TaxTMI 
TaxTMI 
2005 (9) TMI 303
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....lenged on several grounds, arguments before the court have been confined to the legislative competence of the State Legislature to enact the law. Counsel appearing on behalf of the petitioners and the State had fairly stated before the court that it would become necessary for the court to deal with the other challenges only in the event that this court does not accept the principal challenge on the ground of a want of legislative competence. We have come to the conclusion that the provisions of the Act are ultra vires for want of legislative competence in the State Legislature. FACTS 2. The petitioner in Writ Petition No. 5186 of 2001, was a whole time director of Pennar Paterson Securities Limited, a company incorporated under the Companies Act, 1956, with a registered office at Hyderabad. The company was a non-banking finance company and is stated to have advanced money to several companies. The company is stated to have sustained huge losses and on 24-11-1999, the High Court of Andhra Pradesh noted in the course of its order in a company petition that the company had outstanding debts of Rs. 13.07 crores on 30-9-1999. A provisional liquidator was appointed by the High Cour....
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....ender the services in kind, in return, as assured to the public. As such the deposits run into crores of rupees. It has resulted in great public resentment and uproar, creating law and order problem in the State of Maharashtra, specially in the city like Mumbai which is treated as the financial capital of India. It is, therefore, expedient to make a suitable special legislation in the public interest to curb the unscrupulous activities of such financial establishments in the State of Maharashtra." 4. Section 2(c) of the Act defines the expression "deposit" in the following terms : "(c) 'deposit' includes and shall be deemed always to have included any receipt of money or acceptance of any valuable commodity by any financial establishment to be returned after a specified period or otherwise, either in cash or in kind or in the form of a specified service with or without any benefit in the form of interest, bonus, profit or in any other form, but does not include- (i) amount raised by way of share capital or by way of debenture, bond or any other instrument covered under the guidelines given, and regulations made, by the SEBI, established under the Securities and....
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....of such financial establishment shall, on conviction, be punished with imprisonment for a term which may extend to six years and with fine which may extend to one lakh of rupees and such financial establishment also shall be liable for a fine which may extend to one lakh of rupees. Explanation.-For the purpose of this section, a financial establishment, which commits default in repayment of such deposit with such benefits in the form of interest, bonus, profit or in any other form as promised or fails to render any specified service promised against such deposit, or fails to render any specific service agreed against the deposit with an intention of causing wrongful gain to one person or wrongful loss to another person or commits such default due to its inability arising out of impracticable or commercially not viable promises made while accepting such deposit or arising out of deployment of money or assets acquired out of the deposits in such a manner as it involves inherent risk in recovering the same when needed shall, be deemed to have committed a default or failed to render the specific service, fraudulently." 7. Section 4 of the Act provides for the attachment of ....
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.... to apply within thirty days to the designated court under section 5(3) stating the grounds on which Government has issued an order under section 4; the money and property believed to have been acquired out of the deposit and the details of persons in whose name such property is believed to have been invested or acquired or of any other property attached under section 4 for further orders of the designated court. 9. Section 6 empowers the Government, with the concurrence of the Chief Justice of the Bombay High Court to constitute one or more designated courts in the cadre of a District and Sessions Judge for such area or areas or for such case or class or group of cases, as may be specified in the notification. Thereupon, under sub-section (2) of section 6, no court shall have jurisdiction in respect of any matter to which the provisions of the Act apply, and all pending cases stand transferred to the designated court. The powers of the designated court are set out in section 7 of the Act. Sub-section (1) of section 7 requires the designated court on receipt of an application to issue to the financial establishment or to any other person whose property is attached and vested in ....
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....winding up of trading corporations") and 44 ("incorporation, regulation and winding up of corporations with objects not confined to one State") of the Union List to the Seventh Schedule to the Constitution. It was submitted that the definition of the expression "financial establishment" in section 2(d) covers even non-banking financial companies and all other companies save and except for those which are controlled by the State Government and banking companies which fall within the purview of the Banking Regulation Act, 1949. It was submitted that under entry 93 of the Union List Parliament can enact legislation in respect of offences against laws with respect to any of the matters contained in List I. Entry 32 of the State List relates to the incorporation, regulation and winding up of corporations, other than those specified in List I, and hence the State Legislature is denuded of competence in respect of the incorporation, regulation and winding up of those corporations which fall within entries 43 and 44 of the Union List. In the exercise of its legislative power, Parliament has enacted the provisions of sections 58A, 58AA and 58AAA of the Companies Act, 1956 to regulate the re....
