TaxTMI 
TaxTMI 
1997 (3) TMI 457
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....h and Ms. Sunita Sharma for the appearing parties. JUDGMENT Kirpal, J.-These appeals, under section 10 of the Special Court (Trial of Offences Relating to Transactions in Securities) Act, 1992 ('the Special Court Act') arise from the judgment of the Special Court at Bombay which decided common questions of law relating to certain transactions of purchase of securities by the appellant-banks from some of the brokers to whom the Special Courts Act had been made applicable. 2. The appellant-banks had prior to 6-6-1992, entered into contracts with different brokers for the purchase and sale of certain securities which were not listed on any stock exchange. For the purpose of this case these contracts have been regarded as ready-forward transactions or buy-back transactions. The parties are agreed, and it is on this basis that the High Court also proceeded, that the nature of such a transaction is that it consists of two inter-connected legs, namely, the first or the ready leg, consisting of purchase or sale of certain securities at a specified price, and the second or forward leg, consisting of the sale or purchase of the same or similar securities at a latter date at a pri....
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....debenture stock, units of the Unit Trust of India or any other mutual fund or other marketable securities of a like nature in or of any incorporated company or other body corporate; (ii)Government securities; and (iii)rights or interests in securities;" 5. Section 3 of the said Act relates to appointment and functions of Custodian and reads as follows: "Appointment and functions of Custodians.-(1) The Central Government may appoint one or more Custodians as it may deem fit for the purposes of this Act. (2) The Custodian may, on being satisfied on information received that any person has been involved in any offence relating to transaction in securities after the 1st day of April, 1991 and on and before the 6th June, 1992, notify the name of such person in the Official Gazette. (3) Notwithstanding anything contained in the Code and any other law for the time being in force, on and from the date of notification under sub-section (2), any property, movable or immovable, or both, belonging to any person notified under that sub-section shall stand attached simultaneously with the issue of the notification. (4) The property attached under sub-section (3) shall be dealt with by the....
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....) of section 11 provides for the priorities in which the liabilities of the notified person are to be discharged from out of the attached properties. Considering that the Act has been passed because of the diversion of funds from the banks and financial institutions to the individual accounts of certain brokers, the implication of section 11(2)/(3) clearly is that after the discharge of the liabilities under section 11 (2)(a), the amounts which are paid to the banks would probably be those funds which were diverted from the banks by reason of malpractices in the security transactions. In other words, the losses caused to the banks and the financial institutions were to be made from out of the assets of the notified persons. 8. At this stage, it will be relevant to see as to what is the position of the Custodian. Section 4 gives the Custodian the power to cancel such contracts or agreements which have been entered into fraudulently. That apart, he is merely a Custodian of the properties of the notified persons which stand attached under the Act and such properties are to be dealt with by him in such manner as the Special Court may direct. The Act shows that the Custodian has thre....
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....Act, 1956. It was, therefore, contended that as the contracts were void those securities which had been sold to the appellants in the ready leg continued to be, in law, the properties of the notified persons on the date they were so notified and the same stood attached under section 3(3) of the Act. The applications required the Special Court to direct the appellant-banks to return the said securities. Similar applications were also filed, subsequently, by Shri Harshad Mehta, one of the notified parties, with whom such transactions had been entered into by some other appellant-banks. 10. Resisting the applications the appellant-banks had, inter alia, contend-ed that the transactions in question were not illegal and did not contravene the provisions of the Banking Regulation Act, and the circulars issued by the Reserve Bank of India (RBI) thereunder and nor were they contrary to the provisions of the Securities Contract (Regulation) Act, and the notification issued under section 16 thereof. It was further contended that in any case the contracts in question were severable and the illegality, if any, was attached only to the second leg and not to the first leg. The transfer of title....
