. But your uncle is trustee. Some property of the trust is sold. The cheque will come in uncle’s name. Uncle is the owner/holder of the cheque not you though you might be the beneficiary. If there is some problem in the cheque, you file a suit against the issuer of cheque and if uncle doesn’t cooperate then make him co-defendant in the suit. 

CHAPTER II-OF NOTES, BILLS & CHEQUES 

S.4 Promissory note-A Promissory note is an instrument in writing (not being a bank-note or a currency-note) containing an unconditional undertaking, signed by the maker, to pay a certain sum of money only to, or to the order of, a certain person, or to the bearer of the instrument

Illustrations 

A Signs instruments in the following terms:

  1. I promise to pay B or order Rs. 500” 
  2. I acknowledge myself to be indebted to B in Rs. 1,000, to be paid on demand, for value received”
  3. “Mr. B, I O U Rs. 1,000.”
  4. “I promise to Pay ‘B’ Rs. 500 and all other sums which shall be due to him.”
  5. “I promise to Pay ‘B’ Rs. 500, first deducting thereout any money which he may owe me.”
  6. “I promise to Pay ‘B’ Rs. 500 seven days after my marriage with C.”
  7. “I promise to Pay ‘B’ Rs. 500 on D’s death, Provided D leaves me enough to pay that sum.” 
  8. “I promise to Pay ‘B’ Rs. 500 and to deliver to him my black horse on 1 January next.”
  9. The instruments respectively marked (a) and (b) are promissory notes. The instruments respectively marked (c), 
  10. (d), (e), (f), (g) and (h) are not promissory notes

S.5 “Bill of exchange”-A bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person or to the bearer of the instrument. 

A promise or order to pay is not “conditional” within the meaning of this section and section 4, by reason of the time for payment of the amount or any instalment thereof being expressed to be on the lapse of a certain period after the occurrence of a specified event which, according to the ordinary expectation of mankind, is certain to happen, although the time of its happening may be uncertain. 

The sum payable may be certain within the meaning of this section and section 4, although it includes future interest or is payable at an indicated rate of exchange, or is according to the course of exchange, and although the instrument provides that, on default of payment of an instalment, the balance unpaid shall become due. 

The person to whom it is clear that the direction is given or that payment is to be made may be a “certain person” within the meaning of this section and section 4, although he is mis-named or designated by description only

S.6 Cheque-A “cheque” is a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand and it includes the electronic image of a truncated cheque and a cheque in the electronic form

Explanation IFor the purposes of this section, the expressions-

  1. A cheque in the electronic form means a cheque drawn in electronic form by using any computer resource and signed in a secure system with digital signature (with or without biometrics signature) and asymmetric crypto system or with electronic signature, as the case may be;
  2. A truncated cheque means a cheque which is truncated during the course of a clearing cycle, either by the clearing house or by the bank whether paying or receiving payment, immediately on generation of an electronic image for transmission, substituting the further physical movement of the cheque in writing
  3. Explanation IIFor the purposes of this section, the expression “clearing house” means the clearing house managed by the Reserve Bank of India or a clearing house recognised as such by the Reserve Bank of India.
  4. Explanation III-For the purposes of this section, the expressions “asymmetric crypto system”, “computer resource”, “digital signature”, “electronic form” and “electronic signature” shall have the same meanings respectively assigned to them in the Information Technology Act, 2000 (21 of 2000).

S.7 Drawer and Drawee-The maker of a bill of exchange or cheque is called the “drawer”; the person thereby directed to pay is called the “drawee”

  1. Drawee in case of need”-When in the Bill or in any indorsement thereon the name of any person is given in addition to the drawee to be resorted to in case of need, such person is called a drawee in case of need.
  2. Acceptor”-After the drawee of a bill has signed his assent upon the bill, or, if there are more parts thereof than one, upon one of such parts, and delivered the same, or given notice of such signing to the holder or to some person on his behalf, he is called the acceptor
  3. Acceptor for honour”-When a bill of exchange has been noted or protested for non-acceptance or for better security, and any person accepts it supra protest for honour of the drawer or of any one of the indorsers, such person is called an acceptor for honour
  4. Payee”-The person named in the instrument, to whom or to whose order the money is by the instrument directed to be paid, is called the payee

HOLDER (S.8)

S.8 Holder-The “holder” of a promissory note, bill of exchange or cheque means any person entitled in his own name to the possession thereof and to receive or recover the amount due thereon from the parties thereto. 

Where the note, bill or cheque is lost or destroyed, its holder is the person so entitled at the time of such loss or destruction

Holder is meant to be the owner. Ownership here is legal ownership and not equitable ownership. He is the person who is entitled to the possession in his own course and to receive the amount due thereon.

A person may not be a holder but can derive the title.

A person to whom the instrument comes through an offense is not entitled to it. He may the payment on the it but he is not entitled to it. The person should be entitled to receive payment on it. If he is not entitled then he is not the holder of the instrument.

Who will be holder of the instrument?

  1. The bearer of the instrument
  2. The Payee or the endorsee
  3. The one who come across the instrument in succession is holder and owner of the instrument. 
  4. I endorse the instrument for the purpose of collection to my servant. The servant is the holder of the instrument for a limited time-for collection of payment. If he is unable to collect the payment, he is not entitled to its possession. 

If the instrument is assigned, it is separate from the instrument.

If negotiation happens upon the instrument, you negotiate upon it

Difference between Negotiation and Assignment

The difference between negotiation and assignment is that when you endorse the instrument you become party to that instrument and you also become a guarantor. When you assign the instrument you implicitly say whatever right I have in this instrument, I give it to you. But when you endorse it, you give a guarantee as well. If a person gets the instrument as an assignee, he become the holder of the instrument. 

Beneficial/Equitable Owner

This person cannot be regarded as the holder of the instrument. He may have the right of possession of the instrument but is not entitled to that possession. It is the legal owner who is entitled to its possession. He may take the money on behalf of beneficial owner. The person who holds it for someone else’s benefit is the real owner and not the beneficiary. 

Eg-Your father creates a trust in your name. But your uncle is trustee. Some property of the trust is sold. The cheque will come in uncle’s name. Uncle is the owner/holder of the cheque not you though you might be the beneficiary. If there is some problem in the cheque, you file a suit against the issuer of cheque and if uncle doesn’t cooperate then make him co-defendant in the suit. 

HOLDER IN DUE COURSE (S.9) (4-5 marks)

S.9 Holder in due course-“Holder in due course” means any person who for consideration became the possessor of a promissory note, bill of exchange or cheque if payable to bearer, or the payee or indorsee thereof, if payable to order before the amount mentioned in it became payable, and without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title

Holder is meant to be the owner. Holder in Due Course (HDC) is the person who will get the title to the instrument free of defect of the title of previous party. Certain conditions have to be fulfilled-

  1. The person must have acquired the instrument for due consideration
  2. Consideration has to be valuable. 
  3. Consideration once given is not a consideration for second time.

A person claiming to be a ‘holder in due course’ must show: (Khirgamwala)

  1. That, for consideration he became the possessor of a negotiable instrument when it is payable to bearer or the payee or indorsee thereof when it is payable to order. 
  2. That he became the holder of the instrument before the amount mentioned in it became payable 
  3. That he became the holder of the instrument, without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title.

PRIVILEGES OF A HOLDER IN DUE COURSE 

The title of the holder in due course of a negotiable instrument as defined in S.9 is free from equities and other defects which could be urged against prior parties. This special privilege is secured to him by means of certain rules and estoppels contained in the Act. These may be briefly summarised as follows. 

  1. According to S.20, a person who has signed and delivered to another, a stamped but otherwise inchoate instrument, is precluded from asserting, as against a holder in due course, that the instrument has not been filed in accordance with the authority given by him, the stamp being sufficient to cover the amount. 
  2. According to S.42, where a bill of exchange is accepted payable to the order of the drawer in a fictitious name, and is indorsed in the same hand as the drawer’s signature, the acceptor is not permitted to allege, as against a holder in due course, that such name is fictitious. 
  3. According to S.46 and 47, if a bill or note is negotiated to a holder in due course, the other parties to the bill or note cannot avoid liability on the ground that the delivery of the instrument was conditional or for a special purpose only
  4. According to S.58, the defences on the part of the person liable on a negotiable instrument that the instrument had been lost or obtained from him by means of an offences or fraud or for an unlawful consideration, cannot be set up against a holder in due course
  5. According to S.120, no maker of a promissory note and no drawer of a bill of exchange or cheque and no acceptor of a bill of exchange for the honour of the drawer shall, in a suit thereon by a holder in due course, be permitted to deny the validity of the instrument as originally made or drawn. 
  6. According to S.121, no maker of a promissory note and no acceptor of a bill of exchange payable to order shall, in a suit thereon by a holder in due course, be permitted to deny the payee’s capacity at the date of the note or bill to indorse the same. 

1ST ELEMENT-CONSIDERATION

Wrt consideration, inadequacy of consideration does not matter but it affects good faith. Also, all rules mentioned in Contract Act are applicable.

  1. That the consideration should be lawful, ie, 
  2. That it should not be forbidden by law, 
  3. That it should not be fraudulent, 
  4. That it should not be immoral or 
  5. That it should not be opposed to public policy and 
  6. That it should not cause any injury to the person or property of another. 

2ND ELEMENT-BEFORE THE AMOUNT MENTIONED BECAME PAYABLE

It should have been acquired before the amount in it became payable. If the amount is payable on 30 August, then no one can become its holder in due course on 30 August in India

UK Act uses the term ‘Overdue’ ie its date of payment has still not come or it has not expired. So one can still become its holder on 30th Aug. In the case the instrument is payable on a certain date, as per convention (S.22) it provides for 3 working day grace. If the instrument was payable on 1 September, it will become due on 4th Sept. Till 4th sept has expired, it is not overdue. Overdue system has been suggested for India as well. 

Instrument payable on demand-this becomes overdue the moment it is brought into existence/issued.

Shaha v Bengal National Bank Ltd 

  1. A promissory note is supposed to circulate for sometime.
  2. PN cannot be said to be overdue till it is presented for the purpose of payment.
  3. Same is applicable on instruments payable on demand ie NIs and Cheques. 

Limitation Act applies from the moment NI is made out. Maximum life of NI can be 3 years unless something is written to extend the period

It has to be presented and endorsed within a reasonable time. Guarantor cannot be for time immemorial. 

3RD ELEMENT-SUFFICIENT CAUSE OF DEFECT IN TITLE

Without having sufficient cause to believe that a defect exists in a title of a person from whom the instrument is received. 

The Indian law differs from UK law on this aspect-

Under English law, the only question to be considered is whether the holder took the instrument in good faith and, once it is proved that he did so, he is entitled to all the rights of a holder in due course notwithstanding that he was careless, that he made no enquiry, and that he was informed of facts which would have led a reasonable man to make further inquiry, Provided, however, that he had no notice of any defect in the transferor’s title. 

As regards the Indian law, the words used u/s 9 are ‘without having sufficient cause to believe’ Therefore, the legislature seems to have intended to make due care and caution on the part of the holder, a test of his bona fides, and that mere good faith on his part would not suffice. Accordingly, it seems negligence on the part of a holder at the time of taking a negotiable instrument, would disentitle him to the rights of a holder in due course. 

The Indian law is stricter and requires a higher degree of diligence from the person who claims to be a holder in due course than in England where it is sufficient for such a person to show that he took the instrument in good faith. 

Raphael v Bank of England

Bank notes were stolen from bank vaults and thief left the shores of UK. BOE circulated the serial nos. of stolen notes to all currency exchangers. The Paris money exchanger exchanged it for the local currency and made a claim to BOE. BOE refused to pay on the ground that you had knowledge wrt to stolen notes. The court rebutted it on the ground that Raphael had acted in good faith. He might have been negligent but acted in good faith. If the person acted honestly on a NI though he takes it negligently, he has title to it. 

Debts were not transferable in those times. One could transfer it without the defects of the transferor. 

Gill v Cubitt 

BoEs were supposed to be dealt amongst people who knew each other. You have to make inquire regarding strangers otherwise it will not be good-faith. Due care and caution were made the tests of bona fides.

Note:-NI Act was enacted when Gill v Cubitt was the precedent.

Goodwin v Roberts

Ignored the g Gill v Cubitt ratio. 

Fagan v Bank of Bengal (IMP)

PC once again upheld the Gill v Cubitt findings

A person can be holder in due course if he acted honestly though negligently

In India law, there is nothing to suggest defect in-title.

4TH ELEMENT-KNOWLEDGE OF DEFECTS

If, at the time when the holder acquires his title as such, he has sufficient notice that a defect exists in the title of his transferor, he is not a holder in due course. Notice means knowledge of the facts or a suspicion that something is wrong combined with a wilful disregard of the means of knowledge. Notice of defects may be either actual or constructive. 

Where the indorsee of fourteen post-dated cheques aggregating a very large sum had known that they were issued without the possibility of any business transaction between the parties concerned, the court held that the circumstances should have put him on inquiry about the transferor’s title 

DIFFERENCE BW DEFECT IN TITLE AND NO TITLE

Defect in title-Voidable Contracts due to Duress, Fraud, undue influence, lack of consideration, illegal consideration. 

Something which has been stolen or found. Only person who can say that he has a better title is the real owner of that object. Ownership is comparative under all legal system. There is nothing like an absolute owner. It is a relative term-that between x and y, x has a better title than y. 

What are the cases where there is no title?

Where the instrument never came into existence in the eyes of the law Eg-I have written a cheque and put it in the drawer. It will not come into existence till it is given to someone else. 

S.10 Payment in due course means payment in accordance with the apparent tenor of the instrument in good faith and without negligence to any person in possession thereof under circumstances which do not afford a reasonable ground for believing that he is not entitled to receive payment of the amount therein mentioned

APPARENT TENOR OF THE INSTRUMENT 

Apparent Tenor means apparent direction given in the instrument. Thus, a Crossed will not be paid in cash, or a Cheque which is dated after date of.

S.11 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. 

S.12 Foreign Instrument-Any such instrument not so drawn, made or made payable shall be deemed to be a foreign instrument. 

S.13 Negotiable Instrument-

(1) A Negotiable instrument means a promissory note, bill of exchange or cheque payable either to order or to bearer.

Explanation (i)-A promissory note, bill of exchange or cheque is payable to order which is expressed to be so payable or which is expressed to be payable to a particular person, and does not contain words prohibiting transfer or indicating an intention that it shall not be transferable. 

Explanation (ii)-A promissory note, bill of exchange or cheque is payable to bearer which is expressed to be so payable or on which the only or last indorsement is an indorsement in blank. 

Explanation (iii)-Where a promissory note, bill of exchange or cheque, either originally or by indorsement, is expressed to be payable to the order of a specified person, and not to him or his order, it is nevertheless payable to him or his order at his option.] 

(2) A negotiable instrument may be made payable to two or more payees jointly, or it may be made payable in the alternative to one of two, or one or some of several payees.

MEANING OF NEGOTIATION (S.14)

S.14-Negotiation-When a promissory note, bill of exchange or cheque is transferred to any person, so as to constitute that person the holder thereof, the instrument is said to be negotiated. 

S.15-Indorsement-When the maker or holder of a negotiable instrument signs the same, otherwise than as such maker, for the purpose of negotiation, on the back or face thereof or on a slip of paper annexed thereto, or so signs for the same purpose a stamped paper intended to be completed as a negotiable instrument, he is said to indorse the same, and is called the “indorser”

INDORSEMENT IN FULL AND IN BLANK (S.16)

S.16 Indorsement “in Blank” and “in full”

  1. If the indorser signs his name only, the indorsement is said to be “in blank,” and if he adds a direction to pay the amount mentioned in the instrument to, or to the order of, a specified person, the indorsement is said to be “in full”; and the person so specified 
    1. Indorsee-is called the “indorsee” of the instrument.
  2. The provisions of this Act relating to a payee shall apply with the necessary modifications to an indorsee.

AMBIGUOUS INSTRUMENT (S.17)

S.17 Ambiguous instruments-Where an instrument may be construed either as a promissory note or bill of exchange, the holder may at his election treat it as either, and the instrument shall be thenceforward treated accordingly

S.18 Where amount is stated differently in figures and words-If the amount undertaken or ordered to be paid is stated differently in figures and in words, the amount stated in words shall be the amount undertaken or ordered to be paid

INSTRUMENT WHERHE NO TIME FOR PAYMENT IS SPECIFIED (S.19)

S.19 Instruments payable on demand-A promissory note or bill of exchange, in which no time for payment is specified, and a cheque, are payable on demand

INCHOATE STAMPED INSTRUMENTS (S.20)

S.20 Inchoate stamped instruments-Where one person signs and delivers to another a paper stamped in accordance with the law relating to negotiable instruments then in force in India, and either wholly blank or having written thereon an incomplete negotiable instrument, he thereby gives prima facie authority to the holder thereof to make or complete, as the case may be, upon it a negotiable instrument, for any amount specified therein and not exceeding the amount covered by the stamp. The person so signing shall be liable upon such instrument, in the capacity in which he signed the same, to any holder in due course for such amount: 

Provided that no person other than a holder in due course shall recover from the person delivering the instrument anything in excess of the amount intended by him to be paid thereunder

Note-The transfer and the negotiation must be of an inchoate instrument which is not a negotiable instrument under the Act. From the point of view of the proviso to the section it may also be said that in the case of inchoate document, it would be difficult to hold that the possessor of it is a bona fide transferee or in possession of the negotiable instrument. 

S.21-At Sight 

On presentment-In a promissory note or bill of exchange the expressions “at sight” and “on presentment” mean on demand

The expression “After sight” after sight means, in a promissory note, after presentment for sight, and, in a bill of exchange, after acceptance, or noting for non-acceptance, or protest for non-acceptance

MATURITY & DAY OF GRACE (S.22-25)

S.22-Maturity-The maturity of a promissory note or bill of exchange is the date at which it falls due

Days of graceEvery promissory note or bill of exchange but not cheque which is not expressed to be payable on demand, at sight or on presentment is at maturity on the third day after the day on which it is expressed to be payable

NOTE-There is no day of grace in Cheque. Though a Cheque can be encashed after 3 months of the due date (Conform?)

S.23-Calculating maturity of bill or note payable so many months after date or sight-In calculating the date at which a promissory note or bill of exchange, made payable a stated number of months after date or after sight, or after a certain event, is at maturity, the period stated shall be held to terminate on the day of the month which corresponds with the day on which the instrument is dated, or presented for acceptance or sight, or noted for non-acceptance, or protested for non-acceptance, or the event happens, or, where the instrument is a bill of exchange made payable a stated number of months after sight and has been accepted for honour, with the day on which it was so accepted. If the month in which the period would terminate has no corresponding day, the period shall be held to terminate on the last day of such month

Illustrations

  1. A negotiable instrument, dated 29th January, 1878, is made payable at one month after date. The instrument is at maturity on the third day after the 28th February, 1878
  2. A negotiable instrument, dated 30th August, 1878, is made payable three months after date. The instrument is at maturity on the 2nd December, 1878
  3. A promissory note or bill of exchange, dated 31st August, 1878, is made payable three months after date. The instrument is at maturity on the 3rd December, 1878

S.24-Calculating maturity of bill or note payable so many days after date or sight-In calculating the date at which a promissory note or bill of exchange made payable a certain number of days after date or after sight or after a certain event is at maturity, the day of the date, or of presentment for acceptance or sight, or of protest for non-acceptance, or on which the event happens, shall be excluded

S.25-When day of maturity is a holiday-When the day on which a promissory note or bill of exchange is at maturity is a public holiday, the instrument shall be deemed to be due on the next preceding business day

Explanation-The expression “public holiday” includes Sundays: and any other day declared by the Central Government by notification in the Official Gazette, to be a public holiday

FORGERY FREEZES THE TITLE

Forgery-The moment there is a forgery in the instrument, the title freezes. Same cannot be revived ie the signature cannot be adapted later. But Principle of equity and estoppel applies here.

Foster v McKinon 

The person concerned presented a BOE to his father as law and presented it as a railway receipt. Father relying upon that person’s word signed on it. In such case the BOE never comes into existence because he signed it believing it to be a railway receipt. The person was incapable of knowing due to poor sight and had relied upon someone. But if his eyes were working perfectly fine, then he would be liable. But if the person knows that he is signing a NI, he will be liable notwithstanding the amount.

The person should have sufficient cause to believe that there was defect in title

REASONABLE INQUIRY

A person who is not in trade will not want to have a BOE. He might prefer cheque. Because its only traders who take and exchange BOE. The person should make a reasonable inquiry. He cannot be a holder in due course if he did not make those inquiry if there are suspicions. Reasonable man test. 

FRIDAY

Aaa

CHAPTER III-PARTIES TO NOTES, BILLS AND CHEQUES (S.26-45A)

Summary of S.26-28

Who are the Primary parties to the instrument?

  1. The maker of the PN
    1. The person who is primarily liable on the instrument subject to a contract to the contrary (eg-Accommodation Bill)
  2. The drawer of a BoE or Cheque 
    1. He is primarily liable on the BOE till someone accepts it. Who can accept it?
      1. Either the drawee 
      2. The drawee in case of need. 
      3. Can be accepted for honour after it has been dishonoured by non-acceptance
      4. The person who accept it is primarily liable subject to a contract to the contrary. 
        1. Acceptance has to be unconditional
        2. A conditional acceptance unless allowed by others will regarded as dishonour.
      5. There is no concept of acceptance of Cheque. The Bank is under duty to pay if there is money in the account of the issuer. There is no duty of the bank to the holder of the cheque. 
  3. The Payee 
    1. The payee concerned can transfer the PN by endorsement. 
    2. Every prior party is a principal to every subsequent party
    3. The instrument must be unconditional but endorsement can be conditional
    4. A person may limit or exclude his liability in endorsement. 

The person whose name does not appear on PN, he cannot be a guarantor 

Who can make NI?

A minor can draw and endorse but cannot make NI. 

Making of a NI and acceptance of BOE-A minor cannot do so

S.31-Liability of drawee of cheque-

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 so to do, and, in default of such payment, must compensate the drawer for any loss or damage caused by such default

There should be an order by the drawer to the drawee to pay. 

FORGED CHEQUES-

In a forged cheque, there is no order by the drawer to the drawee. No payment made on a forged cheque can be deducted from the account of the drawer. There should be no ambiguity wrt the payment instruction. A payment instruction can be countermanded. The drawer concerned can tell the bank not to pay upon it. The instruction should be during the banking hours and prior to payment of the cheque. Instruction should also be clear. The cheque number should be specified. 

Implied withdrawal of payment instruction-

In cases of lunacy and bankruptcy, intervening death, garnishee order, etc. In case of bankruptcy, no one creditor should be preferred over another creditor. 

GARNISHEE ORDER-

Garnishee order is like an execution order. Property of the defendant is attached and will be sold for the purpose of decretal debt. Possession does not matter. Garnishee order provides that debt money be paid to the court which will use it to satisfy the decretal debt. In these cases, the authority of the customer to make payment order comes to an end. 

There should be sufficient money available for the payment. Where the person concerned definitely has the money. If the account concerned is a trust account and the bank is aware of the fact that it is a trust account. 

There is no concept of Part payment in cheque. It has to be paid fully.

Amount of damages is inversely proportional to amount of cheque. 

Issue 1

Where money is in the account but initially was not supposed to be there. No remedy because he is supposed to know the state of the account bw him and the bank.

Rare Exception-Where the person can say that because of the bank’s mistake he has changed his position. For instance-old widow case. Otherwise If the bank has credited the money by mistake, it can anytime withdraw that. 

Issue 2

Where someone else by mistake has credited money into an account without intention. Can the bank at the instance of the person change it? 

Once the money has been credited, it is the money of that person even if given by mistake. The bank on its own cannot rectify the mistake. The remedy is that he should approach that person and ask his money. 

J&K Bank v Attarunnisha 

J&K govt was crediting money into the account of defendant but later realised that that it had paid extra and hence wanted reversal of those entries. It cannot be done by the bank but by the defendant. 

DISCHARGE OF INDORSER’S LIABILITY (S.39 & 40) 

If the guarantor’s rights are affected, should he still be a guarantor? And when can we say his rights are affected?

S.39 and 40 deal with it. 

S.40-Discharge of indorser’s liability-

Where the holder of a negotiable instrument, without the consent of the indorser, destroys or impairs the indorser’s remedy against a prior party, the indorser is discharged from liability to the holder to the same extent as if the instrument had been paid at maturity

Illustration 

‘A’ is the holder of a BoE made payable to the order of B, which contains the following indorsements in blank:— 

First indorsement, ‘B’; Second indorsement, ‘Peter Williams’; Third indorsement, ‘Wright & Co; Fourth indorsement ‘John Rozario’

This bill A puts in suit against John Rozario and strikes out, without John Rozario’s consent, the indorsements by Peter Williams and Wright & Co. ‘A’ is not entitled to recover anything from John Rozario

Rationale-The reason for the rule is that an indorser of a negotiable instrument, being in the position of a surety, is entitled to the benefit of those securities to which the holder can have no claim except for the instrument itself. ‘The contracts of the several indorsers are so many links of a pendant chain; if the holder dissolves the first, every link falls with it. If the dissolves an intermediate link, all after it are likewise dissolved. But the last link supports nothing, and its dissolution injures no one’. 

S.39-Suretyship-

When the holder of an accepted bill of exchange enters into any contract with the acceptor which, under section 134 or 135 of the Indian Contract Act, 1872 (9 of 1872), would discharge the other parties, the holder may expressly reserve his right to charge the other parties, and in such case they are not discharged

Section 134 of the Indian Contract Act 1872 provides that the surety is discharged 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

Under s 135, a contract between a creditor and a principal debtor by which the creditor makes composition with, or promises to give time to, or not to sue, the principal debtor discharges the surety unless the surety assents to such contract. 

Illustrations (Khirgamwala)

  1. The holder of a bill for Rs 5,000 takes from the acceptor Rs 3,000 in full satisfaction of his claim against him. All the other parties are discharged
  2. The holder of a bill enters into a contract with the acceptor to give him time for payment. The drawer and the indorsers are discharged. 
  3. The holder of a bill agrees with the acceptor, not to sue him upon the bill or not to sue him for certain time. The drawer and the indorsers are discharged
  4. The holder of a bill takes a new bill from the acceptor payable on a future day. The drawer and indorsers are discharged.However, where a new bill is taken by way of collateral security, the indorsers are not discharged.

S.135 differs from common law. 

Under common law, a person may agree with principle debtor not to sue him but can reserve his right against the surety. 

Difference b/w S.39 and S.40

S.39 applies only to bills of exchange whereas S.40 applies to all negotiable instruments. Secondly, u/s 39, express reservation by the holder of his rights against an indorser does not discharge him; whereas u/s 40, if the holder of an instrument destroys or impairs the indorser’s remedy against a prior party, the indorser is discharged from his liability to the holder, despite an express reservation of the holder’s rights against the indorser

Does S.39 lays out a rule which is limited in its application to only BoE or it has laid down a principle of law?

Some cases have said that S.39 applies only to BoE. Law Commission said that it is an exception to common law rule and therefore it should be narrow and limited within its scope.

WHETHR S.39 APPLICABLE ON PN

Murugappa Mudaliar v Muniswami 

HC Madras applied S.39 also on PN. On dishonour of PN, the holder of PN started proceedings against the maker of PN and all its endorsers. Then he withdrew against the maker. HC said that S.39 intents to lay down common law principle. S.39 when it says BoE, it is only an illustration.

This was reiterated in-Bank of Hindustan v Govindarajulu 

The PC in Mahant Singh v Ubayi applied the Common Law principle. 