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....large scale on which small investors have been defrauded created a problem of law and order and the State Legislature was constrained to step in, having regard to the magnitude of the problem. The Legislature having taken cognizance of the public resentment that was caused by defaults in the repayment of deposits, it was submitted that the legislation was referable to entry 1 of List II. Hence, it was submitted that the legislation, in pith and substance, relates to public order and that the encroachment upon entries 43 and 44 of the Union List is only incidental. In the alternative, it was submitted that even if the court was of the view that the legislation was unconstitutional in its application to companies and NBFCs, the validity of the Act could be sustained in its application to individuals and unincorporated bodies. In sum and substance, therefore, the submission on the part of the State is that the Act was enacted to deal with and control fraudulent defaults in the repayment of deposits where far fetched schemes were floated by promoters with no possibility of a commercially viable venture that was capable of refunding deposits or of performing the services which were prom....
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....om the public.... Penal provisions have also been included. There is also a provision for the refund of the amount of deposits received by a company in violation of the requirements of the law." 16. Sub-section (1) of section 58A provides that the Central Government may, in consultation with the Reserve Bank of India, prescribe the limits up to which, the manner in which and the conditions subject to which deposits may be invited or accepted by a company either from the public or from its members. Sub-section (2) of section 58A contains a prohibition on companies inviting any deposit (i) save and except in accordance with the rules made by the Central Government in sub-section (1); (ii) unless an advertisement reflecting the financial position of the company has been issued in the prescribed form and manner; and (iii) unless there is no default by the company in the repayment of any deposit together with interest in accordance with the terms and conditions governing the deposit. Under clause (a) of sub-section (3) every deposit accepted by a company at the commencement of the Amending Act of 1974, in accordance with the directions of the Reserve Bank of India under Chapter III-B....
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.... make repayment of such deposit or part thereof forthwith or within such time and subject to such conditions as may be specified in the order : Provided that the Tribunal may, before making any order under this sub-section, give a reasonable opportunity of being heard to the company and the other persons interested in the matter. (10) Whoever fails to comply with any order made by the Tribunal under sub-section (9) shall be punishable with imprisonment which may extend to three years and shall also be liable to a fine of not less than rupees five hundred for every day during which such non-compliance continues." 19. The provisions of section 58A have been amended by Parliament in 1977, 1988, 1996, 1999, 2000 and in 2002 generally for incorporating provisions to make the law stringent. Clause 9 on the Notes on Clauses relating to the amendment of 1988 was, inter alia, as follows (see [1987] 62 Comp. Cas. (St.) 116) : "As a measure of protecting the interests of depositors, this clause provides for compulsory repayment of deposits unless renewed in the manner specified. It is intended to empower the Company Law Board to take cognizance of any case of non....
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.... section 58AA empowers the Company Law Board where a company has made a default in repayment of any deposit or part thereof or any interest thereupon to a small depositor, to exercise upon its own motion, the powers conferred by sub-section (9) of section 58A and to pass appropriate orders. A "small depositor" is defined by Explanation 2 to section 58AA as a depositor who has deposited in a financial year a sum not exceeding twenty thousand rupees in a company and to include his successors, nominees and legal representatives. Sub-section (9) of section 58AA creates an offence where there is a failure to comply with an order of the Company Law Board. The offence is punishable with imprisonment which may extend to three years and with a fine of not less than five hundred rupees for every day on which non-compliance continues. Every person who was a director of the company is deemed to be guilty of the offence under sub-section (10) of section 58AA. By virtue of the provisions of section 58AAA, every offence connected with or arising out of the acceptance of deposits under section 58A or section 58AA is deemed to be a cognizable offence under the Code of Criminal Procedure, 1973. T....