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....the conclusion that the principles of in pari delicto did not come into play in the present case as the Custodian was not making any claim in the applications but was merely bringing to the attention of the Court the fact that third parties were in possession of properties which stood attached under the provisions of the Special Court Act. The fact that the Custodian had not exercised any power under section 4 of the Special Courts Act, in respect of these transactions, was also taken note of. 13. Having come to the conclusion that the contracts were void, the Court held that the claim of the banks for restitution will have to be dealt with as an ordinary claim against the property of a notified person at the stage of distribution under section 11. It accordingly directed the banks to return the securities to the Custodian. While giving this direction it further observed that if these securities had been transferred by the banks to third parties then no right could be created in their favour as the banks had no right to transfer them and, therefore, the banks should purchase the securities of the same value from the market and deliver the same to the Custodian. 14.The appellant-b....
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....n of this circular reads thus: "Buy-back arrangements in Government and other approved Securities entered into by commercial banks. Please refer to paragraph 10(a) of Governor's letter No. CPC.BC.84/279- A-87 dated 31st March, 1987. 2. It has been observed that banks often enter into buy-back arrangements in respect of Government and other approved Securities among themselves and with their large public sector and corporate clients. The banks are advised to follow the guidelines given hereunder in respect of their buy-back arrangements with banks and others. A. Prohibition against buy-back arrangements in respect of Corporate Securities and Bond issued by Public Sector Undertakings. Bank should not enter into buy-back arrangement in respect of their holdings of public sector bonds or corporate shares and debentures. B. Buy-back arrangements in Government and other Approved Securities with (non-bank) clients: (i)The buy-back deals should be exclusively confined to Government and other Approved Securities and the re-purchase date should be fixed after a minimum period 30 days from the date of sale of the securities in question. (ii)The purchase/sale prices under the arran....
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....]; or (aa)in the interest of banking policy; or] (b)to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company; or (c)to secure the proper management of any banking company gener-ally; It is necessary to issue directions to banking companies generally or to any banking company in particular it may, from time to time, issue such directions as it deems fit, and the banking companies or the banking company, as the case may be, shall be bound to comply with such directions." 20. There can obviously be no doubt, as is evident from the plain reading of the said provisions, that the directions issued under sections 21 and 35A are binding on the banking companies. Section 36(1)(a) and (1)(b), on which reliance is placed, reads thus: "Further powers and functions of Reserve Bank.-(1) The Reserve Bank may- (a) caution or prohibit banking companies generally or any banking company in particular against entering into any particular transac-tion or class of transactions, and generally give advice to any banking company; (b)on a request by the companies concern....
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....ulars, the contracts which were entered into between the banks and the third parties could not be invalidated and the only result of such contravention would be the levy of penalty under section 46 of the said Act. 23. It is not in dispute that the said circulars which have been issued were not made public. The said circulars were confidential documents and required the banking companies to transact their businesses in a parti- cular manner, namely, they should not enter into any buy-back contracts which were not according to the terms of the circulars. The Act itself does not provide that, where the directions issued by the confidential circulars are violated by the bank, the contracts entered into with the third parties would in any way be invalidated. The said circulars also, did not say that the consequence of the directions contained therein not being followed by the banking companies will result in such transaction being regarded as void. Indeed, no such stipulation could be made which would adversely affect third parties to whom no directions have been or could be issued and who were not aware of such directions issued to the banks. 24. It will be appropriate at this stage....
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....that a thing shall be done in a particular manner or form but does not itself set out the consequences of non-compliance the question whether the prescription of law shall be treated as mandatory or directory could only be solved by regarding the object, purpose and scope of that law. If the statute is found to be directory a penalty may be incurred for non-compliance but the act or thing done is regarded as good. It is unnecessary to multiply these cases which are based upon the statement in Maxwell which is quoted over and over again." (p. 1424) It will also be useful to refer to the decision of the High Court of Australia in the case of Yango Pastoral Co. (P.) Ltd. v. First Chicago Australia Ltd. [1978] 139 CLR 411 where Mason, J. made observations in this regard. That was a case where section 8 of the Banking Act, 1959 prohibited a body corporate from carrying on the business of banking without a licence. The question arose whether a mortgage and guarantees given to an unlicensed corporation in the course of carrying on business were void or unen-forceable. The High Court unanimously held that nothing in the statute made them void and that the separate question of illegal perf....