FORGED INSTRUMENTS (S.41 & 42)

S.41 and S.42-deal with issues of Forgery 

S.41-Acceptor bound, although, indorsement forged 

An acceptor of a bill of exchange already indorsed is not relieved from liability by reason that such indorsement is forged, if he knew or had reason to believe the indorsement to be forged when he accepted the bill

S.42-Acceptance of bill drawn in fictitious name. 

An acceptor of a bill of exchange drawn in a fictitious name and payable to the drawer’s order is not, by reason that such name is fictitious, relieved from liability to any holder in due course claiming under an indorsement by the same hand as the drawer’s signature, and purporting to be made by the drawer.

Acceptor-The Drawee (generally bank) when he accepts the instrument to pay the money therein to the holder, he becomes an acceptor. 

Payee-The one who collects the payment or encashes the instrument.

Drawer has drawn the instrument in the name of a fictitious person and then got it endorsed by a reputed person and that is accepted by the fictitious person and then forwarded to someone else. The acceptor can refuse to honour it. If the holder of the instrument can show that the hand that endorsed it is the same hand that drew it, then acceptor is liable. Fictitious does not mean that the name is uncommon but that it was drawn in the name of person who was not intended to be the payee.

ABSENT OR PARTIAL CONSIDERATION (S.43-45)

S.43, 44 and 45 deals with situations where consideration is absent or partial-

S.43-Negotiable instrument made, etc., without consideration-

A negotiable instrument made, drawn, accepted, indorsed or transferred without consideration, or for a consideration which fails, creates no obligation of payment between the parties to the transaction

But if any such party has transferred the instrument with or without indorsement to a holder for consideration, such holder, and every subsequent holder deriving title from him, may recover the amount due on such instrument from the transferor for consideration or any prior party thereto

Exception I-No party for whose accommodation a negotiable instrument has been made, drawn, accepted or indorsed can, if he have paid the amount thereof, recover thereon such amount from any person who became a party to such instrument for his accommodation

Exception II-No party to the instrument who has induced any other party to make, draw, accept, indorse or transfer the same to him for a consideration which he has failed to pay or perform in full shall recover thereon an amount exceeding the value of the consideration (if any) which he has actually paid or performed

Note-Endorser and Endorsee are the immediate party. Maker of the instrument and Payee are the immediate parties. Drawer of BoE is immediate party to Payee and the acceptor of the BoE. If the drawer gives the instrument to the payee for 1K but the payee does not pay that 1K then drawer is not liable upon it. No liability in case of full failure of consideration but proportionally liability in case of partial consideration. It will require collateral inquiry. 

S.44 Partial absence or failure of money-consideration-

When the consideration for which a person signed a promissory note, bill of exchange or cheque consisted of money, and was originally absent in part or has subsequently failed in part, the sum which a holder standing in immediate relation with such signer is entitled to receive from him is proportionally reduced

Explanation-The drawer of a bill of exchange stands in immediate relation with the acceptor. The maker of a promissory note, bill of exchange or cheque stands in immediate relation with the payee, and the indorser with his indorsee. Other signers may by agreement stand in immediate relation with a holder

Illustration 

A draws a bill on B for Rs. 500 payable to the order of A. B accepts the bill, but subsequently dishonours it by non-payment. ‘A’ sues B on the bill, B proves that it was accepted for value as to Rs. 400, and as an accommodation to the plaintiff as to the residue. ‘A’ can only recover Rs. 400

S.45-Partial failure of consideration not consisting of money-

Where a part of the consideration for which a person signed a promissory note, bill of exchange or cheque, though not consisting of money, is ascertainable in money without collateral enquiry, and there has been a failure of that part, the sum which a holder standing in immediate relation with such signer is entitled to receive from him is proportionally reduced

The holder of the bill, in case it was lost, he could ask for the payment, Provided he is able to prove it.

S.45A provides that one can also get a duplicate bill. It does not extend to PN. The person concerned has only got a right against the drawer. Those who have previously written on it (acceptor or indorser), their liability gets wiped off. No right exists against prior indorsers. But you have to indemnify the drawer. 

CHAPTER IV-OF NEGOTIATION (S.46-60)

S.60 Instrument negotiable till payment or satisfactionA negotiable instrument may be negotiated (except by the maker, drawee or acceptor after maturity) until payment or satisfaction thereof by the maker, drawee or acceptor at or after maturity, but not after such payment or satisfaction

IMPORTANT:The bill can be negotiated till it has been payed. Even if it has been payed but has not been canceled and comes to a person (holder in due course) who is unaware that it has been payed, he has to be payed. 

Generally PN is payable in one go. But there can be PN which are payable in instalments. A PN can specify that 10K will be payable after one month, another 10K after another one month. Whosoever pays upon that instalment has to specify in the PN that that instalment has been paid. Otherwise the holder in due course can get full amount. 

Exception

S.46 Delivery-

The making, acceptance or indorsement of a promissory note, bill of exchange or cheque is completed by delivery, actual or constructive. 

As between parties standing in immediate relation, delivery to be effectual must be made by the party making, accepting or indorsing the instrument, or by a person authorised by him in that behalf. 

As between such parties and any holder of the instrument other than a holder in due course, it may be shown that the instrument was delivered conditionally or for a special purpose only, and not for the purpose of transferring absolutely the property therein. 

A promissory note, bill of exchange or cheque payable to bearer is negotiable by the delivery thereof. 

A promissory note, bill of exchange or cheque payable to order is negotiable by the holder by indorsement and delivery thereof

The instrument concerned is delivered. It comes into existence only by delivery. If it has been delivered for a specific purpose. Then the person to whom it has been delivered cannot claim it unless that purpose comes into being. But holder in due course can claim it. 

Eg-I gave a post-dated cheque which can be encashed only when I default on a loan and not prior to that. Delivery can be by myself.

DELIVERY BY POST

Delivery can be by me or the party on my behalf (agent)

When do I deliver a NI to someone? If someone sends it by post, then the postal service is his agent. Till it is delivered, it is still your cheque

S.52 Indorser who excludes his own liability or makes it conditional-

The indorser of a negotiable instrument may, by express words in the indorsement, exclude his own liability thereon, or make such liability or the right of the indorsee to receive the amount due thereon depend upon the happening of a specified event, although such event may never happen. 

Where an indorser so excludes his liability and afterwards becomes the holder of the instrument, all intermediate indorsers are liable to him

Illustrations

  1. The indorser of a negotiable instrument sign; his name adding the words— “Without recourse.” Upon this indorsement he incurs no liability. 
  2. A’ is the payee and holder of a negotiable instrument. Excluding personal liability by an indorsement “without recourse” he transfers the instrument to B, and B indorses it to C, who indorses it to A. A is not only reinstated in his former rights, but has the rights of an indorsee against B and C

Explanation-If one has indorsed it but not delivered it, and if that person dies, his legal representative has to endorse it again and then deliver it. 

He can make the endorsee a holder for limited purpose only. He can exclude the right of the endorse to negotiate. He can provide that endorsee can collect money only after the satisfaction of a condition which is uncertain. Indorsement of instrument can be for uncertain event but condition at the time of making it has to be certain. An indorsement can be conditional as well. There cannot be indorsement for partial amount. 

S.53 Holder deriving title from holder in due course-

A holder of a negotiable instrument who derives title from a holder in due course has the rights thereon of that holder in due course

S.54 Instrument indorsed in blank-

Subject to the provisions hereinafter contained as to crossed cheques, a negotiable instrument indorsed in blank is payable to the bearer thereof even although originally payable to order

S.55 Conversion of indorsement in Blank into indorsement in full-

If a negotiable instrument, after indorsed in blank, is indorsed in full, the amount of it cannot be claimed from the indorser in full, except by the person to whom it has been indorsed in full, or by one who derives title through such person

S.56Indorsement for part of sum due-

No writing on a negotiable instrument is valid for the purpose of negotiation if such writing purports to transfer only a part of the amount appearing to be due on the instrument; but where such amount has been partly paid, a note to that effect may be indorsed on the instrument, which may then be negotiated for the balance

S.57 Legal representative cannot by delivery only negotiate instrument indorsed by deceased-

The legal representative of a deceased person cannot negotiate by delivery only a promissory note, bill of exchange or cheque payable to order and indorsed by the deceased but not delivered.

INSTRUMENT OBTAINED BY UNLAWFUL MEANS (S.58)

S.58 Instrument obtained by unlawful means or for unlawful consideration-

When a negotiable instrument has been lost, or has been obtained from any maker, acceptor or holder thereof by means of an offence or fraud, or for an unlawful consideration, no possessor or indorsee who claims through the person who found or so obtained the instrument is entitled to receive the amount due thereon from such maker, acceptor or holder, or from any party prior to such holder, unless such possessor or indorsee is, or some person through whom he claims was, a holder thereof in due course

Explanation-An instrument which has been lost, obtained by fraud/offense or for unlawful consideration, the holder of such instrument has no rights but holder in due course can claim upon it. The section does not mention forgery. Court has held that the English law wrt forgery is applicable to India as well. 

FORGED INSTRUMENTS-

If the instrument has been forged, no one other than holder (entitled in his own name) can claim under such an instrument. One it is forged, the title is frozen and a genuine signature subsequent signature makes no difference. Only in one situation the person can claim it-The person who gave you the forged instrument, you can claim from him

If the signature of the drawer or acceptor of a bill has been forged, no title passes and in either case, the bill is entirely valueless. For example: 

  1. On a note for Rs 1,000, A forges B’s signature so as to make him the maker. C, a holder, who takes it bona fide and for value, acquires no title to the note
  2. On a bill for Rs 1,000, A’s acceptance to the bill is forged. The bill comes into the hands of B, a bona fide holder for value. B acquires no title to the bill

Forgery cannot be ratified, for a forger does not act, and does not purport to act, on behalf of the person whose signature he forges

However, a person whose signature has been forged may, by his conduct, be estopped from denying its genuineness to an innocent holder. 

RULE OF ESTOPPEL APPLIES

Estoppel also applies-If the person whose signature has been forged, he cannot accept that signature but wrt the person to whom he has claimed that it is his signature, he cannot later claim that it was forged signature.

Forgery freezes the title of only that instrument. If on the basis of that instrument, a new instrument comes into being, that is valid.

Marcanas v Mercantile Bank of India

A trust has given to a person, an instrument for the collection of payment. The person forged his signature and gave it as a security to the Bank. 

FORGED INDORSEMENTS-

The case is, however, different where an indorsement is forged. The answer depends entirely upon the question whether the instrument is indorsed in full or in blank. If an instrument is indorsed in full, the signature of the person to whom or to whose order the instrument is negotiated must be a genuine one, for a title to the instrument can only be established through his indorsement. Therefore, if a bill or note is negotiated by means of a forged indorsement, a person claiming under that indorsement, though he is a purchaser for value and in good faith, cannot acquire the rights of a holder in due course. He acquires no title to the bill or note.

For example: 

  1. A bill is indorsed, ‘Pay John Brown or order’. John Brown must indorse the bill, and if his signature is forged, the bill is worthless
  2. A bill is payable to: ‘A’ or order. It is stolen from ‘A’ and the thief forges A’s indorsement and indorses it to B who takes it in good faith and for value. B acquires no title to the bill, nor can be recover upon it or give a valid discharge for it

Section 58, which protects a holder in due course where a negotiable instrument has been obtained by means of an offence, does not apply to a case of forgery. Where a party, primarily liable on a negotiable instrument pays the amount thereof, to a wrong person, who holds it under a forged indorsement, he remains liable to the true owner. This is subject to an exception in the case of cheques and bank drafts. No holder can acquire a good title to an instrument through a forged indorsement. 

However, different considerations arise where an indorsement is forged on an instrument that is already indorsed in blank. In such a case, when the instrument gets into the hands of any person, a transfer can be made by simply delivery, and it is immaterial as far as the holder is concerned that the transferor indorsed the bill in any name whatsoever. Where an instrument is indorsed in blank and it bears a further forged indorsement, the holder does not derive his title through the forged indorsement, and he can sue any of the parties to the bill without being affected by the forgery. 

For example-

A bill is indorsed; Pay John Brown or order. John Brown indorses the bill in blank. It comes into the hands of A. A passes it by simple delivery to B. B forges A’s indorsement and transfers it to C. As C, the holder, does not derive his title through the forged indorsement of A, but through the indorsement of John Brown which is genuine, he can sue any of the parties to the bill irrespective of A’s forged indorsement. A similar result would follow where the forged indorsement is made on an instrument originally drawn or made payable to bearer

CHAPTER V-PRESENTMENT (S.61-71)

S.61 Presentment for Acceptance-

A bill of exchange payable after sight must, (if no time or place is specified therein for presentment), be presented to the drawee thereof for acceptance, (if he can, after reasonable search, be found), by a person entitled to demand acceptance, within a reasonable time after it is drawn, and in business hours on a business day. In default of such presentment, no party thereto is liable thereon to the person making such default. 

If the drawee cannot, after reasonable search, be found, the bill is dishonoured. 

If the bill is directed to the drawee at a particular place, it must be presented at that place; and if at the due date for presentment he cannot, after reasonable search be found there, the bill is dishonoured. 

Where authorized by agreement or usage, a presentment through the post office by means of a registered letter is sufficient

S.62 Presentment of promissory note for sight-

A promissory note, payable at a certain period after sight, must be presented to the maker thereof for sight (if he can after reasonable search be found) by a person entitled to demand payment, within a reasonable time after it is made and in business hours on a business day. In default of such presentment, no party thereto is liable thereon to the person making such default.

S.63 Drawee’s Time for deliberation-

The holder must, if so required by the drawee of a bill of exchange presented to him for acceptance, allow the drawee forty-eight hours (exclusive of public holidays) to consider whether he will accept it

S.64 Presentment for payment- 

  1. Promissory notes, bills of exchange and cheques must be presented for payment to the maker, acceptor or drawee thereof respectively, by or on behalf of the holder as hereinafter Provided. In default of such presentment, the other parties there to are not liable thereon to such holder. Where authorized by agreement or usage, a presentment through the post office by means of a registered letter is sufficient.
    1. Exception-Where a promissory note is payable on demand and is not payable at a specified place, no presentment is necessary in order to charge the maker thereof
  2. Notwithstanding anything contained in section 6, where an electronic image of a truncated cheque is presented for payment, the drawee bank is entitled to demand any further information regarding the truncated cheque from the bank holding the truncated cheque in case of any reasonable suspicion about the genuineness of the apparent tenor of instrument, and if the suspicion is that of any fraud, forgery, tampering or destruction of the instrument, it is entitled to further demand the presentment of the truncated cheque itself for verification: 

Provided that the truncated cheque so demanded by the drawee bank shall be retained by it, if the payment is made accordingly.

S.65 Hours for presentment-

Presentment for payment must be made during the usual hours of business, and, if at a banker’s within banking hours

S.66 Presentment for payment of instrument payable after date or sight-

A promissory note or bill of exchange, made payable at a specified period after date or sight thereof, must be presented for payment at maturity

S.67 Presentment for payment of Promissory Note payable by instalments-

A promissory note payable by instalments must be presented for payment on the third day after the date fixed for payment of each instalment; and non-payment on such presentment has the same effect as non-payment of a note at maturity

S.68 Presentment for payment of instrument payable at specified place and not elsewhere-

A promissory note, bill of exchange or cheque made, drawn or accepted payable at a specified place and not elsewhere must, in order to charge any party thereto, be presented for payment at that place

S.69 Instrument payable at specified place-

A promissory note or bill of exchange made, drawn or accepted payable at a specified place must, in order to charge the maker or drawer thereof, be presented for payment at that place

S.70 Presentment where no exclusive place specified-

A promissory note or bill of exchange, not made payable as mentioned in sections 68 and 69, must be presented for payment at the place of business (if any), or at the usual residence, of the maker, drawee or acceptor thereof, as the case may be

S.71 Presentment when maker, etc., has no known place of business or residence-

If the maker, drawee or acceptor of a negotiable instrument has no known place of business or fixed residence, and no place is specified in the instrument for presentment for acceptance or payment, such presentment may be made to him in person wherever he can be found

S.72 Presentment of cheque to charge drawer-

Subject to the provisions of section 84, a cheque must, in order to charge the drawer be presented at the bank upon which it is drawn before the relation between the drawer and his banker has been altered to the prejudice of the drawer

S.73 Presentment of cheque to charge any other person-

A cheque must, in order to charge any person except the drawer, be presented within a reasonable time after delivery thereof by such person.

S.74 Presentment of instrument payable on demand-

Subject to the provisions of section 31, a negotiable instrument payable on demand must be presented for payment within a reasonable time after it is received by the holder.

S.75 Presentment by or to agent, representative of deceased, or assignee of insolventPresentment for acceptance or payment may be made to the duly authorized agent of the drawee, maker or acceptor, as the case may be, or, where the drawee, maker or acceptor has died, to his legal representative, or, where he has been declared an insolvent, to his assignee

WHEN PRESENTMENT UNNECESSARY (S.76)

S.76 When presentment unnecessary-No presentment for payment is necessary, and the instrument is dishonoured at the due date for presentment, in any of the following cases:— 

  1. if the maker, drawee or acceptor intentionally prevents the presentment of the instrument, or,  if the instrument being payable at his place of business, he closes such place on a business day during the usual business hours, or,  if the instrument being payable at some other specified place, neither he nor any person authorized to pay it attends at such place during the usual business hours, or,  if the instrument not being payable at any specified place, he cannot after due search be found; 
  2. as against any party sought to be charged therewith, if he has engaged to pay notwithstanding non-presentment
  3. as against any party if, after maturity, with knowledge that the instrument has not been presented— he makes a part payment on account of the amount due on the instrument, or promises to pay the amount due thereon in whole or in part, or otherwise waives his right to take advantage of any default in presentment for payment; 
  4. as against the drawer, if the drawer could not suffer damage from the want of such presentment

Presentment is giving or showing the instrument to concerned person for payment.

Why presentment is necessary?

The necessity arises because the person has to be paid upon the instrument. 

When it is to be presented?

3 circumstances-

  1. For the purpose of payment
  2. For the purpose of acceptance 
  3. Where the instrument is to paid after sight. 

For the purpose of acceptance one need to give the drawee 48 hours exclusive of holiday.

When the amount is payable, it has to be presented it at instalment time or maturity. Default in doing so (except under S.75) will excuse everyone (those who stood as guarantor) to its holder.

Presentment after Sight

S.61 A person cannot be expected to be a guarantor in perpetuity. He will be a guarantor only for a reasonable period of time. So A BOE on sight (on which no date is mentioned) must be presented to the drawee for acceptance within a reasonable time. 

Reasonable time is short. Limitation does not define reasonable period wrt indorsers. Limitation period come into picture for those who stood as guarantor for the instruments. The holder if keeps it for unreasonable time later indorses to 3rd person who does not indorse it for unreasonable time. He will be liable to the latter. Reasonable period depends on circumstances. He one has already kept it for 2 years and then indorses it to B. Reasonable period for B might be 2 months. 

If the drawee vanishes/cannot be found after reasonable search, BoE becomes dishonoured. 

PRESENTMENT OF CHEQUE

Wrt to Cheque-In order to make the drawer liable, the cheque should be presented before the relationship bw drawer and the bank changes to prejudice of the drawer of the cheque. Ie the bank in the interim goes insolvent. In that case, the drawer of the cheque is excused to the extent to which he is prejudiced (S.84)

Eg-I have in my account 50K and give you a check of 20K. You keep the cheque for 3 months. If in the between the bank goes bankrupt, my 50K gone. But you cannot claim 20K from me but from the bank.

If I had only 5K but I had overdraft facility with the bank. In this case, the payee would recover 5K from drawee (bank) and 15K from me

Wrt to the liability of indorsers

The same rule is applicable which was applicable to PN. The holder should present it within a reasonable period otherwise prior indorsers are discharged to that holder. 

Place of Presentment-

If the place is specified, it has to be presented there. If not, then usual place of business

Excuse in presentment

If not attributable to delay, misconduct, negligence, he cannot make the presentment. But the moment the causes stops, he has to make the presentment

When the presentment is unnecessary? (S.76)

  1. When the party to whom it has to be presented, is guilty of misconduct ie prevents the presentment. 
  2. S.61-When he cannot be found after reasonable search.
  3. When he agrees to pay without presentment. Indorsers can specify that presentment is not necessary. By doing so he will expand his liability.
  4. Where the party concerned waves the default in presentment. Waiver can be-
    1. Making Part payments-
      1. If he has paid the part, can he be made liable for the whole? Its a contested issue, though language seems to indicate that he is liable for the whole
    2. Agrees to pay notwithstanding non-presentment
    3. By any conduct on his part, express his willingness to pay. 
  5. Where the drawer will not suffer any loss due to non-presentment. 
    1. If there was no credit in account of the drawer. 
    2. Cross drawing of BoE means liability owed to each other mutually

S.77 Liability of banker for negligently dealing with bill presented for payment-

When a bill of exchange, accepted payable at a specified bank, has been duly presented there for payment and dishonoured, if the banker so negligently or improperly keeps, deals with or delivers back such bill as to cause loss to the holder, he must compensate the holder for such loss

Explanation-People draw BoE which are payable at the Bank. Bank accepts and pays. Only thing is that they are not payable on demand but at specified time. Many a time people accept BoE and mention that it is payable at the bank where they have account. Normally as a matter of practice, banks pay upon such bills. But there is no necessity of the bank to pay. The bank can deduct from the account of customer only if by paying upon it, the customer is validly discharged of his liability upon the bill. The bank has to check whether the person who is demanding the payment is the person authorised for payment and whether there has been forgery upon the instrument. For this acceptor normally takes some time and it has been suggested that Bank should be given some time for this purpose. But in one case it was held that if the bank takes caution, then there would be nothing to be cautious about as it would be out of business or there will be no purpose left

CHAPTER VI-OF PAYMENT AND INTEREST (S.78-81)

S.80 Interest when no rate specified-

When no rate of interest is specified in the instrument, interest on the amount due thereon shall, [notwithstanding any agreement relating to interest between any parties to the instrument], be calculated at the rate of 18% per annum, from the date at which the same ought to have been paid by the party charged, until tender or realization of the amount due thereon, or until such date after the institution of a suit to recover such amount as the Court directs. 

Explanation-When the party charged is the indorser of an instrument dishonoured by non-payment he is liable to pay interest only from the time that he receives notice of the dishonour

Explanation-Where the interest rate on the instrument is not specified or it has been dishonoured subsequent to it, interest is payable at the rate of 18 percent per annum.  Where it is 10K 

If the space for interest is left blank, it is an inchoate but the authority to put up interest is up to 18% and not more than that otherwise it would be regarded as material alteration excusing all the parties to it. 

PAYMENT IN DUE COURSE (S.10)

S.10-Payment 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 do not afford a reasonable ground for believing that he is not entitled to receive payment of the amount therein mentioned

ExplanationPDC can happen Provided-

  1. First it should be according to apparent tenor of the instrument
  2. Should be only in money terms 
  3. Paid at or after maturity
  4. Payment before the maturity is not PDC
  5. It has to be in good faith without negligence to the person in possession of the instrument without having sufficient cause to believe that he is not entitled to receive the payment.
    1. Indian law is more rigorous than UK law. 
    2. The person not only has to make the payment to the holder of the instrument, he also has to make sure that he is entitled to payment. 

A drawer of BoE can later become HDC of that instrument. Same is true with PN. But its not PDC.

If its a payment to order, the drawee has to check whether the holder is the designated payee or indorsee. 

Where the indorsements are in order, ie it has been indorsed by the people who are entitled to indorse it, (cases of forgery freezes the title) 

If the payee has become bankrupt, the drawee can refuse to pay to him, as the amount by law has to go to the official liquidator. 

For a payment to be made, it can be made only by a person who is a party to that instrument (indorsers, payee, acceptor, etc). 

CHAPTER VII-OF DISCHARGE FROM LIABILITY (S.82-90)

DISCHARGE ON AN INSTRUMENT

First method of discharge is ‘payment upon the instrument’

Payment is payment in due course. Discharge does not mean that the instrument comes to an end. 

Everyone is completely discharged only when the person who is primarily liable on it pays upon it. If the interim parties pay upon it then only he and those whose stood as guarantee are discharged. 

Eg-If 3rd indorses pays, then subsequent indorsers are discharged but not prior indorsers who will still be liable to 3rd indorsers.

Cancellation and Release-

S.82 Discharge from liability-

The maker, acceptor or indorser respectively of a negotiable instrument is discharged from liability thereon-

  1. by cancellation-to a holder thereof who cancels such acceptor’s or indorser’s name with intent to discharge him, and to all parties claiming under such holder; 
  2. by release-to a holder thereof who otherwise discharges such maker, acceptor or indorser, and to all parties deriving title under such holder after notice of such discharge; 
  3. by payment-to all parties thereto, if the instrument is payable to bearer, or has been indorsed in blank, and such maker, acceptor or indorser makes payment in due course of the amount due thereon

Explanation-They both have the same effect but method is different

Cancellation is where the name is cut off. (eg holder cuts the name of 3rd person, that 3rd person is discharged of his liability to him only)

Release is where by a contract outside the instrument, a person is released of his liability on the instrument.

S.39-Common law Principe that if I have agreed that I will not sue the acceptor (Drawee), I might reserve my right to sue other parties.

But I might reserve my rights against other parties. In cancellation and release if I reserve my right against other parties, then I can proceed against them.

Cancellation is a unilateral act so S.39 will not apply. If it is by a a contract then S.39 will apply

S.83 and S.86

S.83-Discharge by allowing drawee more than forty-eight hours to accept-

If the holder of a bill of exchange allows the drawee more than [forty-eight] hours, exclusive of public holidays, to consider whether he will accept the same, all previous parties not consenting to such allowance are thereby discharge from liability to such holder. 

S.86Parties not consenting discharged by qualified or limited acceptance-

If the holder of a bill of exchange acquiesces in a qualified acceptance, or one limited to part of the sum mentioned in the bill, or which substitutes a different place or time for payment, or which, where the drawees are not partners, is not signed by all the drawees, all previous parties whose consent is not obtained to such acceptance are discharged as against the holder and those claiming under him, unless on notice given by the holder they assent to such acceptance. 

Explanation-An acceptance is qualified-

  1. where it is conditional, declaring the payment to be dependent on the happening of an event therein stated;
  2. where it undertakes the payment of part only of the sum ordered to be paid; 
  3. where, no place of payment being specified on the order, it undertakes the payment at a specified place, and not otherwise or elsewhere; or where, a place of payment being specified in the order, it undertakes the payment at some other place and not otherwise or elsewhere; 
  4. where it undertakes the payment at a time other than that at which under the order it would be legally due
  5. Note:-Any type of conditional acceptance will mean that those who do not agree to that will be discharged

S.85-Cheque payable to order-

  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 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.

S.85A Drafts drawn by one branch of a bank on another payable to order-

Where any draft, that is, an order to pay money, drawn by one office of a bank upon another office of the same bank for a sum of money payable to order on demand, purports to be endorsed by or on behalf of the payee, the bank is discharged by payment in due course.

S.85 Explanation

  1. Payable to holder 
    1. There can be a possibility that indorsement is forged. If it is forged, the title freezes.
    2. Initially, the person who dealt with BoE were not general public but limited set of people.  The acceptor concerned was supposed to be aware of the signature concerned. As the usage of banking increased, it became means of paying one’s liability. 
    3. 85(1) was added as a protection to the bank. 
    4. The indorsement if forged, the bank is excused if paid in due course. Bank is not supposed to know the signature of the payee concerned
  2. Bearer Instrument
    1. In UK law, once a bearer always a bearer
    2. If it has been indorsed or indorsed restrictively, bank is required to cross-check but not if it acted reasonably. 
    3. Bank will try to see if holder is the indorsee of the cheque. 
    4. It is excused by saying that it paid the bearer of the cheque. 
    5. At the end of the cheque it is written-it is paid to x or bearer

MATERIAL ALTERATION (S.87)

S.87 Effect of Material Alteration-

Any material alteration of a negotiable instrument renders the same void as against anyone who is a party thereto at the time of making such alteration and does not consent thereto, unless it was made in order to carry out the common intention of the original parties

Alteration by indorsee- And any such alteration, if made by an indorsee, discharges his indorser from all liability to him in respect of the consideration thereof

The provisions of this section are subject to those of sections 20, 49, 86 and 125

Law regarding Material Alteration applies to all instruments and deeds. 