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....the power to prohibit under certain circumstances, as where the best or only efficacious regulation consists of suppression. It would, therefore, appear that the word 'regulation' cannot have any inflexible meaning as to exclude 'prohibition'. It has different shades of meaning and must take its colour from the context in which it is used having regard to the purpose and object of the legislation, and the court must necessarily keep in view the mischief which the Legislature seeks to remedy." 24. The law enacted by Parliament, incorporating the provisions of section 58A, is in pursuance of the comprehensive power that is conferred upon Parliament by article 246(1) read with entries 43 and 44 of List I to regulate corporations which fall within the scope and purview of the aforesaid entry. Section 58A(3A) mandates that every deposit accepted by a company must be repaid in accordance with the terms and conditions of the deposit. Sub-section (5) of section 58A creates a criminal offence where a company "omits or fails" to repay the deposit. The expression "omits or fails" is wide enough to cover every default, even a fraudulent default on the part of a company. Under clause (b) of ....
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.... fine is provided for an infraction under clause (b) of sub-section (5) of section 58A of the Central legislation. A fraudulent default within the meaning of section 3 of the State Act attracts a sentence of up to six years' imprisonment under the State Act and a fine which may extend to one lakh of rupees. The expression "financial establishment" in section 2(d) of the State legislation does not include a corporation or a co-operative society owned and controlled by the State or Central Government or a banking company. This analysis, therefore, makes it abundantly clear that there is a substantial overlapping between the sanctions which are imposed by the State Act with those which have been provided for in the Central legislation enacted in the form of sections 58A and 58AA of the Companies Act, 1956. The State Act goes on to make provisions in section 4 for the attachment of properties in the event of a failure to return a deposit on maturity or on demand or to pay interest or to provide a service that was promised against a deposit. Similarly, when the Government has reason to believe that a financial establishment is acting in a calculated manner detrimental to the interest of....
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....es or gifts or disbursing monies in any other way to persons from whom monies are collected and an institution which carries on as its principal business, agricultural operations, industrial activity, purchase or sale of goods or purchase, construction or sale of immovable property. Section 45JA empowers the Reserve Bank of India to determine policy or to issue directions to non-banking financial companies where the bank is satisfied that it is in the public interest to do so or to regulate the financial system or to prevent the affairs of an NBFC being conducted in a manner detrimental to the interest of the depositors or in a manner prejudicial to its own interest. Section 45MC(1)(d) empowers the Reserve Bank to file an application for winding up of an NBFC inter alia where it is unable to pay its debts or where its continuance is detrimental to the public interest or to the interest of the depositors. 27. Wide ranging provisions have been incorporated in Chapter III-B under which the Reserve Bank of India exercises regulatory powers over NBFCs. Section 45Q gives overriding force to Chapter III-B notwithstanding anything inconsistent therewith contained in any other law for th....
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....shed in the Explanation to section 45S. A violation of the provisions of section 45S is made punishable to sub-section (5A) of section 58B with imprisonment for a term which may extend to two years or with fine which may extend to twice the amount of deposit received or Rs. 2,000, whichever is more, or with both. C. Parliamentary legislative competence : 30. The provisions of Chapter III-C of the Reserve Bank of India Act, 1934 were challenged before the Delhi High Court, in Kanta Mehta's case (supra). A Division Bench consisting of Chief Justice Rajinder Singh and Mrs. Justice Leila Seth held that Parliament had legislative competence to enact the provisions of Chapter III-C. The Delhi High Court noted that the main business of the petitioners before the court was of accepting deposits, advancing monies to the public and to those in trade and industry. "Banking" in the Banking Regulation Act, 1949 is defined to mean the accepting of deposits for the purposes of lending or investigation of deposits of money from the public repayable on demand or otherwise and withdrawal by cheque, draft, order or otherwise. But for the absence of facilities to withdraw by cheque and drafts, t....