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....ts disclose that the plaintiff stands to gain by enforcement of rights gained through an illegal activity far more than the prescribed penalty. This circumstance might provide a sufficient foundation for attributing a different intention to the Legislature. It may be that the true basis of the principle is that the Court will refuse to enforce a transaction with a fraudulent or immoral purpose: Bereford v. Royal Insurance Co. Ltd. [1937] 2 K.B. 197 at p. 220. On this basis the common law principle of ex turpi causa can be given an operation consistent with, though subordinate to, the statutory intention, dying relief in those cases where a plaintiff may otherwise evade the real consequences of a breach of a statutory prohibition." [Emphasis supplied] (p. 428) The aforesaid principles will clearly be applicable in the present case as well. The non-compliance of the directions issued by the RBI may result in prosecution/or levy of penalty under section 46, but it cannot result in invalidation of any contract by the bank with the third party. If the contention of the Custodian is accepted it will result in invalidation of agreements by the banks, even where the third parties may not ....
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....r into any contract for the sale or purchase of securities other than such spot delivery contract or contract for cash or hand delivery or special delivery in any securities as is permissible under the said Act and the rules, bye-laws and regulations of a recognised stock exchange: Provided that a contract other than a spot delivery contract or contract for cash or hand delivery or special delivery in any securities on the Cleared Securities List of a recognised stock exchange may be entered into between its members or through or with any such member for the purpose of closing out or liquidating all existing contracts entered into up to the date of this notification and remaining to be performed after the said date, but such contract shall be subject to the rules, bye-laws and regulations of the recognised stock exchange that come into force when further new dealings are prohibited in any securities on the Cleared Securities List and subject also to such terms and conditions, if any, as the Central Government may from time to time impose." As a result of the aforesaid notification, except for sale or purchase of securities under a spot delivery contract or contract for cash or ha....
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....rward leg cannot affect the ready leg of the transaction. 31. Mr. Chagla, appearing for ANZ Grindlays Bank, while assuming that the ready-forward transaction was one composite transaction, submitted that the same was severable into two parts each of which had a separate consideration and a separate object. He submitted that provisions of section 57 of the Indian Contract Act were applicable to the present case and the first set of promises or the ready leg would constitute a binding contract while the second leg, namely, the forward leg would be void. In support of this contention reliance was placed on a decision of the Full Bench of the Nagpur High Court in Asaram v. Ludheshwar AIR 1938 Nag. 335. In that case a joint family was indebted to the defendants. It had proprietary share in land to which the provisions of the Central Provinces Tenancy Act applied. According to section 49 of the said Tenancy Act, alienation of 'sir' land, that is home farm land in cultivation, was ineffective unless the sanction of appropriate official had first been obtained. Section 49 postulated that if a proprietor lost his right to occupy any portion of the 'sir' land as a proprietor....
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....to this very class of cases in 27 N L R 113 at p. 115 and 22 N L R 136 at p. 141. As I have said the whole transaction in this case is not prohibited by statute; on the contrary, the part of it relating to the transfer of the proprietary rights is expressly allowed. Therefore under this rule since the considerations are separable that portion can, in my opinion, be enforced and it is only the surrender which is of no effect...." (p. 343) 32. Section 57 of the Indian Contract Act applies to cases where two sets of promises are distinct. When the void part of an agreement can be properly separated from the rest, the latter does not become invalid. The ready-forward transaction consists of two parts. In the ready leg there is a purchase or sale of securities at a stated price which is executed on payment of consideration for the spot delivery of the security certificates together with transfer forms. The full and absolute ownership of the title in securities vests in the purchaser, the entire property in the security passing immediately upon such delivery and payment. The seller is divested of all the rights, title and interests in the said securities. The forward leg is to be perfor....