As per the Stamp Act, if the instrument is altered (with or without consent) then its a new instrument and this has to be stamped afresh.

Material alternation discharges all prior parties who did not consent to the alteration. MA does not render the instrument completely useless. Those who become party to it subsequent alteration, they will be liable on it

Eg-A altered the instrument and thereafter indorses it and gives it to B. ‘A’ is liable to B. B indorses to C. B is liable to C. 

MA excuses the parties not only on instrument but also on original consideration. 

What is a Material Alteration (MA)?

Merely because its alteration does not mean parties are excused. It has to be material. In UK, it has also to be apparent. MA is something which alters the rights and liabilities of parties to the instrument which are settled or varies the legal affect of a provision as originally expressed or reduces to certainty a provision originally uncertain or prejudices the party bound by deed.

Anirudham v Thomco Bank

MA defined

INSTANCES OF MATERIAL ALTERATION

Change in amount

Changing the amount which is payable on the instrument. 

Liability 

Change of indorser’s liability

Indorser 

Change of indorser is MA

Interest Rate

Where the interest is left bank or not specified, interest rate is assumed to be 18%. Putting interest more than 18% is MA.

Change in Date

If the date is not specified, then you put the original date on which it was made. But putting a different date (earlier or later) is MA. 

Because it affects (extends or reduces) the validity period. 

Change in Place

Putting a different place than otherwise mentioned is MA

Laws differ with places. In British India, each princely state had different laws. If it makes no difference then its not a Material Alteration

Postponing the payment date is also MA

Order of Indorsers 

Changing order of indorsers is MA

Stamping 

Stamping an unstamped instrument is MA

Stamping an instrument which was not stamped will be MA as Stamped instrument are admissible in evidence.

MA will discharge the parties. It does not matter whether the person himself has altered it or has been altered by a someone else, Provided it should be in its custody.

ACCIDENTAL ALTERATION (MIXED VIEWS BY COURTS)

Suffel v Bank of England (IMP)

Queens bench gave the decision that even if the number of the note is accidentally wiped off then it is MA. And the person concerned cannot claim on that bank note. Honk Kong and Shanghai Bank issued bank notes.

HSBC v Lo Lee Shi 

Lo Li Shi had mistakenly given the clothes for laundry and after ironing the notes were discovered but their numbers were erased. PC said that number on the note was not material part. It also said (controversially) that something which is done accidentally will not be regarded as MA

INSTANCES WHERE ALTERATION HAS BEEN HELD NOT TO BE MA

Attestation by witnesses

If an unattested instrument is attested by witnesses 

Changed before its completion 

Change in an inchoate instrument. But the common intention of original parties matters. 

Where the nick name is changed to real name

This will not amount as MA

Whether it was the bearer, it is made payable to order 

This will also not amount to MA

When an alteration is made in BoE or Cheque and the alteration is not visible and the drawee concerned makes payment on the basis of alteration, how much can he deduct from the account of the drawer. 

Eg-A 10K cheque is altered to 1Lac. How much can the drawer deduct from the account? 

Young v Grote 

The court allowed the drawee to deduct the full amount if the change was not apparent. This decision was criticised a lot. 

Many common law courts did not follow this decision.

London Joint Stock Bank v Macmillan and Arthur 1920

The partner of the solicitor’s firm while going out was presented with a cheque by a clerk for payment of petty cash for office expenses. No amount was written in words and in figures it was mentioned 2. The clerk subsequently changed to 120 Pounds. When the bank paid the money, the firm contested it. In the event one draws the cheque, one has to take due care in filling up the amount so that there is no scope for tampering with it or its reduced. If not then the person concerned is liable to the bank for contributory negligence. This is the UK law. But if you are not negligible in filling, then you are liable only to the extent you originally intended while filling.

In India, S.89 mentions that irrespective of whether the drawer was negligent or not, in the event of alteration which is not apparent, and on that basis if drawee makes payment in due course, he can deduct the entire amount. The payee has to later return the extra amount regardless whether he knew of the alteration or not

S.89If a person is in possession of a written doc, and he tampers it, he may first try to prove it original and if he is unable to do so. So you have to put a disclaimer that if possessor tempers with it, then he will not get anything on it as disincentive

S.90-Extinguishment of rights of action on bill in acceptor’s hands-

If a bill of exchange which has been negotiated is, at or after maturity, held by the acceptor in his own right, all rights of action thereon are extinguished

If the BoE comes into the hand of the acceptor after its maturity, you can say that all parties are discharged. He can’t claim the bill upon himself. The same principle will apply to PN. 

Where the bankruptcy code discharges the person who is primarily liable.

Lapse of time-When the limitation period start operating then discharge happens when there is a merger ie on the instrument you have got a court directive then debt on that instrument merges with the court order. 

When there is a delay in giving notice of dishonour, the party concerned is discharged. 

CHAPTER VIII-NOTICE OF DISHONOUR (S.91-98)

When the bill or promissory note is dishonoured, notice has to go to prior parties who are liable upon it. 

Rationale-If a person has gone insolvent or not paid, then the parties concerned should be immediately notified so that they can adjust their account wrt the payment/drawee concerned. 

S.91-Dishonour by non-Acceptance-

A bill of exchange is said to be dishonoured by non-acceptance when the drawee, or one of several drawees not being partners, makes default in acceptance upon being duly required to accept the bill, or where presentment is excused and the bill is not accepted. 

Where the drawee is incompetent to contract, or the acceptance is qualified, the bill may be treated as dishonoured.

S.92-Dishonour by non-Payment-

A promissory note, bill of exchange or cheque is said to be dishonoured by non-payment when the maker of the note, acceptor of the bill or drawee of the cheque makes default in payment upon being duly required to pay the same

S.93 By and to whom notice should be given 

When a promissory note, bill of exchange or cheque is dishonoured by non-acceptance or non-payment, the holder thereof, or some party thereto, who remains liable thereon, must give notice that the instrument has been so dishonoured to all other parties whom the holder seeks to make severally liable thereon, and to someone of several parties whom he seeks to make jointly liable thereon

Nothing in this section renders it necessary to give notice to the maker of the dishonoured promissory note or the drawee or acceptor of the dishonoured bill of exchange or cheque

Dishonour can happen-

  1. Non-Payment (S.92)-
  2. Non-Acceptance (S.92)- 
    1. BoE is dishonoured by non-acceptance ie refusal to accept, incompetence of the drawee, giving a qualified/conditional acceptance. 

Notice of dishonour has to come from the party who is liable upon the instrument. It has to state-

  1. The fact of the dishonour, 
  2. How it has been dishonoured, 
  3. Why he is treating it as dishonour and
  4. The fact that he intends to make him liable. 

Notice can be oral or written-If written, it has to be sent so that it is received at most a day after it was sent. 

S.98 When notice of dishonour is unnecessary-

No notice of dishonour is necessary-

  1. when it is dispensed with by the party entitled thereto- 
    1. The party has agreed that he will be liable for dishonour even without notice
  2. in order to charge the drawer when he has countermanded payment;
  3. when the party charged could not suffer damage for want of notice
    1. An accommodated party is supposed not to have suffered any damage by want of notice
  4. when the party entitled to notice cannot after due search be found; or the party bound to give notice is, for any other reason, unable without any fault of his own to give it; 
  5. to charge the drawers, when the acceptor is also a drawer; 
    1. Where drawer is an acceptor, he need not be given the notice of dishonour
  6. in the case of a promissory note which is not negotiable
    1. Such PN is not negotiated under PN but assigned. Rules of assignment ie actionable claims are applicable. 
    2. In the case of non-negotiable BoE, each particular indorser is as if he is drawing a fresh BoE.  Notice only need to be given to the prior indorser. 
      1. It is basically assignment. Non negotiable instrument are assignable. All debts are assignable.
  7. When the party entitled to notice, knowing the facts, promises unconditionally to pay the amount due on the instrument

CHAPTER IX-OF NOTING AND PROTEST (99-104A)

Noting and Protest-

Noting is where upon the instrument the public notary RECORDS THE FACT of dishonour. And it will specify how and why it was dishonoured.

Protest is where he CERTIFIES the dishonour.

S.99 Noting-

When a promissory note or bill of exchange has been dishonoured by non-acceptance or non-payment, the holder may cause such dishonour to be noted by a notary public upon the instrument, or upon a paper attached thereto, or partly upon each

Such note must be made within a reasonable time after dishonour, and must specify the date of dishonour, the reason, if any, assigned for such dishonour, or, if the instrument has not been expressly dishonoured, the reason why the holder treats it as dishonoured, and the notary’s charges

S.100 Protest-

When a promissory note or bill of exchange has been dishonoured by non-acceptance or non-payment, the holder may, within a reasonable time, cause such dishonour to be noted and certified by a notary public. Such certificate is called a protest

Protest for better securityWhen the acceptor of a bill of exchange has become insolvent, or his credit has been publicly impeached, before the maturity of the bill, the holder may, within a reasonable time, cause a notary public to demand better security of the acceptor, and on its being refused may, within a reasonable time, cause such facts to be noted and certified as aforesaid. Such certificate is called a protest for better security

When it is protested, there is presumption of dishonour. In some foreign jurisdictions, it is mandatory.

Protest for better security (S.100)-When the credit of the liable party is impeached, then the holder of the instrument can ask for security. 

In India, it does not give any advantage other than that, someone may become acceptor for honour. In certain continental jurisdiction, it gives certain rights to the holder ie to regard it as dishonour. 

After it has been noted or protested for non-acceptance, any person can go to the public notary and accept for the honour of the prior parties. If does not specify the party, then it will be assumed that he is accepting it for the drawer. 

Acceptance for honour-by allowing someone to become acceptor for honour, there is postponement of the day of reckoning. When a person accepts it for the honour of someone, the holder still has to go to the drawee and if he refuses then he will go to the acceptor for honour. Whosoever honour he (acceptor for honour) accepts it, that person is liable to him and parties prior to him are liable to him. (X accepts it for the honour of D (4th indorser), then D and prior parties are liable to X. 

The notary public notes it that it has been accepted for honour and details therein. 

Acceptance for honour can also come into being, after it has been protested for better security. 

Acceptance for honour is only for BoE. If the person not mentioned, then it is the drawer. 

Payment for honour can be for BoE as well as PN. 

CHAPTER X-OF REASONABLE TIME (S.105-107)

S.105 Reasonable Time-

In determining what is a reasonable time for presentment for acceptance or payment, for giving notice of dishonour and for noting, regard shall be had to the nature of the instrument and the usual course of dealing with respect to similar instruments; and, in calculating such time, public holidays shall be excluded

S.106 Reasonable time of giving notice of dishonour-

If the holder and the party to whom notice of dishonour is given carry on business or live (as the case may be) in different places, such notice is given within a reasonable time if it is dispatched by the next post or on the day next after the day of dishonour

If the said parties carry on business or live in the same place, such notice is given within a reasonable time if it is dispatched in time to reach its destination on the day next after the day of dishonour

S.107 Reasonable time for transmitting such notice-

A party receiving notice of dishonour, who seeks to enforce his right against a prior party, transmits the notice within a reasonable time if he transmits it within the same time after its receipt as he would have had to give notice if he had been the holder

CHAPTER XI-ACCEPTANCE AND PAYMENT FOR HONOUR (S.108-116)

S.108 Acceptance for Honour-

When a BoE has been noted or protested for non-acceptance or for better security, any person not being a party already liable thereon may, with the consent of the holder, by writing on the bill, accept the same for the honour of any party thereto.

S.109 How acceptance for honour must be made-A person desiring to accept for honour must, by writing on the bill under his hand, declare that he accepts under protest the protested bill for the honourofthedrawerorofaparticularindorserwhomhenames,orgenerallyforhonour.

S.110-Acceptance not specifying for whose honour it is made-

Where the acceptance does not express for whose honour it is made, it shall be deemed to be made for the honour of the drawer

S.111-Liability of Acceptor for Honour-

An acceptor for honour binds himself to all parties subsequent to the party for whose honour he accepts to pay the amount of the bill if the drawee do not; and such party and all prior parties are liable in their respective capacities to compensate the acceptor for honour for all loss or damage sustained by him in consequence of such acceptance. 

But an acceptor for honour is not liable to the holder of the bill unless it is presented, or (in case the address given by such acceptor on the bill is a place other than the place where the bill is made payable) forwarded for presentment, not later than the day next after the day of its maturity

S.112-When acceptor for honour may be charged-

An acceptor for honour cannot be charged unless the bill has at its maturity been presented to the drawee for payment, and has been dishonoured by him, and noted or protested for such dishonour

S.113-Payment for Honour-

When a bill of exchange has been noted or protested for non-payment, any person may pay the same for the honour of any party liable to pay the same, Provided that the person so paying or his agent in that behalf has previously declared before a notary public the party for whose honour he pays, and that such declaration has been recorded by such notary public

S.114-Right of payer for Honour-

Any person so paying is entitled to all the rights in respect of the bill, of the holder at the time of such payment, and may recover from the party for whose honour he pays all sums so paid, with interest thereon and with all expenses properly incurred in making such payment

S.115-Drawee in case of need-

Where a drawee in case of need is named in a bill of exchange, or in any indorsement thereon, the bill is not dishonoured until it has been dishonoured by such drawee

S.116-Acceptance and payment without protest-

A drawee in case of need may accept and pay the bill of exchange without previous protest

CHAPTER XII-OF COMPENSATION (S.117)

S.117 Rules as to compensation-

The compensation payable in case of dishonour of a promissory note, bill of exchange or cheque, by any party liable to the holder or any indorsee, shall be determined by the following rules:— 

  1. the holder is entitled to the amount due upon the instrument, together with the expenses properly incurred in presenting, noting and protesting it; 
  2. when the person charged resides at a place different from that at which the instrument was payable, the holder is entitled to receive such sum at the current rate of exchange between the two places; 
  3. an indorser who, being liable, has paid the amount due on the same is entitled to the amount so paid with interest at eighteen per centum per annum from the date of payment until tender or realization thereof, together with all expenses caused by the dishonour and payment; 
  4. when the person charged and such indorser reside at different places, the indorser is entitled to receive such sum at the current rate of exchange between the two places
  5. The party entitled to compensation may draw a bill upon the party liable to compensate him, payable at sight or on demand, for the amount due to him, together with all expenses properly incurred by him. Such bill must be accompanied by the instrument dishonoured and the protest thereof (if any). If such bill is dishonoured, the party dishonouring the same is liable to make compensation thereof in the same manner as in the case of the original bill.

CHAPTER XIII-SPECIAL RULES OF EVIDENCE (S.118-122)

Evidence Act and other general principles are applicable-

Two things-

  1. Presumptions (rebuttable)
  2. Estoppel

S.118 lays down presumptions as to NI. All these presumptions are rebuttable presumptions

S.118-Presumptions as to negotiable instruments-Until the contrary is proved, the following presumptions shall be made:-

  1. of consideration:-that every negotiable instrument was made or drawn for consideration, and that every such instrument, when it has been accepted, indorsed, negotiated or transferred, was accepted, indorsed, negotiated or transferred for consideration
  2. as to date:-that every negotiable instrument bearing a date was made or drawn on such date;
  3. as to time of acceptance:-that every accepted bill of exchange was accepted within a  reasonable time after its date and before its maturity
  4. as to time of transfer:-that every transfer of a negotiable instrument was made before its maturity
  5. as to order of indorsements:-that the indorsements appearing upon a negotiable instrument were made in the order in which they appear thereon
  6. as to stamp:-that a lost promissory note, bill of exchange or cheque was duly stamped
  7. that holder is a holder in due course:-that the holder of a negotiable instrument is a holder in due course : Provided that, where the instrument has been obtained from its lawful owner, or from any person in lawful custody thereof, by means of an offence or fraud, or has been obtained from the maker or acceptor thereof by means of an offence or fraud, or for unlawful consideration, the burthen of proving that the holder is a holder in due course lies upon holder
    1. Every one assumed to be holder in due course. 
    2. It is also assumed that he brought it for consideration and before maturity. 
    3. Whether there was awareness in the defect of the title of the person? 
    4. There is presumption that holder acted in good faith and without negligence and nothing to show that there was defect in title of the person from whom he got the instrument.  
    5. But if its gets transferred by means of offence, then every subsequent holder will have to prove that he holder in due course. 

S.119-Presumption on proof of Protest-

In a suit upon an instrument which has been dishonoured, the Court shall, on proof of the protest, presume the fact of dishonour, unless and until such fact is disproved

On proof of protest, the instrument shall be presumed to have been dishonoured. This presumption is difficult to rebut as this is certified by the notary. 

S.114 of Evidence Act-provides that the court concerned shall take into account the normal course of events during assessing evidence. If the person concerned has evidence of an event which he does not present in court, then court can presume that that particular event did not occur.

If you have paid consideration, you would made record of that in normal course. If you do not present that record, court can presume that you did not pay not consideration

A businessman concerned in the normal situation, is supposed to maintain record in his books of account that he paid such and such consideration

Even in circumstances where the preservation of records becomes difficult, still you need to have some evidence.

Kundal Lal v Custodian of Evacuee Property

KL claimed that consideration for PN was paid by him, the court asked him the book of records.

Two other presumptions-

  1. Presumption that every instrument is an inland instrument governed by the Indian law.
  2. Presumption that every instrument when delivered, it was delivered unconditionally.

ESTOPPEL

There is an estoppel against denying the original validity of the instrument. Maker, drawer and acceptor for honour of drawer, they cannot deny the original validity of the instrument in a suit thereon by a holder in due course

If I made the instrument and given it out, I cannot subsequently say that I did not make it. I can deny the signature which means that it never came into being. 

If you do not deny the forgery of the signature, then you do not deny the original validity of the instrument. If he was forced/coerced, it is voidable wrt to immediate party.

Also an indorser cannot deny the signature of prior party

S.117 Evidence Act-That the acceptor/drawee of the BoE cannot deny the capacity of drawer to draw upon him. But the acceptor of BoE can deny the signature of the drawer. Here Indian law differs from UK law. In UK, the acceptor of BoE cannot even deny the signature of the drawer. 

S.120-Estoppel against denying original validity of instrument-No maker of a promissory note, and no drawer of a bill of exchange or cheque, and no acceptor of a bill of exchange for the honour of the drawer shall, in a suit thereon by a holder in due course, be permitted to deny the validity of the instrument as originally made or drawn

S.121-Estoppel against denying capacity of payee to indorse-No maker of a promissory note and no acceptor of a bill of exchange [payable to order] shall, in a suit thereon by a holder in due course, be permitted to deny the payee’s capacity, at the date of the note or bill, to indorse the same

When I make and give a BoE to someone, I cannot deny his capacity to indorse it unless there is a contract otherwise. Even if he indorsed it against terms, I can only claim damages against him and not from holder in due course.

S.122-Estoppel against denying signature or capacity of prior party-No indorser of a negotiable instrument shall, in a suit thereon by a subsequent holder, be permitted to deny the signature or capacity to contract of any prior party to the instrument

CHAPTER XVI-RULES OF INTERNATIONAL LAW WRT NI (S.135-137)

This is also known as Conflict of Law or Private Intl Law.

S.11 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.

Foreign Instrument-Defined negatively.What is not an inland instrument is a Foreign Instrument

Inland Instrument-made or drawn in India and payable in or drawn upon resident in India. 

It includes-

  1. If drawn upon a resident of India if paying outside India 
    1. BoE is drawn upon Tata Steel. If paid outside India, its still inland instrument
    2. Mercedes Benz if paying a BoE in India will be inland instrument
  2. Resident of a foreign nation if paying in India

In the case of an Indian bank, if BoE which is drawn upon a branch outside India, it is not an Inland Instrument

FEMA-Foreign Exchange Management Act has to be looked at to determine the inland or foreign instrument. 

Kidston and Sons v Seth Brothers

Calcutta HC Provided that if an instrument is made in India in favour of an Indian, it still is an inland instrument if it was payable in India though the place at which it was drawn might have been outside India. 

Madras HC Judgement

Cheque was drawn outside India to be payable at a bank branch in India. Was held to be an Inland Instrument. 

S.11 says that an inland instrument has to be drawn or made in India-

3 Factors/Principles-

  1. The intention of the legislature will have to be taken into account. If the statute intends to regulate NI, then that particular statutory provision will prevail whether it has relation with that country or not. 
  2. Generally, one sovereign does not intend to govern issues that are primarily the domain of other sovereign. An Indian govt should not be concerned about the happenings outside India. What? It would be discourteous to intervene.
  3. Normally, the parties intent to be governed by the laws of a country. But most of the mercantile laws have rules-‘subject to a contract to the contrary’ and unless and until rules of public policy are violated, parties have a discretion to say what law they intend to be governed by. They can say so expressly or impliedly. In 90% cases, they do not state the law they intend to be governed by. Then courts will have to decipher-
    1. The laws parties intended to be governed by
    2. What law has got the most real connection with that particular contract? For that purpose it will look at-
      1. The language of the contract
      2. The place of the contract
      3. Parties to the contract
      4. Currency to be paid upon
      5. Format and style of the contract
    3. Wrt foreign NI, some rules are specified in the act itself and some are not specified but will be looked at by the conflict of laws.

Validity, Capacity, etc

The law of the place of the contract (Lex Loci Contractus)

If the NI was made in Nepal and if the law of majority there is 16, then it has to be honoured

Mode of acceptance

Whether general or qualified, the law where it is accepted.

Stamp Laws-

One goes by the place where it was made. Whether NI void or inadmissible in evidence due to improper stamping, under that law, it restraints only courts of that country. But if comes to India, it has to be stamped. 

Where it is made-

It will be defined by where it has been delivered and not where it was written

S.134 and S.135 defines liability of the maker and acceptor/indorser.

Liability of the maker/drawer is governed by the place where it was made

Liability of the indorser/acceptor is governed by the place where it was made payable.

S.134-Law governing liability of maker, acceptor or indorser of foreign instrument-

In the absence of a contract to the contrary, the liability of the maker or drawerof a foreign promissory note, bill of exchange or cheque is regulated in all essential matters by the law of the place where he made the instrument, and the respective liabilities of the acceptor and indorser by the law of the place where the instrument is made payable

Illustration 

A bill of exchange was drawn by A in California, where the rate of interest is 25 percent and accepted by B, payable in Washington, where the rate of interest is 6 per cent. The bill is endorsed in India, and is dishonoured. An action on the bill is brought against B in India. He is liable to pay interest at the rate of 6 percent only; but if A is charged as drawer, A is liable to pay interest at the rate of 25 per cent. IMPORTANT

S.135-Law of place of payment governs as to what constitute dishonour-

Where a promissory note, bill of exchange or cheque is made payable in a different place from that in which it is made or indorsed, the law of the place where it is made payable determines what constitutes dishonour and what notice of dishonour is sufficient. 

Illustration 

A bill of exchange drawn and indorsed in India, but accepted payable in France, is dishonoured. The indorsee causes it to be protested for such dishonour, and gives notice thereof in accordance with the law of France, though not in accordance with the rules herein contained in respect of bills which are not foreign. The notice is sufficient

S.136-Instrument made, etc., out of India, but in accordance with the law of India-

If a negotiable instrument is made, drawn, accepted or indorsed outside India, but in accordance with the law of India, the circumstances that any agreement evidenced by such instrument is invalid according to the law of the country wherein it was entered into does not invalidate any subsequent acceptance or indorsement made thereon within India

S.137-Presumption as to foreign law-

The law of any foreign country regarding promissory notes, bills of exchange and cheques shall be presumed to be the same as that of India, unless and until the contrary is proved

X draws a BoE upon B in Malaysia. As per Malaysian law, he could not have done so. But if the Bill comes in India and accepted, from that moment onward, the bill is valid in India. But the maker will not be liable and the indorser who indorser who indorsed in India will be liable. But it has to be stamped in India. 

CHAPTER XIV-CROSSING OF CHEQUES (S.123-131A)

Cross-A box in the cheque. It means that such cheques cannot be paid over the counter but to only a Bank. A Bank will collect it on the behalf of the customer. 

Banks collects it as an agent of its customer. When the cheque is crossed, then it can be paid only through a bank. If it is crossed then only a bank can collect payment upon it. One can also write-NOT NEGOTIABLE. NN means that it cannot further negotiated but can be assigned. No one will collect payment on a non-negotiable cheque unless and until its a case of succession. Theoretically a NN cheque is assignable.  

GENERAL & SPECIAL CROSSING

Sometimes when it is crossed you add the name of the bank to it. Once the name of the bank is added it becomes a special crossing. In such a case, the collection can be made only by the bank mentioned

2 things-

  1. Once crossed, then obliteration of the crossing (general or special) is a material alteration. But if the cheque was not crossed, it can be crossed later and that would not amount to material alteration. Conversion of general crossing into special crossing is also no MA. 
  2. The bank can pay upon that cheque only to a bank for it to be a payment in due course. If specially crossed, then only to that bank whose name is mentioned. That bank however can assign another bank to collect on its behalf by crossing it once again

Illustration ‘A’ has a bank account in SBI. He writes a crossed Cheque of 1K and gives it to ‘B’ who has a bank account in BOB. B will present the Cheque in his Bank ‘BoB’ which will collect the payment from ‘SBI’ and deposit it in ‘B’s account. SBI is the Paying Bank and BOB is the Collecting Bank. 

ECS-Electronic Clearance System

ACCOUNT PAYEE CHEQUES

This meant that cheque can be paid only into the account and not across/over the counter. Originally they did not make a difference. The person named’s bank will collect it and deposit it into his account.

Account payee now means that not just that you have to pay into the account but that it is non-negotiable and non-transferable. It can only be paid into the account of the person named into the cheque

Earlier maintaining an account was privilege. It was assumed that bank would not dishonour the cheques. Cheque facility was therefore granted to limited person who had some financial standing in society. 

Its value is deemed to be equal to the amount mentioned on it. Even a blank cheque leave is considered a good. The person who takes payment upon it, if he is not the real owner of the cheque, he has fraudulently deprived the real owner of its possession, he is guilty of tort of conversion howsoever small the period is. Whether he did not intentionally or not does not matter. 

Generally the Principle is liable for the wrongs committed by the agent during the course of the employment. But Bank as an agent sometimes is liable for the wrongs of its principle which is the customer. If the customer has committed the tort of conversion, the bank is also liable. 

S.131 of the NI was put in- 

S.82 of the BoE Act was put in-was later repealed and replaced by S.4 of the Cheques Act.

S.4 of the Cheques Act gives wider protection. 

S.131-Non-liability of 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 II-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 before receiving payment thereof.

Explanation II-It shall be the duty of the banker who receives payment based on an electronic image of a truncated cheque held with him, to verify the prima facie genuineness of the cheque to be truncated and any fraud, forgery or tampering apparent on the face of the instrument that can be verified with due diligence and ordinary care.

Conditions-

  1. The bank should collect the crossed cheques only for its customer. If it collects of itself (discounted cheque) or someone else, then it will not have the protection of this section.
  2. It should collect in good faith without negligence. Then it is not liable to the original owner merely because there existed a defect in the title of the person for whom it collected the payment.

Issues-

  1. Who can be said to be a customer?
  2. When can we say that the bank has collected it in good faith without negligence?

Who can be said to be a customer?