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....hus : "Therefore, we are in entire agreement with the Delhi High Court." [Emphasis supplied] (p. 212) 33. The Supreme Court affirmed the judgment of the Delhi High Court in Kanta Mehta's case (supra). The Delhi High Court had held that Chapter III-C of the Reserve Bank of India Act, 1934, was within the legislative competence of Parliament. Parliament being empowered to enact the law with reference to entry 45 of List I and, in any event entry 97. The Supreme Court held that it was in entire agreement with the Delhi High Court. Public order : Construing entry 1 List II : 34. Counsel appearing on behalf of the State Government has submitted that the law in question is within the competence of the State Legislature since it is relatable to public order within the meaning of entry 1 of List II of the Seventh Schedule. Entry 1 of the State List is in the following terms : "1. Public order (but not including the use of any naval, military or air force or any other armed force of the Union or of any other force subject to the control of the Union or of any contingent or unit thereof in air of the civil power." 35. On behalf of the petitioners extensive relia....
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....nd tranquility : it is the absence of disorder involving breaches of local significance in contradistinction to national upheavals, such as revolution, civil strife, war affecting the security of the State" (para 18 page 641). In Ram Manohar Lohia v. State of Bihar AIR 1966 SC 740, where the validity of an order of detention under the Defence of India Act, 1962 was questioned, Mr. Justice M. Hidayatullah (as the learned Chief Justice then was) elucidated the important distinction in cases where public order is a legislative head as contra distinguished from those cases where a restriction on personal liberty is sought to be imposed on the ground of public order. The judgments in Lakhi Narayan Das's case (supra), Romesh Thappar's case (supra) and the later judgment in Brij Bhushan v. State of Delhi AIR 1950 SC 129, were cited before the court. In Brij Bhushan's case (supra), Mr. Justice Fazl Ali held that "public order" was wide enough to cover small disturbances of the peace which do not jeopardise the security of the State and the learned judge paraphrased the words "public order" as "public tranquility". In the judgment in Ram Manohar Lohia's case (supra), Mr. Justice Hidayatulla....
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....must be based on the true nature and character of the legislation. For, as the Federal Court held in Lakhi Narayan Das's case (supra): "To ascertain the class to which a particular enactment really belongs, we are to look to the primary matter dealt with by it, its subject-matter and essential legislative feature. Once the true nature and character of a legislation determine its place in a particular list, the fact that it deals incidentally with matters appertaining to other lists is immaterial." Pith and substance : 39. Article 246(1) confers upon Parliament the exclusive power to make laws with respect to any of the matters enumerated in List I of the Seventh Schedule, notwithstanding anything in clauses (2) and (3). Similarly, under clause (2) of article 246, Parliament and, subject to clause (1), the Legislature of the State have power to make laws with respect to any of the matters enumerated in List III, notwithstanding anything in clause (3). The power of the Legislature of the State is to make laws for such State with respect to any of the matters in List II subject to clauses (1) and (2) of article 246 of the Constitution. 40. The entries which are conta....
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....lls, the theory of "pith and substance" has been evolved. These principles were reiterated by a Bench of seven learned judges in Synthe-tics and Chemicals Ltd. v. State of U. P. AIR 1990 SC 1927. The Supreme Court held that the Constitution must not be construed in a narrow or pedantic sense and that construction which is most beneficial to the widest possible amplitude of its power, must be adopted. If there is a conflict between the entries, the first principle is to reconcile them. But if this was not possible, the power of the Union will prevail since the words "notwithstanding" and "subject to" are important and give primacy to the central legislative power. These principles have been reiterated in a recent judgment of the Supreme Court in Prof. Yashpal v. State of Chhattisgarh [2005] 5 SCC 420. 41. The doctrine of pith and substance has an interesting origin. Latham, C.J. while speaking for the High Court of Australia in Bank of New South Wales v. Commonwealth [1947-48] Commonwealth Law Reports, vol. 76, p. 184, traced the origin of the doctrine from "pith and marrow" in patent law. The learned judge noted thus : "... the phrase 'pith and substance' ... is a metap....
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....court to realise the assets and distribute the proceeds equitably among depositors and section 8 provides for the attachment of property of mala fide transferees. None of these provisions would demonstrate that the pith and substance of the Act is in relation to public order. On the contrary, the substance of the Act is to deal with cases involving a fraudulent failure on the part of financial establishments to repay depositors and to secure the repayment to depositors of their deposits by the attachment of properties, avoidance of mala fide transfers, the realisation of the attached assets and by equitable distribution between depositors. The Act creates offences and provides for punishment of those offences in section 3. The law enacted by the State Legislature is essentially a law which defines an offence with reference to a fraudulent default in the repayment of deposits. The law cannot, in pith and substance, be read and regarded as a law with reference to public order. 45. Two decisions of the Supreme Court elaborate upon the genesis and content of a law relating to public order. In State of Rajasthan v. G. Chawla AIR 1959 SC 544, the Supreme Court dealt with the Ajmer (So....