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...., sell or pledge them. The repo merely imposes a contractual obligation to deliver identical securities on the settlement date set by the repo contract and then proceed to hold that the secured lender in a repo is free to deal the collateral". 34. In the present case also some of the banks which had purchased the securities had sold them. There was, at no point of time, any stipulation between the parties that the banks could not trade in the securities which have been purchased by them. The obligation to re-sell the securities to the notified person, in the forward leg of the agreement, could be fulfilled by the purchase by the appellants of the securities from the market and then to sell them to the notified persons, in order to complete the forward leg. The trading in the securities purchased by the banks in the ready leg was not in conflict with any law. The appellants were free to deal with them. This would show that with the first or the forward leg of the transaction being completed the banks had become the absolute owners of the said securities and they could deal with them in any manner in which they liked. There was nothing in the terms of ready-forward transaction which....
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.... "Their Lordships are of opinion that the gift is in fact unconditional, because, as it was complete at the time when the actual transfer took place the parties could not afterwards import a condition; and the petition must be treated as inefficacious for that purpose. But even if it were otherwise - assuming a condition, and an immoral condition - it would be the condition that is immoral and not the consideration; and then the case would fall under the general rule of law that a gift to which an immoral condition is attached remains a good gift, while the condition is void" [Emphasis supplied] In the case of a ready-forward contract the stipulation to re-transfer the securities, on a later date, can only be regarded as condition precedent and it is only this part or condition which will fail. 36. It is not possible to accept the contention of Mr. Setalvad that serving the agreements is into two parts would amount to re-writing or re- arranging the contract. We are here dealing with a case where there was one agreement, but which envisaged two sale transactions. Execution of each transaction envisaged the transfer of title in the securities. The valid part (the ready leg) of th....
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....orry from the respondent's possession without his consent and refused to return it. A suit was filed by the respondent/ plaintiff against the appellant/defendant for the return of the lorry or its value. While upholding the decision in favour of the respondent, the Privy Council observed as follows: "Although the transaction between the plaintiff and the defendant was illegal, nevertheless it was fully executed and carried out: and on that account it was effective to pass the property in the lorry to the plaintiff. There are many cases which show that when two person agree together in a conspiracy to effect a fraudulent or illegal purpose and one of them transfers property to the other in pursuance of the conspiracy then, so soon as the contract is executed and the fraudulent or illegal purpose is achieved, the property (be it absolute or special) which was been transferred by the one to the other remains vested in the transferee, notwithstanding its illegal origin: see Scarfe v. Morgan per Parke B. The reason is because the transferor, having fully achieved his unworthy end, cannot be allowed to turn round and repudiate the means by which he did it - he cannot throw over the ....
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.... KB in Scarfe v. Morgan (5) in a passage quoted by Hannen, J. in the course of the argument: 'if the [illegal] contract is executed, and a property either special or general has passed thereby, the property must remain'. The plaintiff, on the other hand, could not maintain his action without asserting and relying upon the unlawful agreement. He could not, to use the language of Mellor, J. in delivering the judgment of the Court, recover without showing the true character of the deposit; and that being upon an illegal consideration, to which he himself was a party, he was precluded from obtaining 'the assistance of the law' to recover it back." [Emphasis supplied] (p. 185) It would follow that if pursuant to an agreement to do an illegal act a transaction, in part, takes place which would otherwise be valid if there was no such prior agreement, then notwithstanding the illegality of the contract the said completed transaction itself cannot be regarded as invalid. 41. Tinsley v. Millingan [1993] 3 All. ER 65 was a case where the parties, who were living together, jointly purchased a house which was registered in the name of the appellant as the sole legal owner. Bot....