Originally the test was-Customer was a person who habitually maintained an account with the bank (branch) for a certain period of time. The person was supposed to be a customer for certain period of time and had habitually dealt with the bank for the bank to be aware of him. 

Then in-

Taxation Commissioner v English, Scottish & Auz Bank Ltd, PC held

That duration was not of essence,a person is a customer from the moment an account is opened and he is allowed to withdraw. Here a cheque was in favour of a person. It was siphoned during post. The person opened the account with this cheque. The address given was of a posh locality in Sydney. The bank opened the account and the person later withdrew the account and vanished. Issue was whether he could be regarded as a customer. Court held that the person concerned was a customer the moment he could withdraw the amount. 

Ladbrok Co v Tord

The person was not allowed to withdraw the money till the cheque was cleared. The person had stolen a cheque payable to an Oxford Student. The thief presented the cheque for opening the bank account by presenting himself as the student. Account was opened but he was not allowed to withdraw. Court said that a person is a customer the moment he opened the account whether he is allowed to withdraw or not. He was held to be a customer.

Wood v Martin Brank

The person concerned discussed with the bank investment proposals for money which he was about to come into. MB advised him to invest in debentures of a company which had a/c in the bank. The company was not in good position. Acting on that Advise, he invested the money. The company later went insolvent. Whether at the time of advice, he was a customer of the bank? Court held that he was a customer from the moment the negotiations had reached a stage, where a neutral businessman/observer will say that he would open an account Provided he opens an account later on. People who have opened an account are regarded as customers. 

NoteFor the purpose of S.131 those who have habitually dealt with the bank would not be regarded as customers if they don’t have a bank account with the bank.

Great Western Railway Co v London And County Banking Co Ltd

The person who committed the malfeasance was a raid collector of a local municipality. Municipality had an account with the bank. He used to deposit collected money in that and take his commission across the counter. This is how he dealt with the bank. He later stole certain cheques from the GWRC and deposited it into the account. The bank claimed that it was dealing for a customer. The claim was negatived because the raid collector never had any account with the bank. 

Importer Co Ltd v Westminister Bank Ltd

The account payee cheque was from Turkey and was given to a Turkish bank. The Turkish bank contacted an English Bank for payment and got paid. TB habitually dealt with the English Bank but had no ac with the English Bank. Whether the UK bank was guilty? 

Illustration-

What if the bank is unaware of the account opener?

Eg-A opens the account in the name of B but this is his account. 

If someone deals with another person by misrepresenting that person, then the other person is not liable. 

Marfani & Co Ltd Midland Bank

A person ‘A’ working for a firm contacted some eminent gentleman who was the customer of the bank. And represented him that he was Eliazade (rich Persian). The gentleman after sometime confided in him and then ‘A’ told him that he wants to open an account in the Bank. He gave reference of Eliazade. Account was opened and money was deposited. Cheque was drawn in the name of Eliazade. The person ‘A’ took the cheque money and fled. It was held that the real customer of the bank was ‘A’ who opened the account who the bank believed to be ‘Eliazade’ 

Issue-if the account is opened in name of someone else, the who is the customer?

If that person gave consent, then he is the customer thought the account is managed by 3rd person.

Rowlandson v National Bank

An eminent grandmother wanted to open an account in the name of her grandchildren. The account was to be operated for the benefit of the grandchildren by their parents who happened to be their guardian. Guardians did not approve off the opening of the account. But they withdrew money from the account for personal use. Customers were grandchildren.

When can we say that the bank has collected it in good faith without negligence?

S.131 Non-liability of 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 I— 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 before receiving payment thereof.

Explanation IIIt shall be the duty of the banker who receives payment based on an electronic image of a truncated cheque held with him, to verify the prima facie genuineness of the cheque to be truncated and any fraud, forgery or tampering apparent on the face of the instrument that can be verified with due diligence and ordinary care

Protects bank from 2 charges-

  1. Money hadn’t received 
  2. Conversion

Wrt Conversion, it had to act in good faith and without negligence. The issue of good faith crops up because many a times, the person who has drawn the cheque, has overdraft with the bank. It is the bank which is pushing him to pay the overdraft and the person concerned pays into his account money which does not belong to him and the bank is many a times very fast in collecting such deposits. 

Wrt Negligence, the bank concerned is not in negligence, if it owes a duty of care, even if exercise of that care would not have brought out the truth. Duty of care is not wrt to the cheque. Many a time cheque is deposited wrongfully (misrepresenting identity, etc) So duty of care starts with opening of the account. What was sufficient 100 years ago may not be sufficient now. Reasonable prudent man doing business will be the criteria. When one opens an account, it has to usually take into account not just the industry practice but its own internal guidelines. Guidelines wrt KYC norms, etc 

Ladbrok Co v Tord

The person was not allowed to withdraw the money till the cheque was cleared. The person had stolen a cheque payable to an Oxford Student. The thief presented the cheque for opening the bank account by presenting himself as the student. Account was opened but he was not allowed to withdraw. Court said that a person is a customer the moment he opened the account whether he is allowed to withdraw or not. He was held to be a customer. It was also held to guilty of negligence

Loyd Bank v Sawory

There was a stock broker. Two clerks stole cheques and got in favour of themselves and their wives. The bank concerned asked the profession of account openers to ascertain how much money this person will be giving for the purpose of collection. This practice was not followed in the present case. 

Orbit Mining and Trading Company v Westminister Bank

The person concerned opened an account and later on changed his employment. 

Lumsden and Co v London Trusty Saving Bank

A person opened an account in someone else’s name and gave himself as a referee. He did not have bank account there. The bank was held guilty of negligence for not asking him the bank where he had account.

Most of the cases of conversion will arise, where a person misuses his fiduciary relationship to pay into account a cheque which does not belong to him. 

Eg-the guardian concerned puts the cheque into his personal account. 

Eg-the director of a company endorses a cheque payable to his company to his account. 

Bank has to make a reasonable inquiry

Morison v London County and Westminister Bank

The person paid into his account the cheque of the co. The bank grew suspicious and contacted the company. Employer concerned was forgiving by nature and told that everything was normal. The bank clerk was not satisfied and still persisted with inquiry. Later when similar incidents happened again and the company tried to recover them, it was held that by his statement, the Employer had regularised the practice. 

If in the inquiry, the customer concerned validates the cheque, then bank is not liable. 

Marfani Case-IMP

Note:-The court will look if the opening of account, deposit and withdrawl looks like one transaction, if it does then it has to be circumspect. IMPORTANT

SBI v PNB Delhi HC (Ask Rakesh Uncle)

One ‘Durlabh Singh’ opened an account on 10 Dec 1964 in PNB. He was introduced by one ‘Lakshman Das’ whose antecedents were unknown. He (Durlabh Singh) opened an account with Rupees 200. Thereafter the account was not operated. On 26 Dec, he paid a cheque of 80K into his account in PNB. The cheque was drawn by the land acquisition collector of Delhi (SBI Cheques). The cheque was collected by PNB on 29 Dec and from 1st Jan 1965-11 Jan 1965, he withdrew on an average 10K a day so that he was left with 100 Rupees on 11. SBI got a notice from collector, that a chequebook with 20 cheque leaves were missing and those should not be honoured. SBI which had already paid to PNB (PNB had collected the cheques), sough its reimbursement u/s 72 of Contract Act which the PNB tried to avoid by saying that-

  1. It had collected it from its (SBI) customers  
  2. SBI was estopped from denying the signature of its customer. 

Estoppel principle has its origin in Roman Law. The court disagreed as due care/diligence was not observed. 

S.117 of the Evidence Act provides that theDrawee of a BoE in India can deny the signature of the Drawer. 

National Westminister Bank Ltd v Barkley Bank

One person named Ismail was given a cheque of 8K Pound. Ismail was based in Nigeria and was trying to bypass the civil laws of Nigeria. He paid Nigerian pounds for the cheque. NatWest honoured the cheque and paid Barkley Bank 8K Pound which was lying in his account. Subsequently a forgery was discovered and NatWest tried to recover the account. The plea of estoppel was taken and it cannot deny the signature. 

The court held that plea of estoppel will not apply against the bank. If it has paid by mistake, it is entitled to recover the money. Barkley bank was not going to suffer any loss as 8K pound was still lying in that account

Note:-In the case of a cheque, even if it is genuine, the drawer of the cheque at any time can countermand the payment on the cheque. Bank concerned in such a case is not bound to pay. In the case of BoE, the drawee once he has accepted, he is bound to pay. He cannot countermand on that. 

If the cheque is a forged cheque, S.131 is inapplicable as a forged cheque is not a cheque. 

Due care/diligence is important

An Altered cheque or where the signature is forged

Indian Bank v Catholic Syrian Bank

A bank draft of 20 Rs had been altered 29K Rupees. Parties are discharged upon it but it is still NI. Subsequent parties upon it will be liable if it gets further indorsed. IMPORTANT

Indian Overseas Bank v Industrial Chain Concerned

One Sethuraman was a manager of an Industry chain. He approached an IOB branch manager who used to be his class fellow for opening an account. Sethuraman also asked from him an ‘overdraft facility’ which he was refused. The account was opened on October 24, 1974, and over a period of time, cheques were deposited and withdrawn. Subsequently, the Industry informed IOB, that cheques were missing. Whether the bank concerned had acted negligently?

The court found that bank followed the procedures in opening the account. If the bank manager knows someone, then there is no requirement of asking reference for that person. There was nothing abnormal in it. 

Wrt deposits and withdrawl, they were done over a period of 6 months.

Manager was negligent, he did not look into the address of the industrial chain concerned, then he would have found out the truth. 

Standard of Care-Reasonable Man’s test but that will change with time. It has to collect the cheque in reasonable time

These days banking transaction are quite common and same standard that was prevalent 100 years ago cannot be followed now. Hence, IOB was held not liable.

2nd Defence-Liggett Defence 

It is a defence in Equity. If the person concerned is misappropriating something owed to him/her, then there is no liabilities on the parties concerned. 

3rd Defence-Defence of Contributory Negligence

That person concerned who was deprived was also negligence. 

4th Defence-Where the bank collect cheque for its own self. But if it is a holder in due course then it gets the benefit. 

CHAPTER XVII-PENALTIES FOR CHEQUE DISHONOUR (S.138-148)

S.138-Dishonour of cheque for insufficiency, etc., of funds in the account-

Where any cheque drawn by a person on an account maintained by him with a banker for payment of any amount of money to another person from out of that account for the discharge, in whole or in part, of any debt or other liability, is returned by the bank unpaid, either because of the amount of money standing to the credit of that account is insufficient to honour the cheque or that it exceeds the amount arranged to be paid from that account by an agreement made with that bank, such person shall be deemed to have committed an offence and shall, without prejudice to any other provision of this Act, be punished with imprisonment for a term which may be extended to two years’, or with fine which may extend to twice the amount of the cheque, or with both: 

Provided that nothing contained in this section shall apply unless-

  1. the cheque has been presented to the bank within a period of six months from the date on which it is drawn or within the period of its validity, whichever is earlier
  2. the payee or the holder in due course of the cheque, as the case may be, makes a demand for the payment of the said amount of money by giving a notice, in writing, to the drawer of the cheque, within thirty days of the receipt of information by him from the bank regarding the return of the cheque as unpaid; and 
  3. The drawer of such cheque fails to make the payment of the said amount of money to the payee or, as the case may be, to the holder in due course of the cheque, within fifteen days of the receipt of the said notice. 
    1. Explanation-For the purposes of this section, “Debt of other liability” means a legally enforceable debt or other liability

Explanation-

There is no liability on the drawee of the cheque except where it gives a banker’s guarantee or accommodate a BoE.

Liability is only upon the drawer of the cheque. 

Presumptions-

  1. That the drawer has banker customer relation with the Bank
  2. There is sufficient money to honour the cheque
  3. Bank concerned will honour the cheque Provided it is presented in a reasonable time.

Principles of fraudulent preference (one creditor over other), etc are not applicable in a banker-customer relationship.

In case of insufficient funds, 2 remedies available to the payee-

  1. Civil Suit against the drawer
  2. Sue him u/s 420 IPC
    1. Problem-Proving Mens-Rea was difficult 

Therefore S.138 of the NI Act was drafted to punish culpable drawers

It does not penalise the dishonour of the cheque but that he does not seek to honour the liability which he had taken upon himself through the means of the cheque

Two reasons of dishonour-

  1. Insufficiency of funds
  2. It exceeds the arrangements made with the bank (over-draft facility)

Conditions-

  1. Bank will give a notice of dishonour of the cheque to the payee who in turn has to give a notice within 30 days after the receipt of notice of dishonour from the bank
    1. Notice has to reach the drawer within the period of 30 days
    2. Many a times, exorbitant claims are made in the notice.
    3. Notice has to be for the amount concerned. 
    4. Sometimes the drawer persuades the payee that he will present the cheque again. In such a case, the period of 30 days will run from the next dishonour. 
  2. Within 15 days of receipt of notice from the payee, the drawer has to make the payment. If he fails, then the liability starts

Note-Collecting bank will tell the reasons for dishonour. 

Difference b/w collecting bank and paying bank-

Paying Bank-The banker/Bank who is required to pay the cheque drawn on it by a customer is called the paying banker or drawee bank. For example ‘A’ who has bank account in SBI draws a cheque and gives it to ‘B’ who has account in BoB. ‘B’ will present the cheque in ‘BoB’ which will collect the money from ‘A’s’ account in SBI and deposit it in ‘B’s account. Here SBI was the paying bank and BoB was the collecting Bank. 

Collecting bank-A collecting banker is one who undertakes to collect the amount of a cheques & bills for his customer from the paying banker. 

Where one branch of a bank debits the account of its customer in a valid manner, and transfers the money to another branch of the bank or its head office, the transaction does not amount to merely a transfer of the bank’s own money from one branch of the bank to another branch, but involves the receipt of the money by the transferee bank, and hence it becomes a collecting bank. 

Pre-Emptive Steps to avoid the liability- 

  1. Countermanding the Cheque-Asking the bank not to pay upon the Cheque
  2. Closing of an account after drawing the cheque but it is still regarded as insufficiency of balance. 

Note:-S.138 has to be read in such a manner, that it is not rendered ineffective. 

Now banks also charge fine over dishonour of cheque.

Banks generally don’t use the term ‘insufficiency of balance’ They will mention various other excuse like-Contact the drawer. All this will be deemed as insufficiency of balance. 

The drawer concerned cannot say that he did not know of insufficiency of funds in his account. 

What if the payee had not paid consideration for the cheque?

In such a case, drawer can have a valid defence. But he will be liable to the holder in the due course. But the liability shall be civil liability. 

S.139 Presumption in favour of holder-

It shall be presumed, unless the contrary is proved, that the holder of a cheque received the cheque of the nature referred to in section 138 for the discharge, in whole or in part, of any debt or other liability

The person concerned should have drawn the cheque in discharge of his liability. This presumption is a rebuttable presumption. It is an enforceable legal liability. 

Cheques drawn in discharge of time-barred debt is not covered here. 

Where only a part of the legal liability is enforceable, liability will be wrt to that value of the cheque. Legal liability should be equal or greater than the value of the cheque

S.140 Defence which may not be allowed in any prosecution under section 138-

It shall not be a defence in a prosecution for an offence under section 138 that the drawer had no reason to believe when he issued the cheque that the cheque may be dishonoured on presentment for the reasons stated in that section

Procedure of initiation of Complaint-

The person will initiate at the bank branch where he/she presented it for the payment.

In case it is across the counter, it will the branch of the drawer.

S.141 Offences by companies-

  1. If the person committing an offence under section 138 is a company, every person who, at the time the offence was committed, was in charge of, and was responsible to, the company for the conduct of the business of the company, as well as the company, shall be deemed to be guilty of the offence and shall be liable to be proceeded against and punished accordingly: 
    1. Provided that nothing contained in this sub-section shall render any person liable to punishment if he proves that the offence was committed without his knowledge, or that he had exercised all due diligence to prevent the commission of such offence: 
    2. Provided further that where a person is nominated as a Director of a company by virtue of his holding any office or employment in the Central Government or State Government or a financial corporation owned or controlled by the Central Government or the State Government, as the case may be, he shall not be liable for prosecution under this Chapter.] 
  2. Notwithstanding anything contained in sub-section (1), where any offence under this Act has been committed by a company and it is proved that the offence has been committed with the consent or connivance of, or is attributable to, any neglect on the part of, any director, manager, secretary or other officer of the company, such director, manager, secretary or other officer shall also be deemed to be guilty of that offence and shall be liable to be proceeded against and punished accordingly. 
    1. Explanation-For the purposes of this section,-
      1. (a) “Company” means anybody corporate and includes a firm or other association of individuals; and 
      2. (b) “Director” in relation to a firm, means a partner in the firm.

CENTRAL BANKING SYSTEM

THE ROLE OF THE CENTRAL BANK

It creates the money-

Has responsibility to maintain stability of the monetary and the financial system. 

It seeks to maintain the value of the currency that it prints. Some inflation is inherent and in-fact is desirable but the rate should not go to very high extent. 

Value of the currency inside and vis-a-vis other currencies

How does it do that?

Through the banking system

DIFFERENT MECHANISMS OF CONTROL

1st Mechanism-Credit Channel-Putting Obstacles in lending

M0-The base currency (BC) is the one in central bank’s deposits

BC tends to multiply and become M3. Money in the system is not just the printed currency but deposits in the bank. 

M3 is the few multiples of M0. How M0 becomes M3 depends on how easily the banks are able to give loans. If there are obstacles in the bank’s ability to give loans then M3 will be lower. 

Central bank will put some obstacles to lending as a safeguard. At present they can’t lend for buying shares and buying lands.

Then are certain best practices-the person taking the loan will have to satisfy these parameters.

By obstructing the credit channel, a restraint is put on the M0 to multiply.

2nd Mechanism-Statutory Reserved Ratios 

Cash Reserve Ratio or CRR is the multiplier. CRR is the amount of cash reserve that Banks should have. 

Eg-If CRR is 5% then 1K can become 20K. 

S.11 of the Banking Regulation Act provides and S.42 of the RBI Act for CRR for scheduled Banks. For scheduled banks RBI acts as lender of last resort. 

S.11:  Requirement as to minimum paid-up capital and reserves 

In the case of a banking company incorporated outside India- 

(a) the aggregate value of its paid-up capital and reserves shall not be less than fifteen lakhs of rupees and if it has a place or places of business in the city of Bombay or Calcutta or both, twenty lakhs of rupees; and 

(b) the banking company shall deposit and keep deposited with the Reserve Bank either in cash or in the form of unencumbered approved securities, or partly in cash and partly in the form of such securities- 

(i) an amount which shall not be less than the minimum required by clause (a); and 

(ii) as soon as may be after the expiration of each year, an amount calculated at twenty percent of its profit for that year in respect of all business transacted through its branches in India, as disclosed in the profit and loss account prepared with reference to that year under section 29.

S.42 (RBI Act) Cash reserves of scheduled banks to be kept with the Bank. 

(1) Every bank included in the Second Schedule shall maintain with the Bank an average daily balance the amount of which shall not be less than such per cent. of the total of the demand and time liabilities in India of such bank as shown in the return referred to in sub-section (2), as the 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

S.18 gives the power wrt to CRR for non-Scheduled banks. 

S.18: Cash Reserve

  1. Every banking company, not being a scheduled bank, shall maintain in India on a daily basis by way of cash reserve with itself or by way of balance in a current account with the Reserve Bank, or byway of net balance in current accounts or in one or more of the aforesaid ways, a sum equivalent to such per cent of the total of its demand and time liabilities in India as on the last Friday of the second preceding fortnight as the Reserve Bank may specify, by notification in the Official Gazette, from time to time, having regard to the needs of securing the monetary stability in the country] and shall submit to the Reserve Bank before the twentieth day of every month are turn showing the amount so held on alternate Fridays during a month with particulars of its demand and time liabilities in India on such Fridays or if any such Friday is a public holiday under the Negotiable Instruments Act, 1881(26 of 1881), at the close of business on the preceding working day. 
    1. Explanation.–In this section, and in section 24,- 
      1. (a) “liabilities in India” shall not include- 
        1. (i) the paid-up capital or the reserves or any credit balance in the profit and loss account of the banking company; 
        2. (ii) any advance taken from the Reserve Bank 2[or from the Development Bank] or from the Exam Bank 3 [or from the Reconstruction Bank] 4 [or from the National Housing Bank] or from the National Bank 5[or from the Small Industries Bank] by the banking company; 
        3. (iii) in the case of a Regional Rural Bank, also any loan taken by such bank from its Sponsor Bank; 
      2. (b) “fortnight” shall mean the period from Saturday to the second following Friday, both days inclusive; 
      3. (c) “net balance in current accounts” shall, in relation to a banking company, mean the excess, if any, of the aggregate of the credit balances in current account maintained by that banking company with State Bank of India or a subsidiary bank or a corresponding new bank over the aggregate of the credit balances in current account held by the said banks with such banking company; 
      4. (d) for the purposes of computation of liabilities, the aggregate of the liabilities of a banking company to the State Bank of India, a subsidiary bank, a corresponding new bank, a regional rural bank, another banking company, a co- operative bank or any other financial institution notified by the Central Government in this behalf, shall be reduced by the aggregate of the liabilities of all such banks and institutions to the banking company; 
      5. (e) the expression “co-operative bank” shall have the meaning assigned to it in clause (cci) of section 56

Statutory Liquidity Ratio (SLR) is money invested in instruments which are liquid such as govt securities. 

The Repo Rate also sets out the base interest rate. It is also a credit channel.

Repo Rate-It is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds. Repo rate is used by monetary authorities to control inflation.

3rd Method-Market Intervention

Each Rupee which it has printed is a liability on RBI and has to be balanced with equal number of Assets. Assets include Gold, Foreign Reservers and GOI Bonds.

RBI either increases or decreases money Supply. In the recent crisis, RBI lend some billions to govt recently to increase liquidity. They can sold the foreign reserves. It will increase the Rupee supply. 

CAPITAL STRUCTURE OF BANKS

At the time when Licence is issued, RBI imposes various terms and conditions. 

The entity to which license has been given has to be a shell company which can’t do anything else and has enough capital to invest in bank as and when need arise. The entity should dilute its interest in the bank concerned. (Bandhan Bank, Kotak Bank, etc)

Shareholding Pattern

It can be equity or preference shares. Earlier preference shares were not allowed. Terms & Conditions of preference shares shall be according to guidelines prescribed by RBI. They can be redeemable or irredeemable. The PS shall not have any voting right under any circumstances

Ration of Authorised, Subscribed and Paid-up capital should be half (4:2:1). Subscribed capital should be at least half of Authorised capital and Paid-up capital should be at least half of subscribed capital.

Authorised Capital

The authorized capital of a company is the maximum amount of share capital that the company is authorized by its constitutional documents to issue to shareholders. Part of the authorized capital can remain unissued. The authorized capital can be changed with shareholders’ approval. (WP)

Subscribed Capital

Subscribed capital is that part of issued share capital for which company has positively received subscription from the investors. In simple words, when a company issues shares to raise fund, it may or may not find the investors for all of its shares.(Quora )

Paid-Up Capital

Paid-up capital is the amount of money a company has received from shareholders in exchange for shares of stock. Paid-up capital is created when a company sells its shares on the primary market directly to investors. (Investopedia)

No floating charge on paid up capital. (S.14A)

What is a Floating Charge?

A floating charge, also known as a floating lien, is a security interest or lien over a group of non-constant assets. The assets may change in quantity and value. Companies will use floating charges as a means of securing a loan. Typically, a loan might be secured by fixed assets such as property or equipment, but with a floating charge, the underlying assets are usually current assets or short-term assets that can change in value. Current assets are those business possessions that the firm can quickly liquidate for cash and include the accounts receivable, inventory, and marketable securities, among other items.[1] Since the debtor has the power to deal with it, they will dissipate in the course of business.

S.14A Prohibition of Floating Charge on assets 

  1. Notwithstanding anything contained in section 6, no banking company shall create a floating charge on the undertaking or any property of the company or any part thereof, unless the creation of such floating charge is certified in writing by the Reserve Bank as not being detrimental to the interests of the depositors of such company
  2. Any such charge created without obtaining the certificate of the Reserve Bank shall be invalid. 
  3. Any banking company aggrieved by the refusal of a certificate under sub-section (1) may, within ninety days from the date on which such refusal is communicated to it, appeal to the Central Government

It cannot create a floating charge on its assets. Floating charge’s nature keeps on changing. 

Rationale: PF shares are in the nature of debt masquerading as equity. They will be available for the satisfaction of debt. 

The act prohibits floating charge over assets. It is over a class of assets whose value and number will change. Since the debtor has the power to deal with it, they will dissipate in the course of business

EgIron ore procured for the production of steel will dissipate over a period of time. 

Bank gives out deposits in the favor of loan. Loan given by HDFC subject to floating charge is Delhi is prohibited. 

Bank concern have to have assets which have relationship with their risk profile. 

1973 New York Crisis-Two German banks failed. 

TYPES OF CAPITAL A BANK HAS

Tier 1 Capital-Which will not be returned

Makes up 50% of the capital. It refers to core capital that includes equity capital and disclosed reserves. Equity capital is inclusive of instruments that cannot be redeemed at the option of the holder.[2]

Tier 2 Capital-Those which have be returned 

It includes Redeemable, Preferential Capitals, hybrid capital instruments, loan-loss and revaluation reserves as well as undisclosed reserves. This capital operates as supplementary funding because it is not as reliable as the first tier. In 2017, under Basel III, the minimum total capital ratio was 12.5%, which indicates the minimum tier 2 capital ratio is 2%, as opposed to 10.5% for the Tier 1 Capital Ratio.[3]

50% of 8% was to be equity capital

As far as redeemable capital was concerned, they were in the form of preference capital. 

Tier 3 Capital-Bond 

Third form of capital is Bond. They have to be in the nature of subordinate bond and have to be paid after the deposited ones have been paid.

GLOBAL RISK PROFILING: BASEL ACCORDS

BASEL 1 (1988)-

It was issued in 1988 and focused on the capital adequacy of financial institutions. The capital adequacy risk (the risk that an unexpected loss with hurt a financial institution), categorizes the assets of financial institutions into five risk categories (0%, 10%, 20%, 50% and 100%). Under Basel I, banks that operate internationally are required to have a risk weight of 8% or less.

It allots risk profile depending on the purpose for which the loan is given.

If the bank concerned has borrowed money and lend it to its sovereign there is no risk compared to home buyer. 

If the bank’s capital falls below a certain level, it has to take prompt action by stopping private loans

Every risk was taken care of. 

Documentary Credit: The documentary credit is one of the most secure payment methods in international trade, offering the exporter a conditional payment guarantee from the importer’s bank. Documentary credits usually require the presentation of certain documents, which must be complied with before payment can take place.[4]

For international trade documentary credit is very important. 

Bank Guarantee: If x will not pay, I will pay. The terms of a bank guarantee are different from normal guarantee. 

Letters of Credit: A letter issued by a bank to another bank (especially one in a different country) to serve as a guarantee for payments made to a specified person under specified conditions.

For a 100% risk loan, 8% money of my own is required. Eg-‘A’ is giving B loan. If B deposit in govt bond, A’s capital is 100% safe. If B uses the money for lending it to ‘C’ there might be greater to risk. 

BASEL II (1980s)

Basel II is an international business standard that requires financial institutions to maintain enough cash reserves to cover risks incurred by operations. The Basel accords are a series of recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision (BSBS).[5]

Basel II has three pillars: 

  1. Minimum capital, 
  2. Supervisory Review Process, and 
  3. Market discipline Disclosure.

Minimum capital is the technical, quantitative heart of the accord. Banks must hold capital against 8% of their assets, after adjusting their assets for risk.