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.... " 24. The expression 'public order' is of wide connotation. It must have the connotation which it is meant to provide as the very first entry in List II. It has been held by this court in Romesh Thappar v. State of Madras that 'public order' is an expression of wide connotation and signifies state of tranquility which prevails among the members of a political society as a result of internal regulations enforced by the Government which they have established. 25. Reference may also be made to the decision in Ramji Lal Modi v. State of U.P. AIR 1957 SC 620 where this court has held that the right of freedom of religion guaranteed by articles 25 and 26 of the Constitution is expressly made subject to public order, morality and health, and that it cannot be predicated that freedom of religion can have no bearing whatever on the maintenance of public order or that a law creating an offence relating to religion cannot under any circumstances be said to have been enacted in the interests of public order. It has been held that these two articles in terms contemplate that restrictions may be imposed on the rights guaranteed by them in the interests of public order. Ref....
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....on enacted by Parliament in the form of Chapter III-C of the Reserve Bank of India Act, 1934 has similarly been upheld as having been enacted with respect to the legislative heads contained in entry 45 of List I or, at any rate, under entry 97. 47. Counsel appearing on behalf of the State urged that what the legislation does in the present case is to carve out a category from the subject- matter of the Central legislation, namely, the category of fraudulent default and to provide for a special machinery that would be effective in realising the dues of depositors. The Reserve Bank of India, it was submitted, addressed a letter to the Chief Secretary to the State Government on August 12, 1998, requesting that a suitable legislation can be considered on the model of the Tamil Nadu Protection of Interests of Depositors (in Financial Establishments) Act, 1997. Again it was submitted that a Division Bench of this Court had in Kirit Somaiya v. SEBI [1999] 2 LJ 223 and in SEBI v. Libra [1998] 4 LJ 421, adverted to a "mushrooming" of companies which had defrauded investors. This background cannot, however, sustain the legislation once the court comes to the conclusion that there is a cle....
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.... Delhi High Court in Kanta Mehta's case (supra) has been affirmed in para 43 of the judgment of the Supreme Court in T. Velayudhan Achari's case (supra). Summation: 49. This is not a case where a State law is essentially and in substance with respect to a matter in the State List. Were it to be, an incidental encroachment on a subject reserved for the Union would not have risked attracting the vice of unconstitutionality. The substance of legislation determines constitutionality. An incidental trenching on a subject not reserved to the States is permitted when the substance still is within the purview of the power of the State. What is incidental is not of constitutional significance; this is so not because the incident is an aberration but because the incident is not of such overarching significance as to be determinative of the true character of the law. Subjects of legislative power are not defined by boundaries constructed with iron fences. The boundaries are open textured and porous; in their peripheries they may possess common attributes or characteristics. The vice of the State law in this case is that its core has transgressed into a field reserved for Parliament. The....
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....er must truly and essentially address itself to the preservation and maintenance of public order. That is not what the State law does in the present case. The essential nature of the State law in the present case is not public order, but subjects which fall within the Union List. 51. In these circumstances, we hold that : (i) The provisions of section 58A of the Companies Act, 1956 have been upheld by the Supreme Court in Delhi Cloth & General Mills Co. Ltd.'s case (supra). The provisions of Chapter III-C of the Reserve Bank of India Act, 1934 were upheld by the Delhi High Court in Kanta Mehta's case (supra). The judgment of the Delhi High Court is affirmed by the Supreme Court in T. Velayudhan Achari's case (supra); (ii) The Supreme Court held that Parliament has legislative competence to enact section 58A of the Companies Act, 1956 and that the provision was relatable to the legislative heads contained in entries 43 and 44 of List I of the Seventh Schedule. The same principle of law must apply to the subsequent amendments to the Companies Act, 1956 by which the provisions of section 58AA and section 58AAA were introduced; (iii) The legislative compet....