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....x facie the document or whether the illegality of purpose of what would otherwise be a lawful contract emerges during the course of the trial - see Holman v. Johnson [1775] 1 Cowp 341 at 343. [1775-1802] All. ER Rep 98 at 99, per Lord Mansfield, CJ., Pearce v. Brooks [1866] LR 1 Exch 213 at 217-218, [1861-73] All. ER Rep 102 at 103 per Pollock CB, Alexander v. Rayson [1936] 1 KB 169 at 182, [1935] All. ER Rep 185 at 191 and Bowmakers Ltd. v. Barnet Instruments Ltd. [1944] 2 All. ER 579 at 582 and [1945] KB 65 at 70. Second: it is well established that a party is not entitled to rely on his own fraud or illegality in order to assist a claim or rebut a presumption. Thus, when money or property has been transferred by a man to his wife or children for the purpose of defrauding creditors and the transferee resists his claim for recovery he cannot be heard to rely on his illegal purpose in order to rebut the presumption of advancement - see Gascoigne v. Gascoigne [1981] 1 KB 223 at 226, Chettiar v. Chettiar [1962] 1 All. ER 494 at 498, [1962] AC 294 at 302 and Tinker v. Tinker [1970] 1 All. ER 540 at 543, [1970] p. 136 at 143 per Salmon, LJ. Third: it has, however, for some years been....
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....f so, the rights of the owner of the legal title thereby acquired will be enforced, provided that the plaintiff can establish such title without pleading or leading evidence of the illegality. It is said that the property lies where it falls, even though legal title to the property was acquired as a result of the property passing under the illegal contract itself." [Emphasis supplied] (p. 185) Lord Browne Wilkinson then considered the decisions in the cases of Bowmakers Ltd. v. Barnet Instruments Ltd. [1944] 2 All. ER 579, Feret v. Hill [1854] 15 CB 207, Taylor v. Chester [1869] LR 4 QB 309 and Alexander's case (supra) and observed that: "From these authorities the following propositions emerge: (1)Property in chattels and land can pass under a contract which is illegal and therefore would have been unenforceable as a contract. (2)A plaintiff can at law enforce property rights so acquired provided that he does not need to rely on the illegal contract for any purpose other than provided the basis of his claim to a property rights. (3)It is irrelevant that the illegality of the underlying agreement was either pleaded or emerged in evidence: if the plaintiff has acquired lega....
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....itted that under the Indian Contract Act the entire contract was void. The original contract could not be legally entered into and the title in the securities did not, in law, pass, to the appellants. 44. While there can be no dispute that the transactions in question have to be viewed in the context of the law in this country but the decisions of the Courts in England, based on common law principles, have been applied and followed by the Courts in India. This will be evident from the fact that the decision in Sajan Singh's case (supra), which was approved by the House of Lords in Tinsley's case (supra), has been followed by this Court in Smt. Surasaibalini Debi v. Phanindra Mohan Majumdar [1965] 1 SCR 861. 45. In Smt. Surasaibalini Debi's case (supra), the respondent (the plaintiff) was employed at Calcutta in the Court of Wards and the service rules did not permit him to start or carry on any trade or business of his own. It was, therefore, arranged with one Rabinder Mohan Gupta (the defendant), who was the predecessor in interest of the appellant, that the defendant should be held out to be the owner of the suit property, which was a Boarding House, of which the pl....
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.... the illegal transaction and, for this reason, the appeal should be dismissed. While coming to this conclusion Iyyangar, J. extracted the above-quoted passage from the speech of Lord Denning in Sajan Singh's case (supra) and then observed as follows: "It would thus be seen that besides the claim based on his title to the lorry, the plaintiff had also established that while the chattel was in his possession, the defendant had unlawfully taken it away, with his consent. Insofar as his claim was based on this deprivation of possession, it was really an independent cause of action wholly separated from the original purchase of the lorry which was to circumvent the law, and as to this claim in detinue there was no question of its being tainted with any illegality. Besides this, Lords Denning himself pointed out that there were many cases which showed that where a transfer of property was effected in order to achieve an illegal purpose and that purpose was achieved, the plaintiff was disabled from recovering the property for the reason that the Court will not assist him in that endeavour." It was rightly submitted by Mr. Shanti Bhushan that the aforesaid principles, now well-settl....