Supervisory review is the process whereby national regulators ensure their home country banks are following the rules. If minimum capital is the rulebook, the second pillar is the referee system.

Market discipline is based on enhanced disclosure of risk. This may be an important pillar due to the complexity of Basel. Under Basel II, banks may use their own internal models (and gain lower capital requirements) but the price of this is transparency.[6]

Fallout of Basel II: 2008 Financial crisis occurred 

BASEL III

More sophisticated version of Basel 1

Risk profile can be more than 100%. In India the requirement of minimum capital is 9% of the deposits to be in the lending business. If the capital falls below 9%, then banks have to take prompt corrective steps. If the risk on a loan is more than 100% then percentage minimum capital will vary accordingly. Eg-for 250% risk loan, it will be around 22%.

ROLES OF A CENTRAL BANK

LENDER OF LAST RESORT

For this it charges interest rates, impose certain conditions. It has to be immediate. Negotiations cannot go on for months. It should have confidence that the person it is lending will be able to satisfy the conditions and is worthy of credit. Only Scheduled Banks can borrow from RBI. A Bank in order to become schedule bank has to satisfy conditions.

BoE acted as a lender of last resort though it got such powers post WW2. 

In US Federal Reserve acts as a lender of last resort.

Other entities like NABARD also does financing and regulates those whom it finances.  

In State Cooperatives, too there are multiple regulators with RBI sitting at the top. 

Before Independence, Imperial Bank of India used to be the regulating agencies.

VISA and Master-card also impose conditions on banks for using their facilities. 

SUPERVISORY ROLES OF THE RBI OVER OTHER BANKS

Where does the power to supervise come from?

Statute-Under the Banking Regulation Act, some power of supervision lies with RBI and some with Central Govt. 

Most often the facilitating entity also regulates.

1ST ASPECT OF SUPERVISION: CHARTERING RESPONSIBILITIES: LICENCES 

Includes giving Licence to operate. Initially it dealt with the licensed cooperatives. 

S.22 of the Banking Regulations Act 1949

S.22 Licensing of Banking companies 

  1. Save as hereinafter Provided, no company shall carry on banking business in India unless it holds a Licence issued in that behalf by the Reserve Bank and any such Licence may be issued subject of such conditions as the Reserve Bank may think fit to impose.
  2. Every banking company in existence on the commencement of this Act, before the expiry of six months from such commencement, and every other company before commencing banking business in India, shall apply in writing to the Reserve Bank for a Licence under this section: 
    1. Provided that in the case of a banking company in existence on the commencement of this Act, nothing in sub-section (1) shall be deemed to prohibit the company from carrying on banking business until it is granted a Licence in pursuance of this section or is by notice in writing informed by the Reserve Bank that a Licence cannot be granted to it: 
    2. Provided Further that the Reserve Bank shall not give a notice as aforesaid to a banking company in existence on the commencement of this Act before the expiry of the three years referred to in sub-section (1) of section 11 or of such further period as the Reserve Bank may under that sub-section think fit to allow. 
  3. Before granting any Licence under this section, the Reserve Banking may require to be satisfied by an inspection of the books of the company or otherwise that the following conditions are fulfilled, namely:- 
    1. (a) that the company is or will be in a position to pay its present or future depositors in full as their claims accrue; 
    2. (b) that the affairs of the company are not being, or are not likely to be, conducted in a manner detrimental to the interests of its present or future depositors;
    3. (c) that the general character of the proposed management of the company will not be prejudicial to the public interest or the interest of its depositors
    4. (d) that the company has adequate capital structure and earning prospects
    5. (e) that the public interest will be served by the grant of a Licence to the company to carry on banking business in India; 
    6. (f) that having regard to the banking facilities available in the proposed principal area of operations of the company, the potential scope for expansion of banks already in existence in the area and other relevant factors the grant of the Licence would not be prejudicial to the operation and consolidation of the banking system consistent with monetary stability and economic growth; 
    7. (g) Any other condition, the fulfilment of which would, in the opinion of the Reserve Bank, be necessary to ensure that the carrying on of banking business in India by the company will not be prejudicial to the public interest or the interests of the depositors. 
  4. (3A) Before granting any Licence under this section to a company incorporated outside India, the Reserve Bank may require to be satisfied by an inspection of the books of the company or otherwise that the conditions specified in sub-section (3) are fulfilled and that the carrying on of banking business by such company in India will be in the public interest and that the Government or law of the country in which it is incorporated does not discriminate in any way against banking companies registered in India and that the company complies with all the provisions of this Act applicable to banking companies incorporated outside India.
  5. (4) The Reserve Bank may cancel a Licence granted to a banking company under this section- 
    1. (i) if the company ceases to carry on banking business in India; or 
    2. (ii) if the company at any time fails to comply with any of the conditions imposed upon it under sub-section (1); or 
    3. (iii) if at any time, any of the conditions referred to in sub-section (3) and sub-section (3A)] is not fulfilled: 
    4. Provided that before cancelling a Licence under clause (ii) or clause (iii) of this sub-section on the ground that the banking company has failed to comply with or has failed to fulfil any of the conditions referred to therein, the Reserve Bank, unless it is of opinion that the delay will be prejudicial to the interests of the company’s depositors or the public, shall grant to the company on such terms as it may specify, an opportunity of taking the necessary steps for complying with or fulfilling such condition. 
  6. (5) Any banking company aggrieved by the decision of the Reserve Bank cancelling a Licence under this section may, within thirty days from the date on which such decision is communicated to it, appeal to the Central Government. 
  7. (6) The decision of the Central Government where an appeal has been preferred to it under sub-section (5) or of the Reserve Bank where no such appeal has been preferred shall be final.

AK Rai Explanation-

As per S.22 RBI when it gives the Licence, it will look into,

The ability of the person or entity to honour present and future liabilities. 

They have to be tested on a stricter scale as liabilities are short term in nature.

Capital structure and Earning prospects

It will also look at the capital structure and earning prospects including types of shares issued and distributional patterns. 

Management is not prejudicial to the examiner/depositor

Someone who will harm the bank. Earlier banking business was done by big businessman. Banking many times was their side-business. It was natural that they cared more for their primary business. Gambler’s instinct-

Lending and Borrowing priorities

Affairs are not conducted in a manner detrimental to the interests of depositors

Banking Facility in Area

Banking Licence for 2 days were restricted. RBI came up with local area scheme. A bank can start with capital of 25 crores in 1-2 adjoining districts which do not have banking facility. 

Consolidation of banking system, interest of monetary policy and economic growth and public interest.

S.56(o)-Act to apply to co-operative societies subject to modifications 

Note:Now no one use the term ‘Bank’ etc without being a Bank 

A chequing facility (other than agricultural cooperatives) can be given only by a Bank. In other jurisdiction, other entities can also give chequing facilities.

2ND METHOD OF SUPERVISION: ‘NET OWNED FUND’

As per explanation given in Section 45-IA of the Reserve Bank of India Act, 1934, the Net Owned Fund (NOF) means:

  1. The aggregate of the paid-up equity capital and free reserves as disclosed in the latest balance sheet of the company after deducting therefrom
    1. accumulated balance of loss
    2. deferred revenue expenditure
    3. other intangible assets
  2. Further reduced by the amounts representing
    1. Investment of such company in shares of
      1. its subsidiaries
      2. companies in the same group
      3. all other Non-Banking Financial Companies; and
    2. The book value of debentures, bonds, outstanding loans and advances (including hire purchase and lease finance) made to, and deposits with
      1. subsidiaries of such company; and
      2. companies in the same group
  3. to the extent such amount exceeds ten percent of (1) above.[7]

Equity Capital: Common stock capital is an example of equity that a corporation obtains from owners and other parties. A company issues shares of common stock in exchange for cash. Each share conveys an ownership position in the company.[8]

S.45-IA Requirement of Registration and net owned fund. 

  1. Notwithstanding anything contained in this Chapter or in any other law for the time being in force, no non-banking financial company shall commence or carry on the business of a non-banking financial institution without– 
    1. (a) obtaining a certificate of registration issued under this Chapter; and 
    2. (b) Having the net owned fund of twenty-five lakh rupees or such other amount, not exceeding two hundred lakh rupees, as the Bank may, by notification in the Official Gazette, specify. 
  2. Every non-banking financial company shall make an application for registration to the Bank in such form as the Bank may specify: 
    1. Provided that a non-banking financial company in existence on the commencement of the Reserve Bank of India (Amendment) Act, 1997 shall make an application for registration to the Bank before the expiry of six months from such commencement and notwithstanding anything contained in sub-section (1) may continue to carry on the business of a non-banking financial institution until a certificate of registration is issued to it or rejection of application for registration is communicated to it. 
  3. Notwithstanding anything contained in sub-section (1), a non-banking financial company in existence on the commencement of the Reserve Bank of India (Amendment) Act, 1997 and having a net owned fund of less than twenty-five lakh rupees may, for the purpose of enabling such company to fulfil the requirement of the net owned fund, continue to carry on the business of a non-banking financial institution– 
    1. (i) for a period of three years from such commencement; or 
    2. (ii) for such further period as the Bank may, after recording the reasons in writing for so doing, extend, subject to the condition that such company shall, within three months of fulfilling the requirement of the net owned fund, inform the Bank about such fulfilment

3RD METHOD OF SUPERVISION: ‘RULE MAKING POWER’

It flows from S.21, 22, 35A and 36 of the Banking Regulations Act 1949

S.22 is wrt regard to when RBI issues licence. It can prescribe the conditions under which the Licence is given. Eg-Payment Banks cannot take deposits more than 1 lac. 

It gives directions to Banks wrt the terms of conditions of loans.

The Power extends to prescribing the interest rates that can be charged and the Broad Policy Framework. Rates should be linked to the cost of funds. 

The purpose for which loan has to be given-

Certain portion of the loan portfolio has to be for the social sector

Purpose has to be diverse. All loans cannot be issued for 1 sector of economy

Prohibition wrt certain purposes-

For the purposes of land, real estate, shares, etc

Margins-

If the Bank has taken security, what is the margin that security bears with the loan amount. 

For eg-If loan is of 100 Rupees then the security has to be of 200 rupees. 

Terms and conditions on which money can be given-

For Pre-Insolvency Process, it directs the Banks to enter into inter-creditor agreements. If the person concerned is going to be bankrupt then you have re-structure the loan. 

Maximum amount that can be lent-

It takes into account all financial exposure which a person has like-Loans, bank guarantees, letters of credits, etc to ensure that if the entity goes bankrupt, the bank does not go bankrupt. 

Present norm is-more than 15% of the capital cannot be lent to one entity. This is the global best practices. 

For Project Finance and all, the movement a loan is above a particular limit, then the bank cannot lent the loan on its own but banks have to form a consortium to lend (Syndicate Lending)

A person ability to manage one bank is not sufficient. 

These guidelines are binding upon the bank. 

These directions are directory and not mandatory. Though directory but binding

If the directory provisions are violated, the act does not become void. But if they are mandatory, they it becomes void or voidable. 

Eg-If RBI guidelines say you can’t lend above 12%. If a bank lent above that, it is void. The debtor has to immediately return back the loan. If it is directory, it can reprimand the Bank. 

S.35A-The power to give direction under this Section is wider than u/s 21 and 22. It can force the Bank to amend the AOA to given RBI the power to give approval. 

S.36-Prompt corrective actions flow from this. 

S.21: Power of Reserve Bank to control advances by banking companies 

  1. Where the Reserve Bank is satisfied that it is necessary or expedient in the public interest or in the interests of depositors or banking policy so to do, it may determine the policy in relation to advances to be followed by banking companies generally or by any banking company in particular, and when the policy has been so determined, all banking companies or the banking company concerned, as the case may be, shall be bound to follow the policy as so determined. 
  2. Without prejudice to the generality of the power vested in the Reserve Bank under sub-section (1) the Reserve Bank may give directions to banking companies, either generally or to any banking company or group of banking companies in particular, as to- 
    1. (a) the purposes for which advances may or may not be made, 
    2. (b) the margins to be maintained in respect of secured advances, 
    3. (c) the maximum amount of advances or other financial accommodation which, having regard to the paid-up capital, reserves and deposits of a banking company and other relevant considerations, may be made by that banking company to any one company, firm, association of persons or individual, 
    4. (d) the maximum amount up to which, having regard to the considerations referred to in clause (c),guarantees may be given by a banking company on behalf of any one company, firm, association of persons or individual, and 
    5. (e) the rate of interest and other terms and conditions on which advances or other financial accommodation may be made or guarantees may be given.] 
  3. Every banking company shall be bound to comply with any directions given to it under this section.

S.22 Licensing of banking companies 

  1. Save as hereinafter Provided, no company shall carry on banking business in India unless it holds a Licence issued in that behalf by the Reserve Bank and any such Licence may be issued subject of such conditions as the Reserve Bank may think fit to impose.
  2. Every banking company in existence on the commencement of this Act, before the expiry of six months from such commencement, and every other company before commencing banking business in India, shall apply in writing to the Reserve Bank for a Licence under this section: 
    1. Provided that in the case of a banking company in existence on the commencement of this Act, nothing in sub-section (1) shall be deemed to prohibit the company from carrying on banking business until it is granted a Licence in pursuance of 1[this section] or is by notice in writing informed by the Reserve Bank that a Licence cannot be granted to it: 
    2. Provided Further that the Reserve Bank shall not give a notice as aforesaid to a banking company in existence on the commencement of this Act before the expiry of the three years referred to in sub-section (1) of section 11 or of such further period as the Reserve Bank may under that sub- section think fit to allow. 
  3. Before granting any Licence under this section, the Reserve Banking may require to be satisfied by an inspection of the books of the company or otherwise that the following conditions are fulfilled, namely:- 
    1. (a) that the company is or will be in a position to pay its present or future depositors in full as their claims accrue; 
    2. (b) that the affairs of the company are not being, or are not likely to be, conducted in a manner detrimental to the interests of its present or future depositors;] 
    3. (c) that the general character of the proposed management of the company will not be prejudicial to the public interest or the interest of its depositors; 
    4. (d) that the company has adequate capital structure and earning prospects; 
    5. (e) that the public interest will be served by the grant of a Licence to the company to carry on banking business in India; 
    6. (f) that having regard to the banking facilities available in the proposed principal area of operations of the company, the potential scope for expansion of banks already in existence in the area and other relevant factors the grant of the Licence would not be prejudicial to the operation and consolidation of the banking system consistent with monetary stability and economic growth; 
    7. (g) any other condition, the fulfilment of which would, in the opinion of the Reserve Bank, be necessary to ensure that the carrying on of banking business in India by the company will not be prejudicial to the public interest or the interests of the depositors.] 
  4. (3A) Before granting any Licence under this section to a company incorporated outside India, the Reserve Bank may require to be satisfied by an inspection of the books of the company or otherwise that the conditions specified in sub- section (3) are fulfilled and that the carrying on of banking business by such company in India will be in the public interest and that the Government or law of the country in which it is incorporated does not discriminate in any way against banking companies registered in India and that the company complies with all the provisions of this Act applicable to banking companies incorporated outside India.
  5. (4) The Reserve Bank may cancel a Licence granted to a banking company under this section- 
    1. (i) if the company ceases to carry on banking business in India; or 
    2. (ii) if the company at any time fails to comply with any of the conditions imposed upon it under sub-section (1); or 
    3. (iii) if at any time, any of the conditions referred to in sub-section (3) 3[and sub-section (3A)] is not fulfilled: 
    4. Provided that before cancelling a Licence under clause (ii) or clause (iii) of this sub-section on the ground that the banking company has failed to comply with or has failed to fulfil any of the conditions referred to therein, the Reserve Bank, unless it is of opinion that the delay will be prejudicial to the interests of the company’s depositors or the public, shall grant to the company on such terms as it may specify, an opportunity of taking the necessary steps for complying with or fulfilling such condition. 
  6. (5) Any banking company aggrieved by the decision of the Reserve Bank cancelling a Licence under this section may, within thirty days from the date on which such decision is communicated to it, appeal to the Central Government. 
  7. (6) The decision of the Central Government where an appeal has been preferred to it under sub-section (5) or of the Reserve Bank where no such appeal has been preferred shall be final.

4TH METHOD OF SUPERVISION: ‘INSPECTION’

Provided for in S.35A of the Banking Regulation Act

S.35A: Inspection 

(1) Notwithstanding anything to the contrary contained in section 235 of the Companies Act, 1956 (1 of 1956)], the Reserve Bank at any time may, and on being directed so to do by the Central Government shall, cause an inspection to be made by one or more of its officers of any banking company and its books and accounts; and the Reserve Bank shall supply to the banking company a copy of its report on such inspection. 

(1A) (a) Notwithstanding anything to the contrary contained in any law for the time being in force and without prejudice to the provisions of sub-section (1), the Reserve Bank, at any time, may also cause a scrutiny to be made by any one or more of its officers, of the affairs of any banking company and its books and accounts; and 

(b) A copy of the report of the scrutiny shall be furnished to the banking company if the banking company makes a request for the same or if any adverse action is contemplated against the banking company on the basis of the scrutiny. 

(2) It shall be the duty of every Director or other officer or employee of the banking company to produce to any officer making an inspection under sub-section (1) or a scrutiny under sub-section (1A)] all such books, accounts and other documents in his custody or power and to furnish him with any statements and information relating to the affairs of the banking company as the said officer may require of him within such time as the said officer may specify. 

(3) Any person making an inspection under sub-section (1) for a scrutiny under sub-section (1A)] may examine on oath any Director or other officer or employee of the banking company in relation to its business, and may administer an oath accordingly. 

(4) The Reserve Bank shall, if it has been directed by the Central Government to cause an inspection to be made, and may, in any other case, report to the Central Government on any inspection or scrutiny made under this section, and the Central Government, if it is of opinion after considering the report that the affairs of the banking company are being conducted to the detriment of the interests of its depositors, may, after giving such opportunity to the banking company to make a representation in connection with the report as, in the opinion of the Central Government, seems reasonable, by order in writing- 

(a) prohibit the banking company from receiving fresh deposits; 

(b) Direct the Reserve Bank to apply under section 38 for the winding up of the banking company: 

Provided that the Central Government may defer, for such period as it may think fit, the passing of an order under this sub-section, or cancel or modify any such order, upon such terms and conditions as it may think fit to impose. 

(5) The Central Government may, after giving reasonable notice to the banking company, publish the report submitted by the Reserve Bank or such portion thereof as may appear necessary. 

Explanation: For the purpose of this section, the expression “banking company” shall include- 

(i) in the case of a banking company incorporated outside India, all its branches in India; and 

(ii) in the case of a banking company incorporated in India- 

(a) all its subsidiaries formed for the purpose of carrying on the business of banking exclusively outside India; and 

(b) all its branches whether situated in India or outside India.

(6) The powers exercisable by the Reserve Bank under this section in relation to regional rural banks may (without prejudice to the exercise of such powers by the Reserve Bank in relation to any regional rural bank whenever it considers necessary so to do) be exercised by the National Sank in relation to the regional rural banks, and accordingly, sub-sections (1) to (5) shall apply in relation to regional rural banks as if every reference therein to the Reserve Bank included also a reference to the National Bank.

S.36: Further powers and functions of Reserve Banks 

  1. The Reserve Bank may- 
    1. (a) caution or prohibit banking companies or any banking company in particular against entering into any particular transaction or class of transactions, and generally give advice to any banking company
    2. (b) on a request by the companies concerned and subject to the provision of section 44A, assist, as intermediary or otherwise, in proposals for the amalgamation of such banking companies; 
    3. (c) Give assistance to any banking company by means of the grant of a loan or advance to it under clause(3) of sub-section (1) of section 18 of the Reserve Bank of India Act, 1934 (2of 1934); 
    4. (d) at any time, if it is satisfied that in the public interest or in me interest of banking policy or for preventing the affairs of the banking company being conducted in a manner detrimental to the interests of the banking company or its depositors it is necessary so to do, by order in writing and on such terms and conditions as may be specified therein- 
      1. (i) require the banking company to call a meeting of its Directors for the purpose of considering any matter relating to or arising out of the affairs of the banking company; or require an officer of the banking company to discuss any such matter with an officer of the Reserve Bank; 
      2. (ii) depute one or more of its officers to which the proceedings at any meeting of the Board of Directors of the banking company or of any committee or of any other body constituted by it; require the banking company to give an opportunity to the officers so deputed to be heard at such meetings and also require such officers to send a report of such proceedings to the Reserve Bank; 
      3. (iii) Require the Board of Directors of the banking company or any committee or any other body constituted by it to give in writing to any officer specified by the Reserve Bank in this behalf at his usual address all notices of, and other communications relating to, any meeting of the Board, committee or other body constituted by it; 
      4. (iv) appoint one or more of its officers to observe the manner in which the affairs of the banking company or of its offices or branches are being conducted and make a report thereon; 
      5. (v) Require the banking company to make, within such time as may be specified in the order, such changes in the management as the Reserve Bank may consider necessary.
  2. The Reserve Bank shall make an annual report to the Central Government on the trend and progress of banking in the country, with particular reference to its activities under clause(2) of section 17 of the Reserve Bank of India Act, 1934 (2 of 1934), including in such report its suggestions, if any, for the strengthening of banking business throughout the country. 
  3. The Reserve Bank may appoint such staff at such places as it considers necessary for the scrutiny of the returns, statements and information furnished by banking companies under this Act, and generally to ensure the efficient performance of its functions under this Act

POWERS OF RBI OVER ADMINISTRATION OF BANKS

3 Limbs with regard to it

WRT CONTROLS OVER THE BANK

In S.21, RBI while give giving directions takes into account several factors wrt to Banking Company.

Licence has two Limbs

  1. The person who is going to be promoter of the company and 
  2. The company

The promoter should be a person who should be above board. 

SEBI requires that acquisition of 5% shares have to be notified to the stock exchange. It required prior permission of RBI. Subsequently in 2012, the act was amended and S.12B was added on request of RBI to give certain powers-that 5% or more transfer of shares will require prior permission of RBI. The person to whom the Licence has been given, he should not be able to exercise voting powers that overrides all other shareholders. No person can exercise voting power in excess of 10% which the RBI by regulation can increase to 25%. Currently it is 15%. 

Benami shares are not permitted here. In a normal company, you can have shares on trust basis. 

WRT CONTROL OVER THE MANAGEMENT

S.10A-Board of Directors to include persons with professional or other experience

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

S.10BB-Power of Reserve Bank to appoint Chairman of the Board of Directors appointed on a whole-time basis or a Managing Director of a banking company

S.12A-Election of new Directors

S.35B-Amendments of provisions relating to appointments of Managing Directors, etc., to be subject to previous approval of the Reserve Bank 

  1. In the case of a banking company- 
    1. (a) no amendment of any provision relating to the maximum permissible number of Directors or the appointment or re-appointment or termination of appointment or remuneration of a Chairman, a Managing Director or any other Director, whole-time or otherwise or of a manager or a chief executive officer by whatever name called, whether that provision be contained in the company’s memorandum or articles of association, or in an agreement entered into by it, or in any resolution passed by the company in general meeting or by its Board of Directors shall have effect unless approved by the Reserve Bank
    2. (b) No appointment or re-appointment or termination of appointment of a Chairman, a Managing or whole-time Director, manager or chief executive officer by whatever name called, shall have effect unless such appointment, re-appointment or termination of appointment is made with the previous approval of the Reserve Bank.
      1. Explanation.For the purpose of this sub-section, any provision conferring any benefit or providing any amenity or perquisite, in whatever form, whether during or after the termination of the term of office 6[of the Chairman or the manager] or the chief executive officer by whatever name called or the Managing Director, or any other Director, whole-time or otherwise, shall be deemed to be a provision relating to his remuneration.
  2. Nothing contained in sections 268 and 269, the proviso to sub-section (3) of section 309, sections 310 and 311, the proviso to section 387, and section 388  in so far as section 388 makes the provisions of sections 269, 310] and 311 apply in relation to the manager of a company of the Companies Act, 1956 (1 of 1956), shall 3[apply to any matter in respect of which the approval of the Reserve Bank has to be obtained under sub-section (1)]. 
  3. (2A) Nothing contained in section 198 of the Companies Act, 1956 (1 of 1956) shall apply to a banking company and the provisions of sub-section (1) of section 309 and of section 387 of that Act shall, in so far as they are applicable to a banking company, have effect as if no reference had been made in the said provisions to section 198 of that Act.
  4. No act done by a person as Chairman or a Managing or whole-time Director]or a Director not liable to retire by rotation or a manager or a chief executive officer by whatever name called, shall be deemed to be invalid on the ground that it is subsequently discovered that hisappointment or reappointment] had not taken effect by reason of any of the provisions of this Act; but nothing in this sub-section shall be construed as rendering valid any act done by such person after his appointment or reappointment] has been shown to the banking company not to have had effect

S.36(1)(d)-(1) The Reserve Bank may at any time, if it is satisfied that in the public interest or in me interest of banking policy or for preventing the affairs of the banking company being conducted in a manner detrimental to the interests of the banking company or its depositors it is necessary so to do, by order in writing and on such terms and conditions as may be specified therein- 

  1. require the banking company to call a meeting of its Directors for the purpose of considering any matter relating to or arising out of the affairs of the banking company; or require an officer of the banking company to discuss any such matter with an officer of the Reserve Bank; 
  2. depute one or more of its officers to which the proceedings at any meeting of the Board of Directors of the banking company or of any committee or of any other body constituted by it; require the banking company to give an opportunity to the officers so deputed to be heard at such meetings and also require such officers to send a report of such proceedings to the Reserve Bank; 
  3. require the Board of Directors of the banking company or any committee or any other body constituted by it to give in writing to any officer specified by the Reserve Bank in this behalf at his usual address all notices of, and other communications relating to, any meeting of the Board, committee or other body constituted by it; 
  4. appoint one or more of its officers to observe the manner in which the affairs of the banking company or of its offices or branches are being conducted and make a report thereon; 
  5. Require the banking company to make, within such time as may be specified in the order, such changes in the management as the Reserve Bank may consider necessary

S.36AA-Power of Reserve Bank to remove managerial and other persons from office 

  1. Where the Reserve Bank is satisfied that in the public interest or for preventing the affairs of a banking company being conducted in a manner detrimental to the interests of the depositors or for securing the proper management of any banking company it is necessary so to do, the Reserve Bank may, for reasons to be recorded in writing, by order, remove from office, with effect from such date as may be specified in the order, any Chairman, Director, chief executive officer(by whatever name called) or other officer or employee of the banking company. 
  2. No order under sub-section (1) shall be made unless the Chairman, Director or chief executive officer or other officer or employee concerned has been given a reasonable opportunity of making a representation to the Reserve Bank against the proposed order: 
    1. Provided that if, in the opinion of the Reserve Bank, any delay would be detrimental to the interests of the banking company or its depositors, the Reserve Bank may, at the time of giving the opportunity aforesaid or at any time thereafter, by order direct that, pending the consideration of the representation aforesaid, if any, the Chairman or, as the case may be, Director or chief executive officer or other officer or employee, shall not, with effect from the date of such order– 
      1. (a) act as such Chairman or Director or chief executive officer or other officer or employee of the banking company; 
      2. (b) in any way, whether directly or indirectly, be concerned with, or take part in the management of, the banking company. 
  3. (a) Any person against whom an order of removal has been made under sub-section (1) may, within thirty days from the date of communication to him of the order, prefer an appeal to the Central Government. 
    1. (b) The decision of the Central Government on such appeal, and subject thereto, the order made by the Reserve Bank under sub-section (I),shall be final and shall not be called into question in any court. 
  4. Where any order is made in respect of a Chairman, Director or chief executive officer or other officer or employee of a banking company under sub-section (1), he shall cease to be 2[a Chairman or, as the case may be, a Director,]chief executive officer or other officer or employee of the banking company and shall not, in any way, whether directly or indirectly, be concerned with, or take part in the management of, any banking company for such period not exceeding five years as may be specified in the order. 
  5. If any person in respect of whom an order is made by the Reserve Bank under sub-section (1) or under the proviso to sub-section (2) contravenes the provisions of this section, he shall be punishable with fine which may extend to two hundred and fifty rupees for each day during which such contravention continues. 
  6. Where an order under sub-section (1) has been made, the Reserve Bank may, by order in writing, appoint a suitable person in place of [the Chairman or Director], or chief executive officer or other officer or employee who has been removed from his office under that sub-section, with effect from such date as may be specified in the order. 
  7. Any person appointed as Chairman, Director or chief executive officer or other officer or employee under this section shall, – 
    1. (a) 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; 
    2. (b) Not Incur any obligation or liability by reason only of his being aChairman, Director or chief executive officer or other officer or employee or for anything done or omitted to be done in good faith in the execution of the duties of his office or in relation thereto. 
  8. Notwithstanding anything contained in any law or in any contract, memorandum or articles of association, on the removal of a person from office under this section, that person shall not be entitled to claim any compensation for the loss or termination of office

S.36AB-Power of Reserve Bank to appoint additional Directors 

  1. If the Reserve Bank is of opinion that in the interest of banking policy or in the public interest or] in the interests of the banking company or its depositors it is necessary so to do, it may, from time to time by order in writing, appoint, with effect from such date as may be specified in the order, one or more persons to hold office as additional Directors of the banking company: 
  2. Any person appointed as additional Director in pursuance of this section- 
    1. (a) shall hold office during the pleasure of the Reserve Bank and subject thereto for a period not exceeding three years or such further periods not exceeding three years at a time as the Reserve Bank may specify; 
    2. (b) shall not incur any obligation or liability by reason only of his being a Director or for anything done or omitted to be done in good faith in the execution of the duties of his office or in relation thereto; and 
    3. (c) shall not be required to hold qualification-shares in the banking company. 
  3. For the purpose of reckoning any proportion of the total number of Directors of the banking company, any additional Director appointed under this section shall not be taken into account

S.36ACA-Supersession of Board of Directors in certain cases 

  1. Where the Reserve Bank is satisfied, in consultation with the Central Government, that in the public interest or for preventing the affairs of any banking company being conducted in a manner detrimental to the interest of the depositors or any banking company or for securing the proper management of any banking company, it is necessary so to do, the Reserve Bank may, for reasons to be recorded in writing, by order, supersede the Board of Directors of such banking company for a period not exceeding six months as may be specified in the order: 
    1. Provided that the period of supersession of the Board of Directors may be extended from time to time, so, however, that the total period shall not exceed twelve months. 
  2. The Reserve Bank may, on supersession of the Board of Directors of the banking company under sub-section (1) appoint in consultation with the Central Government for such period as it may determine, an Administrator (not being an officer of the Central Government or a State Government) who has experience in law, finance, banking, economics or accountancy. 
  3. The Reserve Bank may issue such directions to the Administrator as it may deem appropriate and the Administrator shall be bound to follow such directions. 
  4. Upon making the order of supersession of the Board of Directors of a banking company, notwithstanding anything contained in the Companies Act, 1956(1 of 1956)-
    1. (a) the Chairman, Managing Director and other Directors shall, as from the date of supersession, vacate their offices as such; 
    2. (b) all the powers, functions and duties which may, by or under the provisions of the Companies Act, 1956(1 of 1956) or this Act, or any other law for the time being in force, be exercised and discharged by or on behalf of the Board of Directors of such banking company, or by a resolution passed in general meeting of such banking company, shall, until the Board of Directors of such banking company is reconstituted, be exercised and discharged by the Administrator appointed by the Reserve Bank under sub-section (2): 
      1. Provided that the power exercised by the Administrator shall be valid notwithstanding that such power is exercisable by a resolution passed in the general meeting of such banking company. 
  5. The Reserve Bank may constitute, in consultation with the Central Government, a committee of three or more persons who have experience in law, finance, banking, economics or accountancy to assist the Administrator in the discharge of his duties. 
  6. The committee shall meet at such times and places and observe such rules of procedure as may be specified by the Reserve Bank. 
  7. The salary and allowances to the Administrator and the members of the committee constituted under sub-section (5) by the Reserve Bank shall be such as may be specified by the Reserve Bank and be payable by the concerned banking company. 
  8. On and before the expiration of two months before the expiry of the period of supersession of the Board of Directors as specified in the order issued under sub-section (1), the Administrator of the banking company, shall call the general meeting of the company to elect new Directors and reconstitute its Board of Directors. 
  9. Notwithstanding anything contained in any other law or in any contract, the memorandum or articles of association, no person shall be entitled to claim any compensation for the loss or termination of his office. 
  10. (10)The Administrator appointed under sub-section (2) shall vacate office immediately after the Board of Directors of such banking company has been reconstituted

49C: Alteration of the Memorandum (MOA) of a Banking Company 

Notwithstanding anything contained in the Companies Act, 1956 (1 of 1956), no application for the confirmation of the alteration of the memorandum of a banking company shall be maintainable unless the Reserve Bank certifies that there is no objection to such alteration

AK Rai Explanations-

At least 51% of the Board should have competence and MD and Chairman shall be competent in Bankings and Economics.

The MD, Chairman and Directors shall not have any substantial interest in any company other than a S.25 Company, shall not be engaged in any other trade, vocation, business. Only Directors are permitted to have small scale business. Full time Chairman and MD cannot be Chairman and MD in any other company other than their own subsidiary company. 

RBI has the power to remove them. It can ask the co to remove such MD, Chairman and Directors who are not qualified. If the company does not follow, then it can on its own appoint. 

RBI can appoint the MD, Chairman in case there is vacancy in public interest. It can ask the co to appoint new Board of Directors. 

Any appointment reappointment, termination, alteration, remuneration, will require the prior approval of the RBI. 

Any change in the AoA or MoA of the co requires the prior approval of RBI u/s 49C. 

S.36(1)(d)-It gives RBI the power to ask the Board of Directors to consider an issue.

WRT TO POWER TO GRANT EXEMPTIONS

In certain areas, RBI can give exemptions to Banks wrt to certain prohibitions like-

Eg-Banks have been prohibited to created floating charge

S.20, S.20A-Prohibition of remuneration of Directors

S.19-Restriction on nature of subsidiary companies 

  1. A banking company shall not form any subsidiary company except a subsidiary company formed for one or more of the following purposes, namely:- 
    1. (a) the undertaking of any business which, under clauses (a) to (o) of sub-section (3) of section 6, is permissible for a banking company to undertake, or 
    2. (b) with the previous permission in writing of the Reserve Bank, the carrying on of the business of banking exclusively outside India, or 
    3. (c) the undertaking of such other business, which the Reserve Bank may, with the prior approval of the Central Government, consider to be conducive to the spread of banking in India or to be otherwise useful or necessary in the public interest. 
      1. Explanation. -For the purposes of section 8, a banking company shall not be deemed, by reason of its forming or having a subsidiary company, to be engaged indirectly in the business carried on by such subsidiary company.
  2. Save as Provided in sub-section (1), no banking company shall hold shares in any company, whether as pledgee, mortgagee or absolute owner, of an amount exceeding thirty per cent of the paid-up share capital of that company or thirty per cent of its own paid-up share capital and reserves, whichever is less: 
    1. Provided that any banking company which is on the date of the commencement of this Act holding any shares in contravention of the provisions of this sub-section shall not be liable to any penalty therefor if it reports the matter without delay to the Reserve Bank and if it brings its holding of shares into conformity with the said provisions within such period, not exceeding two years, as the Reserve Bank may think fit to allow. 
  3. Save as Provided in sub-section (1) and notwithstanding anything contained in sub-section (2), a banking company shall not, after the expiry of one year from the date of the commencement of this Act, hold shares, whether as pledgee, mortgagee or absolute owner, in any company in the management of which any Managing Director or manager of the banking company is in any manner concerned or interested. 
  4. Save as Provided in clause (c) of sub-section (1), a banking company may form a subsidiary company to carry on the business of credit information in accordance with the Credit Information Companies (Regulation) Act, 2005

REPORTING REQUIREMENT-SUPERVISION 

Preparation of Account-Account has to be prepared in accordance with BRA and Companies Act, and directions issued by RBI under 35A fo BRA.

NPA Recognition-

U/S 27 liability and asset account have to be submitted to RBI on a monthly basis

S.29-It has to prepare its accounts

S.29A-RBI can get the Bank submit not only its account but its associate enterprises. 

S.30-Audits

All the principles of Audit as per Companies Act are applicable. Appointment, removal requires the prior permission of RBI

RBI can order Special Audit at the cost of the Banking Company 

Auditor concerned will audit will as per the regulations of RBI

S.35-RBI can conduct an inspection of the Bank at the direction of the Central government.

DISCIPLINARY POWERS OF THE RBI

The person concerned is dependent on RBI for certain facilities. 

It has the power to cancel the Licence u/s 22(4) and 23(4). 

Penal Interest u/s 24(5)-if the Bank concerned does not maintain SLR

POWER TO IMPOSE FINE

S.46, S.47 and S.47A

Fine when Banks do not follow the provisions of the Act

S.46-Court can impose fine and imprisonment 

S.47-Courts cannot interfere except on advise of RBI

S.47A-RBI on its own can impose fine

PROHIBITION ON FRESH DEPOSITS

S.42(3A) of the RBI Act provides for prohibition on fresh deposit if the Bank does not maintain the Cash Reserve Ration. 

S.35(4)-

Every Bank is a kind of Poonzi Scheme as it is dependent on deposits 

POWER TO WIND-UP

Following sections of the Banking Regulations Act 1949 are pertinent in this regard 

S.37(4)-Suspension of business

S.38(1)(b)-Winding up by High Court

S.38(3)-Winding up by High Court

They give the power to RBI to initiate winding up procedure of the Bank for infringement of various sections. 

Because RBI is a specialised agency, Tribunals will take the help of RBI during the process. 

ACQUISITION OF BANK

S.36AE to AJ of the RRA 1949 deals with that if on an inspection of UOI, the Bank concerned has not followed directions u/s 21 and 35A, RBI at direction of UOI can initiate acquisition of the Bank.

S.45 provides for a compulsary reconstruction and re-amalgamation with another Bank. But that does not mean that depositors will necessarily be paid for. 

Credit Insurance Guarantee of India-though which deposits upto 1 lac are insured. This prevents a run on the bank by the small depositors.

RBI is the lender of the last resort

No one is willing to lend as they are afraid. DFHL and PMC Banks case. There is a bit of opaqueness about the accounts of a financial institution, people stop lending to each other. The financial institution will reserve some cash to pay its liabilities in times of need.

RBI is a Banker to the Central Govt.

Wrt to State Govt. it is a banker as per the agreement it has entered with them

In 1997 another role was given to RBI-regulator of NBFCs.

TYPES OF RISKS IN BANKING 

LIQUIDITY RISKS

It borrows short but lends long. So there is always a possibility of mis-match in liquidity. Anyone can withdraw the deposits at any time. Liquidity is the ability of a firm, company, or even an individual to pay its debts without suffering catastrophic losses. Conversely, liquidity risk stems from the lack of marketability of an investment that can’t be bought or sold quickly enough to prevent or minimize a loss.[7]

CREDIT RISKS

The money to whom you have lent is unable to return it as per the lending terms. Credit risk is the possibility of a loss resulting from a borrower’s failure to repay a loan or meet contractual obligations. Traditionally, it refers to the risk that a lender may not receive the owed principal and interest, which results in an interruption of cash flows and increased costs for collection.[8]

INTEREST RATE RISKS 

It comes as you money is lent at one rate at long term but you might be required to borrow at higher rate to remain solvent. In US, a saving and loan crisis happened 1980s. Saving and loan associations lent money for housing and mortgages purposes for 30 years at 6%. They borrowed at money at higher interest to pay their depositors. 

EXCHANGE RATE RISKS

When you have borrowed in one currency and lent in another currency. I have brought dollars at 65/- and lent it in Rupees. I will be paid back in Rupees but suppose dollar price increase to 75/-South-East Nation Crisis. The Banks borrowed Dollars and lent it in local currencies. When their currency depreciated, there was a crisis. 

SYSTEMIC RISKS 

The entire system is in crisis and the bank is in problem. All banks are interlinked. If one fails, all face problems. 

REPUTATION RISKS

Bank reputational risk is the risk of loss of reputation. Unlike other risks that banks have to manage credit, market, operational, liquidity, etc. Reputational risk is intangible and hard to measure. Reputational risk can cause damage to a bank’s brand and reputation.[9]

LEGAL RISKS 

Legal risk is the risk of loss to an institution which is primarily caused by: (a) a defective transaction; or (b) a claim (including a defence to a claim or a counterclaim) being made or some other event occurring which results in a liability for the institution or other loss.[10]

HOW TO DEAL WITH THE RISKS?

LIQUIDITY RISK

Follow the statutory dos and donts

The practices that bank follow to avoid the risks

Each bank has a risk management committee

S.36AD: Punishments for certain activities in relation to banking companies 

  1. No person shall-
    1. (a) obstruct any person from lawfully entering or leaving any office or place of business of a banking company or from carrying on any business there, or 
    2. (b) hold, within the office or place of business of any banking company, any demonstration which is violent or which prevents, or is calculated to prevent, the transaction of normal business by the banking company, or 
    3. (c) Act in any manner calculated to undermine the confidence of the depositors in the banking company. 
  2. Whoever contravenes any provision of sub-section (1) without any reasonable excuse shall be punishable with imprisonment for a term which may extend to six months, or with fine which may extend to one thousand rupees, or with both. 
  3. For the purposes of this section “Banking Company” includes the Reserve Bank, the Exim Bank, the Reconstruction Bank the National Housing Bank] the National Bank, the Small Industries Bank] the State Bank of India, a corresponding new bank, a regional rural bank and a subsidiary bank

S.9 of the Banking regulation Act prohibits investment in an immovable property. 

S.9 Disposal of non-banking assets 

Notwithstanding anything contained in section 6, no banking company shall hold any immovable property howsoever acquired, except such as is required for its own use, for any period exceeding seven years from the acquisition thereof or from the commencement of this Act, whichever is later or any extension of such period as in this section Provided, and such properly shall be disposed of within such period or extended period, as the case may be: 

Provided that the banking company may, within the period of seven years as aforesaid deal or trade in any such property for the purpose of facilitating the disposal thereof: 

Provided Further that the Reserve Bank may in any particular case extend the aforesaid period of seven years by such period not exceeding five years where it is satisfied that such extension would be in the interests of the depositors of the banking company

The Bank might have lent in a liquid form but seeks to return it in illiquid form. Where the assets are small, it is done through a process of securitisation. 

Loan Participation & Sub-Participation

LP-A loan participation is an instrument that allows multiple lenders to participate or share in the funding of a loan. The originating lender underwrites and closes the loan, and subsequently or sometimes simultaneously sells portions of the loan to other participants.[11]

In sub-participation you don’t have proprietary interest in the debt.

CREDIT RISKS

Banks don’t give loans for buying lands. 

Take adequate security before lending

The first security is the person itself

Second is the collateral security

Concerns

It should be adequate 

Volatility 

Insurance 

EXCHANGE & INTEREST RATE RISK

Interest Rate Risk

By not taking a long term deposit at high interest rate. 

The longer the duration the higher the interest rate but nowdays the 

Floating Rate Loans-Loans which are linked to a particular benchmark. 

Participation, sale, securitisation, etc

Swaps-I have taken a loan at 14% because I don’t have choice. Manas has got a loan at 9% plus RBI Repo rate. Swap means exchanging debts. Both will pay each other’s interest rates. Manas will agree to such an agreement under apprehension that floating interest rate may go high. Bank is the counter-party in between. 

Exchange Rate Risk 

When you lend in the currency in which you have borrowed.

S.25 of Banking Regulation Act-75% of a Banks deposit has to be Indian assets. 

Swaps are more common in foreign currency assets. 

MANAGEMENT RISK 

Following provisions of the BRA 1949 are relevant-

S.20-Restrictions on loans and advances
(1) Notwithstanding anything to the contrary contained in section 77 of the Companies Act, 1956 (1 of 1956), no banking company shall,- 

(a) grant any loans or advances on the security of its own shares, or- 

(b) enter into any commitment for granting any loan or advance to or on behalf of- 

(i) any of its Directors, 

(ii) any firm in which any of its Directors is interested as partner, manager, employee or guarantor, or 

(iii) any company [not being a subsidiary of the banking company or a company registered under section 25 of the Companies Act, 1956 (1 of 1956), or a Government company] of which 2[or the subsidiary or the holding company of which] any of the Directors of the banking company is a Director, Managing agent, manager, employee or guarantor or in which he holds substantial interest, or 

(iv) any individual in respect of whom any of its Directors is a partner or guarantor. 

(2) Where any loan or advance granted by a banking company is such that a commitment for granting it could not have been made if clause (b) of sub-section (1) had been in force on the date on which the loan or advance was made, or is granted by a banking company after the commencement of section 5 of the Banking Laws (Amendment) Act, 1968(58 of 1968), but in pursuance of a commitment entered into before such commencement, steps shall be taken to recover the amounts due to the banking company on account of the loan, or advance together with interest, if any, due thereon within the period stipulated at the time of the grant of the loan or advance, or where no such period has been stipulated, before the expiry of one year from the commencement of the said section 5: 

Provided that the Reserve Bank may, in any case, on an application in writing made to it by the banking company in this behalf, extend the period for the recovery of the loan or advance until such date, not being a date beyond the period of three years from the commencement of the said section 5, and subject to such terms and conditions, as the Reserve Bank may deem fit: 

Provided Further that this sub-section shall not apply if and when the Director concerned vacates the office of the Director of the banking company, whether by death, retirement, resignation or otherwise. 

(3) No loan or advance, referred to in sub-section (2), or any part thereof shall be remitted without the previous approval of the Reserve Bank, and any remission without such approval shall be void and of no effect. 

(4) Where any loan or advance referred to in sub-section (2), payable by any person, has not been repaid to the banking company within the period specified in that subsection, then, such person shall, if he is a Director of such banking company on the date of the expiry of the said period, be deemed to have vacated his office as such on the said date. 

Explanation.–In this section- 

(a) “loans or advance” shall not include any transaction which the Reserve Bank may, having regard to the nature of the transaction, the period within which, and the manner and circumstances in which, any amount due on account of the transaction is likely to be realised, the interest of the depositors and other relevant considerations, specify by general or special order as not being a loan or advance for the purpose of this section; 

(b) “Director” include a member of any board or committee in India constituted by a banking company for the purpose of Managing, or for the purpose of advising it in regard to the management of, all or any of its affairs. 

(5) If any question arises whether any transaction is a loan or advance for the purposes of this section, it shall be referred to the Reserve Bank, whose decision thereon shall be final.

S.20A-Restrictions on power to remit debts 

(1) Notwithstanding anything to the contrary contained in section 293 of the Companies Act, 1956 (1 of 1956), a banking company shall not, except with the prior approval of the Reserve Bank, remit in whole or in part any debt due to it by- 

(a) any of its Directors, or 

(b) any firm or company in which any of its Directors is interested as Director, partner, Managing agent or guarantor, or 

(c) any individual if any of its Directors is his partner or guarantor. 

(2) Any remission made in contravention of the provisions of sub-section (1) shall be void and of no effect.

Power of vote u/s 12-Regulation of paid-up capital, subscribed capital and authorised capital and voting rights of shareholders

S.12-Regulation of paid-up capital, subscribed capital and authorised capital and voting rights of shareholders

(1) No banking company shall carry on business in India, unless it satisfies the following conditions, namely:- 

(i) that the subscribed capital of the company is not less than one-half of the authorised capital, and the paid-up capital is not less than one-half of the subscribed capital and that, if the capital is increased, it complies with the conditions prescribed in this clause within such period not exceeding two years as the Reserve Bank may allow; 

(ii) that, notwithstanding anything contained in the Companies Act, 1956(1 of 1956), the capital of such banking company consists of– 

(a) equity shares only; or
(b) equity shares and preference shares: 

Provided that the issue of preference share shall be in accordance with the guidelines framed by the Reserve Bank specifying the class of preference shares, the extent of issue of each class of such preference shares (whether perpetual or irredeemable or redeemable), and the terms and conditions subject to which each class of preference shares may be issued: 

Provided further that no holder of the preference share, issued by the company, shall be entitled to exercise the voting right specified in clause (b) of sub-section (2) of section 87 of the Companies Act, 1956(1 of 1956);

(2) No person holding shares in a banking company shall, in respect of any shares held by him, exercise voting rights on poll in excess of ten per cent of the total voting rights of all the shareholders of the banking company

Provided that the Reserve Bank may increase, in a phased manner, such ceiling on voting rights from ten per cent. to twenty-six per cent.

(3) Notwithstanding anything contained in any law for the time being in force or in any contract or instrument no suit or other proceeding shall be maintained against any person registered as the holder of a share in a banking company on the ground that the title to the said share vests in a person other than the registered holder : 

Provided that nothing contained in this sub-section shall bar a suit or other proceeding- 

(a) by a transferee of the share on the ground that he has obtained from the registered holder a transfer of the share in accordance with any law relating to such transfer; or 

(b) on behalf of a minor or a lunatic on the ground that the registered holder holds the share on behalf of the minor or lunatic. 

(4) Every Chairman, Managing Director or chief executive officer by whatever name called of a banking company shall furnish to the Reserve Bank through that banking company returns containing full particulars of the extent and value of his holding of shares, whether directly or indirectly, in the banking company and of any change in the extent of such holding or any variation in the rights attaching thereto and such other information relating to those shares as the Reserve Bank may, by order, require and in such form and at such time as may be specified in the order.

S.16-Prohibition of common Directors 

S.10(A)(2)(b)-Board of Directors to include persons with professional or other experience 

Not less than fifty-one per cent, of the total number of members of the Board of Directors of a banking company shall consist of persons, who- 

shall not- 

(1) have substantial interest in, or be connected with, whether as employee, manager or Managing agent,- 

(i) any company, not being a company registered under section 25 of the Companies Act, 1956 (1 of 1956), or 

(ii) any firm, 

which carries on any trade, commerce or industry and which, in either case, is not a small-scale industrial concern.

S.10B(4)-Every Chairman who is appointed on a whole-time basis and every Managing Director of a banking company appointed under sub-section (1A)]shall be person who has special knowledge and practical experience of- 

  1. the working of a banking company, or of the State Bank of India or any subsidiary bank or a financial institution, or 
  2. financial, economic or business administration

S.10(1)(b)-Prohibition of employment of Managing agents and restrictions on certain forms of employment

No banking company shall employ or continue the employment of any person- 

(i) who is, or at any time has been, adjudicated insolvent, or has suspended payment or has compounded with his creditors, or who is, or has been, convicted by a criminal court of an offence involving moral turpitude; or 

(ii) whose remuneration or part of whose remuneration takes the form of commission or of a share in the profits of the company: 

Provided that nothing contained in this sub-clause shall apply to the payment by a banking company of- 

(a) any bonus in pursuance of a settlement or award arrived at or made under any law relating to industrial disputes or in accordance with any scheme framed by such banking company or in accordance with the usual practice prevailing in banking business; 

(b) any commission to any broker(including guarantee broker), cashier-contractor, clearing and forwarding agent, auctioneer or any other person, employed by the banking company under a contract otherwise than as a regular member of the staff of the company; or

(iii) whose remuneration is, in the opinion of the Reserve Bank, excessive; 

S.8-Prohibition of Trading

Notwithstanding anything contained in section 6 or in any contract, no banking company shall directly or indirectly deal in the buying or selling or bartering of goods, except in connection with the realisation of security given to or held by it, or engage in any trade, or buy, sell or barter goods for others otherwise than in connection with bills of exchange received for collection or negotiation or with such of its business as is referred to in clause (i) of sub-section (1) of section 6: 

Provided that this section shall not apply to any such business as is specified in pursuance of clause (o) of sub-section (1) of section 6.

Explanation: For the purposes of this section, Goods means every kind of movable 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. 

S.19-Restriction on nature of subsidiary companies 

(1) A banking company shall not form any subsidiary company except a subsidiary company formed for one or more of the following purposes, namely:- 

(a) the undertaking of any business which, under clauses (a) to (o) of sub-section (3) of section 6, is permissible for a banking company to undertake, or 

(b) with the previous permission in writing of the Reserve Bank, the carrying on of the business of banking exclusively outside India, or 

(c) the undertaking of such other business, which the Reserve Bank may, with the prior approval of the Central Government, consider to be conducive to the spread of banking in India or to be otherwise useful or necessary in the public interest. 

Explanation: For the purposes of section 8, a banking company shall not be deemed, by reason of its forming or having a subsidiary company, to be engaged indirectly in the business carried on by such subsidiary company.

(2) Save as Provided in sub-section (1), no banking company shall hold shares in any company, whether as pledgee, mortgagee or absolute owner, of an amount exceeding thirty per cent of the paid-up share capital of that company or thirty per cent of its own paid-up share capital and reserves, whichever is less: 

Provided that any banking company which is on the date of the commencement of this Act holding any shares in contravention of the provisions of this sub-section shall not be liable to any penalty therefor if it reports the matter without delay to the Reserve Bank and if it brings its holding of shares into conformity with the said provisions within such period, not exceeding two years, as the Reserve Bank may think fit to allow. 

(3) Save as Provided in sub-section (1) and notwithstanding anything contained in sub-section (2), a banking company shall not, after the expiry of one year from the date of the commencement of this Act, hold shares, whether as pledgee, mortagagee or absolute owner, in any company in the management of which any Managing Director or manager of the banking company is in any manner concerned or interested. 

2(4) Save as Provided in clause (c) of sub-section (1), a banking company may form a subsidiary company to carry on the business of credit information in accordance with the Credit Information Companies (Regulation) Act, 2005. 

REPUTATION RISK

S.36AD-Punishments for certain activities in relation to banking companies 

  1. No person shall 

(a) obstruct any person from lawfully entering or leaving any office or place of business of a banking company or from carrying on any business there, or 

(b) hold, within the office or place of business of any banking company, any demonstration which is violent or which prevents, or is calculated to prevent, the transaction of normal business by the banking company, or 

(c) act in any manner calculated to undermine the confidence of the depositors in the banking company. 

(2) Whoever contravenes any provision of sub-section (1) without any reasonable excuse shall be punishable with imprisonment for a term which may extend to six months, or with fine which may extend to one thousand rupees, or with both. 

(3) For the purposes of this section “Banking Company” includes the Reserve Bank, the Exim Bank, the Reconstruction Bank the National Housing Bank] the National Bank, the Small Industries Bank] the State Bank of India, a corresponding new bank, a regional rural bank and a subsidiary bank.

SYSTEMIC RISK

Cooperate with other banks. 

CREDIT

Roy Goode Legal Problem in Credit & Security (5 chapters)

(1-2) questions from this portion in form of short notes.

SECURITY 

Concept of Security

Two factors played a role in deciding whether something is security-

  1. Right of Redemption-
    1. If it is a security, then the terms which are inconsistent with it being a security will be ignored.
    2. Like once a mortgage always a mortgage, there cannot clog on equity of redemption. If there is, court will regard it as invalid. 
  2. A security should remain a security
    1. Subsequent to the Companies act coming into force, it has been made compulsary for a co to get its security registered. If unregistered, then it is invalid against any other creditor and it would also be invalid as against liquidator. 
    2. Co Act though does not use the term-good faith and without knowledge, etc, it will nonetheless invalid if unregistered

CLASSIFICATION OF SECURITIES

REAL AND PERSONAL SECURITY

Real security means that, on the basis of a creditor’s right against the debtor (principal debt), a creditor acquires a limited real right in the property of the debtor as security for the payment of the creditor’s right (principal debt) by the debtor. Real security differs from personal security in that a creditor does not acquire a limited real right in the property of the debtor in the case of personal security, but only acquires a creditor’s right against a third party as security for the payment of the principal debt by the debtor. Such a third party is normally surety of the debtor.[12]

Personal Security is basically a guarantee

TANGIBLE AND INTANGIBLE SECURITIES 

Tangible assets are physical; they include cash, inventory, vehicles, equipment, buildings and investments. Intangible assets do not exist in physical form and include things like accounts receivable, pre-paid expenses, and patents and goodwill.[13]

IPR is intangible security 

Giving up your contractual rights 

Creating a charge over the debt owed to it.

Goodwill can be a separate security of its own. (Kingfisher example)

POSSESSORY AND NON-POSSESSORY SECURITY 

In Possessory, the lender takes possession of the security. Eg-Pledge, Lein, Usufructuary Mortgage 

Its not very wise to take the possession of the security

SECURITY OVER EXISTING AND FUTURE PROPERTY 

Many a time the property comes into existence on the basis of loan given by a creditor. Eg-If someone wants to order a boiler or ship or aircraft, etc it will not be available on shelf but will come into existence in future.

FIXED AND FLOATING CHARGE

There is restriction on borrowers control over the security in fixed charge. Eg-a bus is a security. It is a fixed security as he cannot sell it or mortgage it. In case of floating charge, the creditor give freedom to the borrower to deal with the security

For instance, if I have business of footwear and I import and export footwear. If there is security created on those footwear, that will be a floating securing. 

Note: Charge is always an equity but security can be legal (registrable) or equitable.

TITLE TRANSFER AND CHARGE

In title charge, certain rights are transferred to someone. Something in the property is given to someone else. Title transfer does not necessarily means sale. Sale is just one method of title transfer.

Charge over an immovable charge is a legal charge. 

Two difference between charge and title transfer

  1. Charge is an equity. 
  2. It does not give right in the property but in relation to that property. 
  3. Mortgage is generally legal or might be equitable in certain circumstances. 

English Mortgage-Where the mortgagor binds himself to repay the mortgage money on a certain date and transfers the mortgaged property absolutely to the mortgagee but subject to a proviso that he will retransfer it to the mortgagor upon payment of the mortgage money. (legal service India)

LEGAL SECURITY AND EQUITABLE SECURITY 

Security can be legal or Equitable

Legal security is created by following all legal processes. Equitable security is where law regards it to be existing even though it has not been created by following the process of the law.In India, mortgage by deposit of titles is legal security but in UK it is equitable mortgage. In an equitable mortgage, the owner has to transfer his title deed to the lender, thereby creating a charge on the property. The owner also orally confirms the intent of creating a charge on the property. An equitable mortgage is also known as an implied or constructive mortgage. No legal procedure is involved in an equitable mortgage, but it is considered mortgage in the interest of justice (under equity). The borrower obtains money from the bank/lender with an agreement that his property, on which the equitable mortgage is created, will act as security for the loan. The borrower has to submit his title deed to the lender as security for the money borrowed.

All Charges are created in equity.

A security interest may be equitable for any one of the six reasons namely-

  1. It relates to a future property 
  2. There is no transfer or agreement to transfer at all but merely a charge 
  3. There is no present transfer, merely an agreement for transfer or declaration of trust by the debtor 
  4. Transfer is not made in accordance with legal requirements.
  5. Transfer is made not to the creditor but to a third party as a trustee for the creditor. 
  6. Transferor’s title to the asset is equitable and not legal.

SECURITY FOR FIXED AND CONTINUING INDEBTEDNESS

The moment you pay the debt, security comes to an end. But in certain cases like Bank overdraft facility, there is a revolving credit for which the security is not discharged merely because the debit balance is reduced to zero or the account goes into credit. (Roy Goode)

SECURITY FOR DEBTOR’S OBLIGATION AND SECURITY FOR THIRD PARTY INDEBTEDNESS 

A person may given an. Asset in security not only for his own indebtedness but also for that of a third party. For example-A without itself incurring any personal obligation may mortgage or charge its property to secure a debt due to the creditor from B. This is basically a kind of guarantee.

NATURE OF SECURITY INTEREST 

A SI is a right given to one party in the asset of another party to secure payment or performance by that other party or by a third party. A fixed or specific or consensual security interest possesses the following characteristics-

  1. It is a right given by the debtor to a creditor in an asset 
  2. The right is by way of grant of an interest in the debtor’s asset and not by way of reservation of title to the creditor.
  3. The right is given for a purposes of securing an obligation.
  4. The asset is given in security only and not by way of outright transfer and 
  5. The agreement restricts the debtors right to dispose of the asset free from the security interest. 

A debtor can give security over its own obligation so that a Bank can take a charge over its customer’s credit balance. (the BCCI case in the House of Lords) 

Swiss Bank v Lloyd Bank 

Held that a covenant by a borrower in a loan agreement to observe all exchange control requirements one of which was the proceeds of the borrower’s securities were to be applied in discharge of the loan did not create a security interest since the loan agreement did not require the loan to be paid out of the proceeds and the requirement was simply a stipulation by BOE when granting exchange control consent. 

INTENTION TO GIVE SECURITY 

The word security is very loosely used. When we took admission here, we gave a security deposit. For room rent, we give security deposit. But they are not security

4 necessary things wrt to Security

  1. Determination of Security 
  2. Conditions for Attachment 
  3. Perfection of Security
  4. Who gets priority 

Perfection of Security-Security interest in an asset (mortgaged as a collateral) protected from claims by other parties. A lien is perfected by registering it with appropriate statutory authority so that it is made legally enforceable and any subsequent claim on that asset is given a junior status. Also called perfected lien. (Business Dictionary)

Some other things-

  1. Fixed security is a right given by debtor to creditor in an asset
  2. Fixed security involves a Grant of an interest in the debtor’s asset and not reservation of title in them.
  3. Right is given for the purpose of securing an obligation
  4. Asset is given in security only and is not an outright transfer
  5. If it is fixed security then debtor’s ability to dispose it free from security interest is restricted 

Fixed security is right given by debtor to creditor in an asset

Eg-The money given as security in college, What is it? 

Escrow Agent-One who will act for both parties. (Gherulal Parekh Case) Money will be kept with the neutral person and he will return it to the one who will win the case. 

15/11/2019

Missing

Anumati v PNB

SC went by the assumption that chargebacks are valid. 

CONDITIONS OF REPAYMENTS

When one deposits money, it is with an understanding that he will be paid back. 

Method of financing group companies. 

I give my house on lease to a tenant with the condition that can extend the least every 5 years. It is not a sale but lease. There is equity of redemption of possession with the owner

Whether direction as to application of Proceeds is Security?

Palmer v Carey 

A lender financed a trader in goods, on the basis the proceeds of sale of the goods be paid into an account in the name of the lender, and that the lender recoup himself on a monthly basis in respect of sums advanced, with the balance being released to the trader subject to a right for the lender to retain a sum representing an agreed share of the trader’s profit. The trader subsequently became bankrupt. At the date of the bankruptcy, a substantial sum was owing to the lender in respect of sums advanced. The lender claimed security over goods and proceeds of sale that were still in the hands of the trader.

Held: The lender had no such security: ‘The law as to equitable assignment, as stated by Lord Truro in Rodick v Gandell, is this: ‘The extent of the principle to be deduced is that an agreement between a debtor and a creditor that the debt owing shall be paid out of a specific fund coming to the debtor, or an order given by a debtor to his creditor upon a person owing money or holding funds belonging to the giver of the order, directing such person to pay such funds to the creditor, will create a VALID EQUITABLE CHARGE UPON SUCH FUND, in other words, will operate as an equitable assignment of the debts or fund to which the order refers. An agreement for valuable consideration that a fund shall be applied in a particular way may found an injunction to restrain its application in another way. But if there be nothing more, such a stipulation will not amount to an equitable assignment. It is necessary to find, further, that an obligation has been imposed in favour of the creditor to pay the debt out of the fund. This is but an instance of the familiar doctrine of equity that a contract for valuable consideration to transfer or charge a subject matter passes a beneficial interest by way of property in that subject matter if the contract is one of which a Court of equity will decree specific performance. (Swarb)

In the cases discussed below, money was kept apart with the direction that it has to be applied in a particular way. 

Palmer v Cary

There was a seller of goods and he was financed in a way, that the he was given loans to buy good for resale. The price of the sale had to be deposited in a particular account from which the creditor would deduct the buying price, 1/3 of the Profits and then later on turn over the money to the reseller. The reseller after some expressed inability to sell the goods and handed them all to the financier for settling dues and later filed for bankruptcy. He was preferring one creditor over all other creditors which is known as fraudulent preference. Therefore the goods given to the financier got stuck in fraudulent transfer as such transfers are void. The goods were now owned by the Financier. Financier said that old arrangement between him and the reseller got revived. 

It was held that it was not a security but a mere arrangement as to how the financier would be paid off. (IMP)

Re Txu Europe (Pension Fund Case)

A company created pension fund for its senior executives and promised a defined pension. Later, the Pension fund became insufficient due to market fluctuations. To assuage the concern of executives, company decided to keep aside a certain sum of money for the pension. But it was not put in the pension fund. The co later became insolvent and went into a liquidation proceedings. What was the status of that particular money kept apart for the pension? There was an understanding bw the company and employees that this will be used in case there is deficit in the pension fund. It was held that there was no security over it. Since no security was provided over it, it was available to every creditor

Note: A having an arrangement with bank ‘A’ that it will pay certain monthly EMI to Bank B to settle a home loan he has taken from Bank ‘B’. This EMI is not security but only a contract or agreement to pay off the loan. Security would be something else for the Home loan.

Flightline Ltd v Edwards (Freezing Order)

The agency of a ticket booking agent was revoked. During a court mediated agreement, it was agreed that agency would be restored and the agent concerned deposited 4 million Pounds and it was agreed that his dues would be paid from that account and that in no case the amount in that account would fall below 3.5 million. The agent later went bankrupt. What was the status of the account? 

Held that the creditor of the company who had obtained a freezing order over assets could no longer claim that the order created security over those assets because a freezing order did not impose an obligation on the part of the respondent to satisfy any judgment debt out of those assets. (cms-law now)

Re:Coslet (reclamation of coal site)

The municipal corp called for the tender for the reclamation of coal bearing areas. Terms of the tender provided that in case the co would not take out its machinery before the reclamation of the site and in case the co went fails to do so, the municipal council would take possession of the machinery for reclamation and later sell the machinery to recover the cost. HL held that the first limb ie taking control of the machine for the purpose of reclamation was not a security. It was only a direction. The second limb ie selling the machinery to recover the cost was a security

Security interest created by grant and not by reservation of Title (Confirm)

In security, something is given by the owner concerned to the creditor. Ownership is the remainder of rights. Two methods of financing-

  1. The creditor buys the property and gives back to the debtor with the conditions that he repays the loan by earning from it. It is reservation of title and not a security.
  2. The creditor gives the loan for purchasing the vehicle and then the vehicle is hypothecated in favor if the creditor.

Romalpa Ltd v Aluminium Industries Ltd

A Dutch co gave aluminium strips to Romalpa. That the title in that strip was with the Dutch co. The Romalpa could deal with the strip-sell or resell it provided that the property in that strip would still be with the dutch co till the price has been paid off. Romalpa sometimes later went into liquidation and a few thousand Pounds were owed to the Dutch co. Few thousands tons supplied by the Dutch co to it was lying with it. How to treat this aluminum and some money lying with the Romalpa? It was a trust amount to be separated from other creditors. Court held that property rights never went to Romalpa. It could be regard as a security only if the property rights had passed to Romalpa. Romalpa was dealing with Bailee. The Dutch co has the rights to both. 

RESERVATION OF TITLE

Types of situation where there is reservation of Title?

  1. Hire Purchase
  2. If you sell it, I have right to the proceeds provided it is specified
  3. Mixing it with others is a problem. If Someone else has a right to Y then how do you deal with it. 
  4. One way out is, there should be a charge on it. 

Note:Reservation of title does not mean security

DOCTRINE OF SPEAFICATIO 

Specification occurs where new property rights are established as a result of some action upon an existing property that results in a change of species.

For example:-A marble is used for building a statute. A person who had title to the marble, should he have title over the statute if someone makes one mistakenly. The amount of labour changes the very nature of the marble. Therefore you cannot claim title over the statute. Right to the price of marble lies which in essence is an equitable charge

3&4 Conditions to be regarded as a security

The right is given for an obligation and asset is given in security only and not outright transfer. 

If it is given in transfer, then though might use the term security it would be regarded as a transfer. Court will look at the intention of parties. 

Siebe Gorman & Co Ltd v Barclays Ltd

Roughly 900 Pounds worth of BoE were assigned by Siebe Gorman as a security to Barclays. Barclays Bank collected the Bills. The amount of loan was higher than the amount due on the BoE. So Barclays Bank collected the money on BoE and then used it to set-it off the amount due from the assigner. The term used was ‘Security for the loan’ The company went bankrupt. The liquidator said that since the security was not registered, it was ineffective and asked the 900 Pounds BoE from the Bank. The parties must have intended it to be an outright transfer and not security

NOTE: Assignment is generally contradictory to security except in English Mortgage. 

ESSENCE OF SECURITY

When goods are given as a security, what is the essence of security?

  1. Right of redemption
  2. Who retains the Possession (generally the debtor retains the possession)
  3. Duty to pay the surplus value to the debtor. 
  4. Personal Liability (generally there is personal liability for deficit if the sale value falls below the debt)
  5. Price is fixed in advance.

You have a right to get them but have no duty to get them back. In normal mortgage, the person will ask the repayment of the loan. Here he will ask the enforcement of contract to buy. 

COMMON FUND

It is something where the money is deposited for being given out to one of the two parties. It is imputed with trust. It is not a security because you have beneficial interest in it which is not subject to redemption. Like an escrow agent?

Lowel Construction Ltd v Independent States PLC

Lowel Ltd was the building contractor and ISPLC was the employer or client. Money was to be deposited in advance in an Escrow account with money to be given to Lowel Construction on certificate of completion by architect and if there are some damages, it will be reduced accordingly.

What was the nature of this money? 

Liquidator challenged it as a security. 

It was imputed with trust in favor of the construction co. There was a vested right in it. Certain vested propriety rights if conditions are fulfilled. 

Fixed security implies a restraint over the debtors dominion 

If it is a co, not only has the restriction to be there, it has to be enforced 

TYPES OF SECURITY INTERESTS 

Four types of fixed securities (consensual)

Pledge (creditor has the possession) P

Lein (creditor has the possession) P

Charge (creditor has no possession) NP

Mortgage (creditor may or may not have the possession) 

All securities will come under either of those. Hypothecation is a charge. (creditor has no possession)

PLEDGE

Pledge is the transfer of possession over to the borrower. Pledge is only upon movables. It is on movables and tangible property. Pledge upon intangible is like creating a charge. (For eg-security rights in a co) Movables might be a reflection of ones right in something else. 

Negotiable Instruments can be pledges. It is a reflection of your right to money. It is not something which can be duplicated. Every other type of instrument can be pledged and also gives the right to be a duplicate. 

Eg-Railway receipts-They give you a right to be duplicated if they are lost. Other examples are bills of lading, shares and debenture certificates, FD receipts. But when you pledge it, mere possession does not give right of pledge. It has to be registered by the issuer of the receipts so no duplicate can be issued. 

If you give warehouse receipt to someone else, it is a pledge. It’s not an ideal pledge

SHARE WARRANTS

A Share Warrant is a document issued by the company under its common seal, stating that its bearer is entitled to the shares or stock specified therein. Share warrants are negotiable instruments. They are transferable by mere delivery without registration of transfer.[14]

Note:-There cannot be second pledge on the pledge by the Pledger. But the Pledgee can sub-pledge. 

CONTRACTUAL LEIN 

A lien is the right of a creditor in possession of goods, securities or any other assets belonging to the debtor to retain them until the debt is repaid, Provided that there is no contract express or implied, to the contrary. It is a right to retain possession of specific goods or securities or other movables of which the ownership vests in some other person and the possession can be retained till the owner discharges the debt or obligation to the possessor.[15

It gives you right to possession but not a sale. We are dealing here with consensual loan. 

Banker’s Lein

Banker’s lein is a type of pledge. A bankers’ lien on negotiable securities has been judicially defined as ‘an implied pledge’. A banker has, in the absence of agreement to the contrary, a lien on all bills received from a customer in the ordinary course of banking business in respect of any balance that may be due from such customer. (Chalmers on Bills of Exchange)

CHARGE (IMP)

A legal charge is a method by which a lender protects the money they have lent to an individual or company. It is a legal document signed by the borrower and which is registered against a property at the Land Registry so as to alert any potential buyer of the existence of the debt.[16]

It is a security which is created in equity. In charge, you don’t get possession. You can approach the court for the purpose of its sale if there is breach of loan conditions or security conditions get imperil.

Eg-Creating a charge over contractual rights against the builder concerned in case of a house loan. 

MORTGAGE

Typical mortgage is the English mortgage. It is a transfer of right/title in the property while charge is creation of right in the property. 

It is a transfer of ownership in the property and its reversion in case the debt is paid. It can be in every kind of property. Goods can be mortgaged, debt can be mortgaged, IP can be mortgaged. Any property right can be mortgaged. Court assumes EM in movable mortgage. 

Possession-usufructuary Mortgage 

Personal Liability-PL is there in English Mortgage

Ownership-In conditional mortgage, ownership is given. Ownership is transferred in EM and retransfer in case if debt is paid. 

In conditional mortgage and usufructuary Mortgage right of redemption is lost. There is no sale in case of default. Mortgagee becomes the owner of the property. Because there is no sale, there is no personal liability. 

WHAT IF DEBTOR MISAPPROPRIATES THE PROPERTY?

If the debtor has misappropriated the property, then what is the remedy which the creditor has?

Theoretically speaking, he/she has got the right to choose, follow the property or follow the money

If the property is fungible (money in bank account, wheat in godown)

If the property is not fungible but it losses it property 

There is lots of cost involved. A boiler which is affixed on ground cannot be removed without some destruction.

It is wrongdoers fault that he mixed his property with someone else’s property and if he ought to suffer. 

Johnes v D. Merchant (Fur-coat case)

The person concerned stole 17 beavers skins belonging to his wife, mixed it with his own beaver skins and brought a fur coat for his mistress. The court held that the fur-coat belongs to the wife and not the mistress.

WHAT IS TRACING? 

Tracing is a legal process, not a remedy, by which a claimant demonstrates what has happened to his/her property, identifies its proceeds and those persons who have handled or received them, and asks the court to award a proprietary remedy in respect of the property, or an asset substituted for the original property or its proceeds. Tracing allows transmission of legal claims from the original assets to either the proceeds of sale of the assets or new substituted assets.

This right is primarily based in equity. There has to be equitable relationship for this right to be claimed. 

Equity provided an ease of tracing. The thief who stole it held it for the purpose of the owner.

Foskett v McKeown (suicide case)

The HoL said that there is distinction between tracing and law in equity. The person had an investment advisory firm. That was supposed buy land for investors in Portugal. Instead of buying land, the business went into tailspin and he committed suicide. He had brought insurance policy for the benefit of his kids and mother (9:1) By the law an implied trust is created ie will be regarded as the property of the children and not an estate of the deceased. One Million Pounds was paid out of this insurance policy. Investigations revealed that some premiums of the insurance were paid out of the funds for the investors. Hence, the investors concerned wanted 40% of the insurance money. The court said held-Tracing is thus neither a claim nor a remedy. It is merely a process by which a claimant demonstrates what has happened to his property, identifies its proceeds and the persons who have handled or received them, and justifies his claim that the proceeds can properly be regarded as representing his property.

Another Example

Uncle stole money from trust and gave it to the nephew. He invested the money on a restaurant party. From the remaining amount, he brought a necklace for his wife. Necklace could not be taken back.

Re: Hallet Re Oatway

Facts: Mr Oatway was a trustee of a person’s will. He took £3000 of trust money and mixed it with £4000 of his own. He used £2137 from the fund to buy shares in a co and dissipated the rest. Then he died. The beneficiaries of the trust wished to trace their money into the £2475 that were the proceeds of the shares.

Held-That the beneficiaries could claim the proceeds of the shares. That a trustee cannot say the purchased assets were not bought with trust money.

What if the money is used for the purpose of paying of a debt?

It doesn’t mean the beneficiary becomes the creditor but if the debt was secured, principle of subrogation can be applied.

Boscowen v Bajwa (House sale)

The money 40K was advanced for buying a property. It was not to be given to the seller till the sale deed was executed. But the intermediary wrongly gave the money to the seller in advance who used the money to pay off his mortgage debt. Then someone got a judgement against Y and in execution proceedings seller’s house was sold. The question arose who has right to sale proceedings? It was held that the person who advanced the money

DEFENCES TO TRACING CLAIMS 

In most jurisdictions, there are several reasonably well establishing defences to tracing claims, although the case law is not entirely consistent. The common defences to an equitable tracing claim are:

  1. Good faith purchaser for value and without notice.
  2. Dissipation
  3. Discharge of a debt (such that the proceeds are no longer traceable and there is no substitute asset)
  4. Innocent change of position (usually, but not always, by an innocent third party

Importantly, in each case it is only the remedy of tracing that is lost. The claimant may well still enjoy a personal claim against the wrongdoer, even though they may have lost their proprietary right to trace into substituted assets.

ATTACHMENT OF SECURITY 

Rights of creditor against the debtor. It can be a right in rem. But till it is not attached, it is not right in rem.

Rules-

The statutory/legal formalities wrt security ought to be fulfilled

When the law prescribes a certain procedure to do an act, that has to be followed. Its not a directory but mandatory provision. 

Identifiability of the Subject Matter

Subject matter of the security need to be identified.

In SOGA property in goods passes after goods have been identified. 

If there 85 chairs, either you sell/secure all of them or identify the requisite no of them as is required.

Debtor should have an interest/power to dispose 

The person concerned should have the authority to create a security interest. 

There should be an obligation which subsists

The bank concerned take security in advance and then gives the loan 

In overdraft facility the person concerned, takes the loan and pays later. Credit card is an overdraft facility.

Monthly salary of a govt servant cannot be given as a security. 

If there is any contingency wrt the security, then they should be fulfilled.

A person can stand as a guarantor Provided the bank restructures the loan. 

In case of a pledge/contractual lein, possession needs to be transferred. 

Possession can be actual or constructive. 

AGREEMENT TO GIVE SECURITY 

Agreement to give a security may itself create a security if there are actual transfer. Its security is created in equity

Certain conditions have to be fulfilled-

It is an agreement to give security in present and not a mere contract. 

Re Bank of Credit and Commerce International 

An obligation by the employer under building contract to set aside a separate fund retention monies deducted from interim payments as provided in architects certificates does not make the contractor a secured creditor until the fund has in fact been established. (V. IMPORTANT)

Issue arose in Holroyd v Marshall 

It was wrt machinery where finance was given to buy a machinery. Depreciation can be very fast. 

In that case the House of Lords affirmed that under English law a person could grant a mortgage or other security interest over future property, ie. property that they did not actually own at the time of granting the charge. Prior to decision, the generally accepted principle under English law was that pursuant to the nemo dat rule it was impossible for a person to convey a security interest in property which they did not own at the time of granting the charge. 

Possession in case of an intangible property

Eg-Debt is an intangible right. How can it be possessed?

Dearle v Fall 

Provided an English common law rule to determine priority between competing equitable claims to the same asset. The rule broadly provides that where the equitable owner of an asset purports to dispose of his equitable interest on two or more occasions, and the equities are equal between claimants, the claimant who first notifies the trustee or legal owner of the asset shall have a first priority claim.

CONTRACTUAL SET-OFF
‘A’ deposits money with B-Bank under an agreement which empowers B-Bank to set off against its deposit liability, any claim it has against ‘A’ on any other account. Exercise of this contractual right of set-off will of course result in B-Bank being paid its claim up to the amount of the deposit. Is it a security in law? 

A right of set-off even if given by contract is a purely personal right to set-off one claim against another. The party assuring it never acquires rights in the other’s monetary claim at all; he merely asserts a countervailing claim which operates in pro-tango extinction of his monetary liability. It follows that a contractual set-off does not create a security interest

However the distinction between contractual security and set off has blurred lately 

Re Bank of Credit and Commerce International SA (no.8)

Held that there is no conceptual barrier to a person charging back to its creditor the obligation owed to it by that creditor.  

REGISTRATION OF SECURITY 

Registration will be required depending upon the type of the property.

Where there are multiple possessors or it has to be determined that from whom revenue is to come.  There can be multiple type of interests in a land. 

Registration where entity is an artificial entity

One has to maintain a register wrt to its assets, etc.

Issue-What is the date from which the notice is affected?

Earlier the standard was whenever the registration was done, it related back to the execution of the doc.

The date of effective registration is when 3rd parties are made aware of. 

Issue-What is the notice for?

Registration is a notice for only that which is required to be registered. Something which is not required to be registered, if filed, that is not notice wrt that detail. This issue crops up wrt to negative pledge clauses. Negative pledge is one over which there is no security. 

Imperial Bank v Bengal National Bank

IB took two floating charges over the house loans given by BNB. IB did not registered in land registry as it was difficult. Defendant bank went into liquidation and the liquidator denied its liability to pay to the imperial bank as it was not registered in land registry. 

A charge over an immovable property also requires registration. 

Registration is not perfection mechanism but notice to creditors

Under the SARFESI Act, there is a registration requirement for those who have been given the benefit of it. This is a security and not an ideal perfection mechanism. Through this creditor amongst themselves tell each other what they took as a security where there is no perfection mechanism or where the perfection mechanism is imperfect. 

People give security on the basis of deposit of title deeds to one bank. Some docs wrt the title still remains with them. They go to another bank and execute English mortgage. The second bank may loose in debt recovery as it has no priority over the first bank. Now, pledge and lein are also required to be registered. Earlier they were registered under the SARFESI Act. Non-registration does not mean that bank loses its priority in debt recovery. Though it could be penalised for that.

FLOATING CHARGE

What is floating charge?

A floating charge, also known as a floating lien, is a security interest or lien over a group of non-constant assets. The assets may change in quantity and value. Companies will use floating charges as a means of securing a loan. Typically, a loan might be secured by fixed assets such as property or equipment, but with a floating charge, the underlying assets are usually current assets or short-term assets that can change in value.[18]

Earlier it used to be that equity allowed a person to give mortgage undertaking. I have a factory which manufactures potato chips. I could create floating charge over individual limbs of the factory. I could mortgage the entire factory, godown, etc. 

In Graham v Chapman, court held that mortgaging of entire undertaking was not possible. 

So, some mechanism were to be found so business could raise money. 

So companies consolidation tried to bypass this decision by allowing the co to raise money by registering a charge over undertaking which become effective/attach on liquidating of undertaking or happening of a defined event. That’s how floating charges evolved. 

When a property is given in trust, trustee can deal with it in a manner as if it is his own but for the benefit of the beneficiary. If he misappropriates, the beneficiary can get him removed and replaced.  

In the case of a trust, trust is not only over the property given in trust but over all property that is generated out of the trust.

Holroyd v Marshal

Held that a trust property can come into existence in future but it should be well defined. Intention is necessary.

CAN THERE BE A CHARGE OVER PARTS OF A BUSINESS?

Re:Panama, NZ, Auz Royal Mail co

Such charges were held to be valid

Re: Yorkshire Woolcomber’s Association Ltd 

Court laid down the distinguishing qualities of a charge. 

Floating charge is a present security

There is no requirement of re-registration after it crystallises. Because it is a present security, you get certain rights wrt it. 

Eg-If I purchase a land through which a river passes, I get a right over the passing water but I don’t have right over the water that has passed my land. 

In case of insolvency of companies, secured creditors got paid first then preferential creditors and then unsecured creditors. After the amendment, floating charge holders were placed above unsecured creditors. 

It was argued that floating charge be made fixed charge. 

DIFFERENCE BETWEEN A FLOATING CHARGE AND A FIXED CHARGE

A floating security such as floating charge differs from a fixed security in that it relates not to a specific asset but to an identifiable funds of assets, the debtor being authorised by the terms of the security agreement to dispose of all of the assets comprising the fund free from the security interest (Roy Good)

There are two kinds of charge, fixed charge, and floating charge. The former is a charge on the real asset of the company that is IDENTIFIABLE, DEFINITE AND ASCERTAINED ASSET when the charge is created. Conversely, the latter is slightly different, which is created over the assets circulatory in nature, i.e. the charge is not attached to any definite property.[19]

The following are the major differences between fixed charge and floating charge:

  1. The charge that can be easily identified with a certain asset is known as Fixed Charge. The charge which is created on assets that changes periodically is Floating Charge.
  2. Fixed Charge is specific in nature. Unlike floating charge which is dynamic.
  3. Registration of movable assets is voluntary in the case of fixed charge. Conversely, when there is a floating charge, the registration is compulsory irrespective of the asset type.
  4. The fixed charge is a legal charge while the floating charge is an impartial one.
  5. Fixed Charge is given preference over floating charge.
  6. The fixed charge covers those assets that are specific, ascertainable and existing during the creation of the charge. On the other hand floating charge, covers present or future asset.
  7. When the asset is covered under fixed charge, the company cannot deal with the asset until and unless the charge holder agrees for so. However, in the case of floating charge the company can deal with the asset until the charge is converted to fixed charge.

4 cases-

Siebe Gorman & Co Ltd v Barkley’s Bank 

BB took a charge over the assets of the co. The charge was given the designation of fixed charge. As per the terms, the co did not have authority to deal with the receivables comprised in fixed charge. The money had to be put into a particular account with the bank. Account was not subject to charge and the co could deal with the money. Though account concerned was not subject to any charge but it could take money out of it to satisfy the debt. 

The court held that the entire structure was a fixed charge. Held that if book debts (Accounts receivables) were paid into a separate account, then a charge over them would be deemed to be fixed.

Re: Bright-Life 

A similar structure was there with the difference that the lender concerned was also a finance co and not a bank. There was no question of maintaining an account with it. Court held that it was a floating charge because money when recovered immediately disappears as the person concerned could do anything wrt it. 

Re: Bullas

Facts-New Bullas Trading Ltd granted a charge over book debts (Accounts receivable) in favour of 3i plc. It said that this was a fixed charge over the uncollected debts and a floating charge over their proceeds, which went into a designated bank account (or another one that 3i could specify in writing). 

Held, controversially, that it was possible to separate a book debt from its proceeds, and that it was possible to create a fixed charge over the book debt but only a floating charge over the proceeds.

Note: Book Debts or Accounts receivable are legally enforceable claims for payment held by a business for goods supplied and/or services rendered that customers/clients have ordered but not paid for. These are generally in the form of invoices raised by a business and delivered to the customer for payment within an agreed time frame.

Re: Spectrum Ltd

If the debtor allows the creditor to deal freely with the assets, it is a floating charge. 

Facts-Spectrum Plus Ltd carried on the business of a manufacturer of dyes, paints, pigments and other chemical products for the paint industry. Spectrum opened an overdraft facility, and made an agreement with, National Westminster Bank Plc (Natwest) that said it was granting a fixed charge, or in the words of the contract, a specific charge of all book debts and other debts now and from time to time due or owing to Spectrum to secure a £250,000 overdraft. Spectrum was prohibited from charging or assigning debts, and was required to pay the proceeds of collection into a Natwest account. But there were no restrictions on Spectrum’s operation of the account. Spectrum’s account was always overdrawn but it used the proceeds of the debts as and when it was necessary. When Spectrum went into liquidation, Natwest argued that the charge was a fixed charge over book debts and proceeds. The Inland Revenue, which was a major creditor, argued the debenture was merely a floating charge, so its claim for tax owed took priority over the bank under the Insolvency Act 1986 section 175.

Held-It was apparent that if the House of Lords decided in favour of the Inland Revenue, the expectations of a significant number of banks, who had relied on being able to have fixed charges and thus absolute priority in insolvency, would be defeated. Many people had assumed, or at least argued they had assumed that the law since Siebe Gorman & Co Ltd v Barclays Bank Ltd was that if book debts were paid into a separate account, then a charge over them would be deemed to be fixed. Accordingly, it was submitted that if the Lords were to overrule Siebe Gorman, they should only do so prospectively, and not retrospectively. Held that if the debtor allows the creditor to deal freely with the assets, it is a floating charge. 

HOW TO DIFFERENTIATE BETWEEN FLOATING AND FIXED CHARGE?

To be regarded as a FC, there ought to be a control exercised in realty. If control is not exercised in reality then it will be regarded as floating charge. Fixed may be regarded as floating but the reverse is not true. 

Generally fixed assets are susceptible to fixed charge. But floating can be also be created over fixed assets. A floating charge can also be created over a depleting pool. Jewellery in shop is subject to floating charge. 

Wrt current assets, there are floating charge but there can be fixed charge as well

CRYSTALLISATION OF FLOATING CHARGE INTO FIXED CHARGE 

Crystallization is the process by which a floating charge converts into a fixed charge. If a company fails to repay the loan or goes enters liquidation, the floating charge becomes crystallized or frozen into a fixed charge.With a fixed charge, the assets become fixed by the lender so the company cannot use the assets or sell them.[20]

Crystallization can also happen if a company ends operations or if the borrower and lender go to court and the court appoints a receiver. Once crystallized, the now-fixed rate security cannot be sold, and the lender may take possession of it.

CRYSTALLISATION BY OPERATION OF LAW

Where the floating charge crystallise, the debtor concerned should be able to deal with it as the running business requires it.

If the running business is not running business, then it ought to …

In the event of insolvency the charge will crystallise. (attached or fixed)

Where creditor by his own act or through court takes control over the charged properties. Charge is that the debtor concerned has freedom to deal with it. If the freedom to deal with the asset is taken away, there is Crystallisation

If the term of loan agreement, I have appointed a receiver, then the charge will come to an end. 

MORE THAN ONE FLOATING CHARGE ON SAME ASSETS 

This is not possible. There cannot be more than one floating charge on a same set of assets. 

Usually it will crystallise over all class of assets. 

EXCEPTIONS TO SECURITY 

MARSHALLING OF SECURITY  (S.81 TPA) 

Marshalling securities is the process of organizing, ranking, and distributing funds or resources in a manner put forward by law as being the most effective way to discharge debts that are owed to various creditors.

Marshalling of securities is generally applied when one claimant has two possible funds in the hands of a debtor to whom the claimant is able to resort to satisfy his/her demand. If the second claimant has an interest in only one of the funds, the second claimant can force the first to satisfy the claims out of the fund in which he/she, the second claimant, has no lien. In other words, when a person has two funds by which his/her debt is secured, and a creditor has a claim only on one of these funds, a court of equity will compel the creditor having a double security to resort to that fund which will leave the other creditor his/her security. This is also called marshalling assets.

Marshalling of securities takes place in favor of simple contract creditors, and of legatees, devisees and heirs, and in a few other cases, but not in favor of the next of kin.[21]

S.81 TPA Marshalling, securities

If the owner of two or more properties mortgages them to one person and then mortgages one or more of the properties to another person, the subsequent mortgagee is, in the absence of a contract to the contrary, entitled to have the prior mortgage-debt satisfied out of the property or properties not mortgaged to him, so far as the same will extend, but not so as to prejudice the rights of the prior mortgagee or of any other person who has for consideration acquired an interest in any of the properties.

S.79-Mortgage to secure uncertain amount when maximum is expressed

If a mortgage made to secure future advances, the performance of an engagement or the balance of a running account, expresses the maximum to be secured thereby, a subsequent mortgage of the same property shall, if made with notice of the prior mortgage, be postponed to the prior mortgage in respect of all advances or debits not exceeding the maximum, though made or allowed with notice of the subsequent mortgage. 

Illustration 

A mortgages Sultanpur to his bankers, B & Co., to secure the balance of his account with them to the extent of Rs.10,000. A then mortgages Sultanpur to C, to secure Rs.10,000, C having notice of the mortgage to B & Co., and C gives notice to B & Co. of the second mortgage. At the date of the second mortgage, the balance due to B & Co. does not exceed Rs. 5,000. B & Co. subsequently advance to A sums making the balance of the account against him exceed the sum of Rs.10,000. B & Co. is entitled, to the extent of Rs.10,000, to priority over C.

Bank Charge

The term bank charge covers all charges and fees made by a bank to their customers. In common parlance, the term often relates to charges in respect of personal current accounts or checking account monthly charges for the provision of an account. Charges for specific transactions (other than overdraft limit excesses). (Google)

INSOLVENCY AND BANKRUPTCY CODE 2013

Prior to 2013 Act, the priority rules in case of Insolvency were-

First was paid the fixed security (Pro-rata workman dues)

What they could recover due to payment to workmen was paid to them. 

S.123 of the Company Act

IBC applicable to every co except Banking co

A secured creditor has option to retain security all by himself but he can relinquish the security u/s 52. If he relinquishes then the order comes in-

Cost of the insolvency proceedings

Secured creditors and the workman dues 

Unsecured creditors 

S.69 and S.69A of TPA

When the mortgagee sell the property on his own. 

S.69-Power of sale when valid

(1) A mortgagee, or any person acting on his behalf, shall, subject to the provisions of this section have power to sell or concur in selling 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 and in no others, namely:-

(a) where the mortgage is an English mortgage, and neither the mortgagor nor the mortgagee is a Hindu, Muslim 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 8[was, on the date of the execution of the mortgage-deed], situate within the towns of Calcutta, Madras, Bombay, 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 five hundred rupees is in arrear and unpaid for three months after becoming due. 

(3) When a sale has been made in 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 damnified by an unauthorised or improper or irregular exercise or 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 Court under 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.

(5) Nothing in this section or in section 69A applies to powers conferred before the first day of July, 1882.

69A. Appointment of receiver

(1) A mortgagee having the right to exercise a power of sale under section 69 shall, subject to the provisions of sub-section (2), be entitled to appoint, by writing signed by him or on his behalf, a receiver of the income of the mortgaged property or any part thereof.

(2) Any person who has been named in the mortgage-deed and is willing and able to act as receiver may be appointed by the mortgagee. If no person has been so named, or if all persons named are unable or unwilling to act, or are dead, the mortgagee may appoint any person to whose appointment the mortgagor agrees; failing such agreement, the mortgagee shall be entitled to apply to the Court for the appointment of a receiver, and any person appointed by the Court shall be deemed to have been duly appointed by the mortgagee. A receiver may at any time be removed by writing signed by or on behalf of the mortgagee and the mortgagor, or by the court on application made by either party and on due cause shown. A vacancy in the office of receiver may be filled in accordance with the provisions of this sub-section.

(3) A receiver appointed under the powers conferred by this section shall be deemed to be the agent of the mortgagor; and the mortgagor shall be solely responsible for the receiver’s act or defaults, unless the mortgage-deed otherwise provides or unless such acts or defaults are due to the improper intervention of the mortgagee.

(4) The receiver shall have power to demand and recover all the income of which he is appointed receiver, by suit, execution or otherwise, in the name either of the mortgagor or of the mortgagee to the full extent of the interest which the mortgagor could dispose of, and to give valid receipts accordingly for the same, and to exercise any powers which may have been delegated to him by the mortgagee, in accordance with the provisions of this section.

(5) A person paying money to the receiver shall not be concerned to inquire if the appointment of the receiver was valid or not.

(6) The receiver shall be entitled to retain out of any money received by him, for his remuneration, and in satisfaction of all costs, charges and expenses incurred by him as receiver, a commission at such rate not exceeding five per cent, on the gross amount of all money received as is specified in his appointment, and, if no rate is so specified, then at the rate of five per cent. on that gross amount, or at such other rate as the court thinks fit to allow, on application made by him for that purpose.

(7) The receiver shall, if so directed in writing by the mortgagee, insure to the extent, if any, to which the mortgagee might have insured, and keep insured against loss or damage by fire, out of the money received by him, the mortgaged property or any part thereof being of an insurable nature.

(8) Subject to the provisions of this Act as to the application of insurance money, the receiver shall apply all money received by him as follows, namely:—

(i) in discharge of all rents, taxes, land revenue, rates and outgoings whatever affecting the mortgaged property;

(ii) in keeping down all annual sums or other payments, and the interest on all principal sums, having priority to the mortgage in right whereof he is receiver;

(iii) in payment of his commission, and of the premiums on fire, life or other insurances, if any, properly payable under the mortgage-deed or under this Act, and the cost of executing necessary or proper repairs directed in writing by the mortgagee;

(iv) in payment of the interest falling due under the mortgage;

(v) in or towards discharge of the principal money, if so directed in writing by the mortgagee, and shall pay the residue, of any, of the money received by him to the person who, but for the possession of the receiver, would have been entitled to receive the income of which he is appointed receiver, or who is otherwise entitled to the mortgaged property.

(9) The provisions of sub-section (1) apply only if and as far as a contrary intention is not expressed in the mortgage-deed; and the provisions of sub-sections (3) to (8) inclusive may be varied or extended by the mortgage-deed; and, as so varied or extended, shall, as far as may be, operate in like manner and with all the like incidents, effects and consequences, as if such variations or extensions were contained in the said sub-sections.

(10) Application may be made, without the institution of a suit, to the court for its opinion, advice or direction on any present question respecting the management or administration of the mortgaged property, other than questions of difficulty or importance not proper in the opinion of the court for summary disposal. A copy of such application shall be served upon, and the hearing thereof may be attended by, such of the persons interested in the application as the Court may think fit. The costs of every application under this sub-section shall be in the discretion of the Court.

(11) In this section, “the Court” means the Court which would have jurisdiction in a suit to enforce the mortgage.

SARFESI ACT 2002

The full form of SARFAESI Act as we know is Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. Banks utilize this act as an effective tool for bad loans (NPA) recovery. It is possible where non-performing assets are backed by securities charged to the Bank by way of hypothecation or mortgage or assignment.

Upon loan default, banks can seize the securities (except agricultural land) without intervention of the court.

The Act is EFFECTIVE ONLY FOR SECURED LOANS where bank can enforce the underlying security eg hypothecation, pledge and mortgages. In such cases, court intervention is not necessary, unless the security is invalid or fraudulent. However, if the asset in question is an unsecured asset, the bank would have to move the court to file civil case against the defaulters.

How does it work?

The Act gives powers of “seize and desist” to banks. Banks can give a notice in writing to the defaulting borrower requiring it to discharge its liabilities within 60 days. If the borrower fails to comply with the notice, the Bank may take the following measures:

  1. Take possession of the security for the loan
  2. Sale or lease or assign the right over the security
  3. Manage the same or appoint any person to manage the same

The Act also provides for the establishment of Asset Reconstruction Companies (ARCs) regulated by RBI to acquire assets from banks and financial institutions. The Act provides for sale of financial assets by banks and financial institutions to asset reconstruction companies (ARCs). RBI has issued guidelines to banks on the process to be followed for sales of financial assets to ARCs.

Background of the Act

The previous legislation enacted for recovery of the default loans was Recovery of Debts due to Banks and Financial institutions Act,1993 based on the recommendations of the Narasimham Committee I. This act had created the forums such as Debt Recovery Tribunals and Debt Recovery Appellate Tribunals for expeditious adjudication of disputes with regard to ever increasing non-recovered dues. However, there were several loopholes in the act and these loopholes were mis-used by the borrowers as well as the lawyers. This led to the government introspect the act and this another committee under Mr. Andhyarujina was appointed to examine banking sector reforms and consideration to changes in the legal system.

This committee recommended to enact a new legislation for the establishment of securitisation and reconstruction companies and to empower the banks and financial institutions to take possession of the Non performing assets.

Thus, via the Sarfaesi Act, for the first time, the secured creditors were empowered to recover their dues without the intervention of the court.

Constitutionality of the SARFESI Act

After the act was passed, its was challenged as unconstitutional in the court and this delayed its coming into force for 2 years. In the Mardia Chemicals v Union of India, the Supreme Court upheld the validity of the Act was upheld.

Rights of Borrowers

The above observations make it clear that the act was able to provide the effective measures to the secured creditors to recover their long standing dues from the Non performing assets, yet the rights of the borrowers could not be ignored, and have been duly incorporated in the law.

  1. The borrowers can at any time before the sale is concluded, remit the dues and avoid loosing the security.
  2. In case any illegal act is done by the Authorised Officer, he will be liable for penal consequences.
  3. The borrowers will be entitled to get compensation for such acts.
  4. For redressing the grievances, the borrowers can approach firstly the DRT and thereafter the DRAT in appeal. The limitation period is 45 days and 30 days respectively

Pre-conditions

The Act stipulates four conditions for enforcing the rights by a creditor.

  1. The debt is secured
  2. The debt has been classified as an NPA by the banks
  3. The outstanding dues are one lakh and above and more than 20% of the principal loan amount and interest there on.
  4. The security to be enforced is not an Agricultural land.

Methods of Recovery

According to this act, the registration and regulation of securitisation companies or reconstruction companies is done by RBI. These companies are authorized to raise funds by issuing security receipts to qualified institutional buyers (QIBs), empowering banks and Financial Institutions to take possession of securities given for financial assistance and sell or lease the same to take over management in the event of default.

This act makes provisions for two main methods of recovery of the NPAs as follows:

Securitisation: Securitisation is the process of issuing marketable securities backed by a pool of existing assets such as auto or home loans. After an asset is converted into a marketable security, it is sold. A securitization company or reconstruction company may raise funds from only the QIB (Qualified Institutional Buyers) by forming schemes for acquiring financial assets.

Asset Reconstruction: Enactment of this Act has given birth to the Asset Reconstruction Companies in India. It can be done by either proper management of the business of the borrower, or by taking over it or by selling a part or whole of the business or by rescheduling of payment of debts payable by the borrower enforcement of security interest in accordance with the provisions of this Act.

Further, the act provides Exemption from the registration of security receipt. This means that when the securitization company or reconstruction company issues receipts, the holder of the receipts is entitled to undivided interests in the financial assets and there is not need of registration unless and otherwise it is compulsory under the Registration Act 1908.

However, the registration of the security receipt is required in the following cases:

  1. There is a transfer of receipt
  2. The security receipt is creating, declaring, assigning, limiting, extinguishing any right title or interest in an immovable property.

Is Mortgaged House exempted? 

The Act covers any asset, movable or immovable, given as security whether by way of mortgage, hypothecation or creation of a security interest. There are some exceptions in the act such as personal belongings. However, only that property given as security can be proceeded under the provisions of Act. If the property of the borrower is his own mortgaged residential house, it is also NOT exempted from the Sarfaesi act.

Powers of Debt Recovery Tribunal

The debt Recovery Tribunals have been empowered to entertain appeals against the misuse of powers given to banks. Any person aggrieved, by any order made by the Debts Recovery Tribunal may go to the Appellate Tribunal within thirty days from the date of receipt of the order of Debts Recovery Tribunal.

Role of Chief Metropolitan Magistrate or District Magistrate

The Chief Metropolitan Magistrate or District Magistrate has been mandated to assist secured creditor in taking possession of secured asset. These officers will make sure that once the creditor has given him in writing that all other formalities of the act have been done, the CMM or DM will take possession of such asset and documents relating thereto; and forward such assets and documents to the secured creditor. Now, here, you have to note that such an act of the CMM or DM cannot be called in question in any court or before any authority.

Role of the High Court:

The act allows taking the matter to high courts only in some matters related to the implementation of the act in Jammu & Kashmir. However, High Courts have been entertaining writ petitions under article 226 (Power to issue writs) of the constitution of India.

Proposed amendments to the Act

The government had approved bill to amend the act. The Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Bill, 2011, amends two Acts — Sarfaesi Act 2002, and Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (DRT Act). Via these amendments:

  1. Banks and asset reconstruction companies (ARCs) will be allowed to convert any part of the debt of the defaulting company into equity. Such a conversion would imply that lenders or ARCs would tend to become an equity holder rather than being a creditor of the company.
  2. The amendments also allow banks to bid for any immovable property they have put out for auction themselves, if they do not receive any bids during the auction. In such a scenario, banks will be able to adjust the debt with the amount paid for this property. This enables the bank to secure the asset in part fulfillment of the defaulted loan.
  3. Banks can then sell this property to a new bidder at a later date to clear off the debt completely.

However lenders will be able to carry this property on their books only for seven years, as per the Banking Regulation Act, 1949.

2 major things wrt SARFESI ACT

It allowed the creation of Asset Reconstruction Companies and Securitisation Companies 

Enforcement of security interests 

Rationale behind the creation of ARCs

If ‘A’ owes B 10K and B allows A to pay 8K through debt reconstruction. A moral issue arise as to why other borrowers of 10K will pay 10K? 

Therefore the debt is sold to third party or ARC. 

ICCCI Bank v Someone 

SC held that the borrower cannot object to the lender transferring the debt. 

How ARC (Asset reconstruction company) operated?

It pays cash down but it is rare. 

It issues the creditor debentures. 

It issues security receipts to the creditor (when I recover I will give it to you)

Enforcement of Security 

This question  starts after an account has been declared to be non-performing asset. 

3 stages of an non-performing asset

Sub-Standard 

Where it is unpaid for one year to 3 years

It remains doubtful 

When the account turns NPA, it will give a notice to the borrower asking him 60 days to repay. 

If the amount is unpaid on 60th days the bank can take the security and appoint a manager to take care.

If the security is severable, it will be severed. 

After creditor has taken over the possession, borrower has 45 days to appeal  

BANKER-CUSTOMER RELATIONSHIP

When one becomes a customer?

Traditional and Modern concepts 

Implied contract 

Relationship is only with the concerned Branch of the Bank and not all branch 

Canara Bank v Canara Sales Corporation 

If you don’t contest the account statement given, then it will be deemed to be true. 

Tahing Case from HK

If you don’t contest the account statement given, then it will be deemed to be true. 

BANKS POWER TO COMBINE ACCOUNTS

It is a power inherent in the Bank irrespective of no of accounts at no of branches held at the Bank. The customer concerned expects the Bank to pay cheques from one account. Relationship is only with the concerned Branch of the Bank and not all branch. 

At any point of the time, it can combine the accounts to determine the worth of relationships. Banks have a right of Set-off. Present Insolvency Act does not allow set-off for corporate customers

Condition of Mutuality 

In order for the bank to combine accounts there must be mutuality, ie it must be the same customer and the same legal entity for the bank. However, accounts held at different branches of the same bank may still be combined. Although it has not been finally determined by case law, most commentators accept that accounts in different currencies may be combined, as may accounts in different countries (so long as the governing law in each country permits such combination).

Re:European and Agra Bank Claims 

Two Banks had gone insolvent. One account was a credit Balance. The liquidators wanted the credit account be not used in settling debit account. Court said it can be done as they are one account. 

Garnett v M’Kewan (different accounts)

The person concerned ran up a negative balance in one account then exercising overdraft facility disappeared. Then opened another account in another branch of the same Bank. Bank combined the accounts. Court said that despite different branches, there is one relationship between the Bank and the Customer. The Bank at any time can assess both accounts

Greenwood Teale v Williams Co

The managing partner was maintaining many accounts with the Bank-trust account, firm account, personal account, etc. Money in trust account was done away with and put in firm account. He has money due from personal account. The Bank combined the personal account with firm account. Bank didn’t know that it was subject to trust. Court allowed the combination but it laid down 3 exceptions to Bank’s ability to combine accounts

  1. If there is specific or implied contract to the contrary. 
  2. If circumstances change then the Bank concerned can combine account by giving notice. Changed Circumstances ie if the co is going insolvent.

Natwest Bank v Halesowen Ltd

Bank had agreed that it will not press the matter for four month and a new account was opened. But the company called a meeting of creditors and gave its property in trust. It is as good as declaring insolvency. Bank then combined the account. Court held it to be change in circumstances. It was finally determined that this was a type of set-off right rather than anything related to the banker’s lien (a separate common law right).

When there is implied contract to the contrary?

1st Exception-When accounts are opened in different jurisdictions

2nd Exception-If the accounts are in different currencies

3rd Exception-Where the money has been received for a specific purpose. 

4th Exception-In the case of a Trust Account 

Trust account includes account subject to charge.

If the Bank is not aware that it is a trust money, then Bank can combine.

Barclays Bank Ltd v Quist Close Investment Ltd 

QCI borrowed money for declaring dividend and deposited it in the Bank and the Bank knew of it. The co concerned went into liquidation later and the Bank was not allowed to combine. That money will go to the lender/creditor 

Union Bank of Auz v Murray 

Held that where the customer holds the money in the account as trustee and so is not beneficially entitled to it, it cannot be combined.

Daniels v Imperial Bank of Canada

Personal account balance can be used satisfy the Trust account. 

Firm JaiKishan Das Jindaram v CBI

Laid down that in case the money is due from a partnership firm, the account of the individual parter cannot be used to satisfy the debt of the partnership firm.

Charge has to be created with the Bank’s knowledge.

Right to Set-off

Right of Set-off (consolidation) can also be claimed if Bank knows that real owner of money owes it money. 

Bhogal v Punjab National Bank

Facts-It was regarding Benami accounts. 

Held-A banker was required to pay all cheques drawn by a customer in accordance with the mandate given to him if he had funds belonging to the customer, and he was not entitled without warning to refuse to honour a customer’s cheque, when there was money in his account to cover it, merely on the basis of a suspicion that the account was held by the customer as nominee for a third party who was indebted to bank.  Instead, clear and indisputable evidence was required that the customer held his account as a nominee or bare trustee for the third party before the bank could set off the credit in one account against the debit in another.  Accordingly, since the evidence did not clearly establish that the accounts of ASB and YB were nominee accounts, the bank could not raise a defence of equitable set-off in their actions. The bank’s appeals would therefore be dismissed.(Islamic Banker)

Uttamchandani v CBI

BANKS POWER TO EXERCISE LEIN

A banker’s lien is a legal right arise in many common law jurisdictions of a bank to exercise a lien over any property in the custody of the bank as security for the indebtedness of the customer to the bank. The precise effect of a banker’s lien varies according to the laws of a particular jurisdiction. Under English common law it applies to all property coming into the possession of the bank in the usual course of banking business, subject to the important exception that it does not apply to property which is deposited with the bank for safe custody. (WP)

Indian Contract Act permits Banker’s Lein 

Whatever is the ration of cases on Banker’s Lein, they are not final word

BL is by custom and if the custom changes, then Bank will be able to take benefit of the changed Custom though there might be precedent to the contrary. 

In essence it is an implied pledge

BL can be exercised by the Bank over anything that comes to it during the course of Banking business. Business that Banks normally do. It is not on money deposited in safe deposit vault. 

BL evolves. 

In relation to monetary instruments, bank may exercise BL such cheques deposited for collection, dividend liens, paper securities, receivables for collection.

Right of combination of account and BL are inter-related. 

When BL cannot be exercised?

Where there is specific contract to the contrary 

If I have given the property for a specific purpose, you cannot exercise BL

If there are 3rd party right wrt it (Trust, etc). The Bank should be made aware of that. 

Brandeo v Barnett 

Instrument concerned given for collection was in name of a 3rd party. Bank was allowed to exercise Lein on it as it was unaware that it belonged to a 3rd party.


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