TaxTMI 
TaxTMI 
2010 (9) TMI 236
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....Shukla, Adv., Mr. Gagan Gupta, Adv., Mr. Mayank, Adv. and M/s. Parekh and Co., Advs JUDGMENT S.H. Kapadia, CJI. Leave granted. 2. The short question which we are required to decide in this batch of cases is - Whether inter se transfer of Non-Performing Assets ("NPA" for short) by banks is illegal under Banking Regulation Act, 1949 ("BR Act, 1949" for short) as held by the Gujarat High Court in the impugned judgment? According to the impugned judgment(s), assignment of debts by banks inter se is not an activity which is permissible under the said BR Act, 1949 and consequently all executed contracts of assignment of debts were illegal. According to the impugned judgment(s), the assignee banks were not entitled to substitution in place of original lender (assignor) in proceedings relatable to companies in liquidation pending in the Company Court. Facts in Civil Appeal : SLP(C) No. 2240 of 2009 3. On 31-3-2006 a Deed of Assignment was executed between Kotak Mahindra Bank Ltd., as assignee (Applicant) on one hand and ICICI Bank Ltd., as assignor. The recitals in the Deed show that ICICI Bank, in the course of its business, had granted various credit facilities to vario....
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....td., a company which subsequently went under liquidation. By way of Company Application in the pending winding up proceedings before the Company Court, Kotak Mahindra Bank Ltd., moved Company Application for being substituted in place of original secured creditor, ICICI Bank Ltd. This was pursuant to the Deed of Assignment dated 31-3-2006. The Company Application for substitution was moved at a stage of provisional/final winding up proceedings. Before the Company Court, Kotak Mahindra Bank Ltd., submitted that, as per BR Act, 1949 read with the Guidelines of Reserve Bank of India dated 13-7-2005, sale and purchase of debts, including the rights in immovable properties being secured creditors, can be sold by loaners and purchased by banks/financial institutions as assignees. According to Kotak Mahindra Bank Ltd., since proceedings for winding up were pending before the Company Court at various stages including the stage for disposal of properties of the companies-in-liquidation, they had approached the Company Court to be substituted in place of the original secured creditor, ICICI Bank Ltd. Before the Company Court, the secured creditor, ICICI Bank Ltd., admitted the execution of t....
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....td., (assignor). The Division Bench has not examined the other questions referred to above. Submissions 6. Shri Harish N. Salve, learned senior counsel, appearing on behalf of the appellants submitted that the Division Bench of the High Court erred in holding that in assigning debts with underlying security the assignor banks were trading in debts which was not permissible under the BR Act, 1949 because the assignor bank had never purchased debts, it had advanced loans against security which was a part of its banking business. That, it was only when the account became NPA that the assignor bank decided to dispose of the debt(s) which was its asset along with the underlying security. Similarly, the assignee bank, Kotak Mahindra Bank Ltd., which acquired the debt along with the underlying security also did not sell the debt or the underlying security acquired as per RBI Guidelines. On the contrary, the assignee bank seeks to enforce recovery. Therefore, according to the learned counsel, neither the assignor bank nor the assignee bank ever traded in the debts as wrongly held by the impugned judgment. According to the learned senior counsel, there is a fundamental error in the ap....
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....d in sections 8 and 9 and neither of the said provisions limits or prohibits assignment of debts. According to the learned counsel, there is one more error in the impugned judgment. According to the High Court, Parliament had enacted Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ("SARFAESI Act" for short) because the BR Act, 1949 did not permit banks to assign debts; that the SARFAESI Act is an exclusive Act for assignment of debts and that the said SARFAESI Act permitted banks to assign debts not inter se but only to certain specified entities like Asset Management Companies ("AMC" for short)/Asset Reconstruction Companies. According to the learned counsel, the High Court had failed to appreciate the object of the SARFAESI Act. It has failed to appreciate the provisions of that Act. According to the learned counsel, the concept of securitization is an economic and commercial concept; that, "asset construction" has been defined under section 2(b) as acquisition by any securitization company or reconstruction company of any right or interest of any bank or financial institution in any financial assistance for the purpose of real....
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....nment of financial instruments in possession of ICICI Bank Ltd., to Kotak Mahindra Bank Ltd., transfers not only the right of recovering debt but also transfers the obligations under the financial instruments "as if the said financial instruments were executed by the clients of ICICI Bank in favour of the assignee". That, the assignment of a debt can never carry with it the assignment of the obligations of the assignor. Unless there is a novation of the contract by all parties, there cannot be a transfer of the obligations of the assignor. In this connection, Shri Andhyarujina relied upon section 130 of the TP Act, 1882. Therefore, according to the learned counsel, such an assignment cannot be legally sustained without novation of original contract executed by the assignor and the debtor. Consequently, such assignment cannot under any circumstances come within the permissible mode of business under section 6(1) of the BR Act, 1949. According to the learned counsel, there is no merit in the argument of the appellant that the words in section 6 of the BR Act, 1949 "in addition to the business of banking" itself give to the ICICI Bank (assignor) the right to carry on all kinds of acti....
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.... of assignment the debt is not extinguished, the debt remains, the debtor remains, only the creditor changes. That, the assignee Bank cannot be said to be recovering debt when it in fact assigns the debt because both the debtor and the debt continue to exist and they are not extinguished. In the written submissions submitted on behalf of the borrower, one additional point is taken. According to the borrower, in the present batch of cases all rights and liabilities have crystallized on the date of the winding up order and, therefore, assignment of debt by a bank cannot be permitted after the company is ordered to be wound up as that would amount to violating the provisions of the Companies Act, 1956. For the aforestated reasons, the learned counsel submitted that no interference is called for with the impugned judgment(s) and the appeals preferred by the assignor deserve to be dismissed. 9. Issues : (i) Whether the Gujarat High Court was right in holding that assignment of debts by banks inter se is not an activity permissible under the BR Act, 1949 and consequently all executed contracts of assignment of debts were illegal? (ii) Whether the High Court was right....
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....ng, raising, or taking up of money; the lending or advancing of money either upon or without security; the drawing, making, accepting, "discounting, buying, selling, collecting and dealing in bills of exchange, hoondees, promissory notes, coupons, drafts, bills of lading, railway receipts, warrants, debentures, certificates, scrips and other instruments and securities whether transferable or negotiable or not; the granting and issuing of letters of credit, traveller's cheques and circular notes; the buying, selling and dealing in bullion and specie; the buying and selling of foreign exchange including foreign bank notes; the acquiring, holding, issuing on commission, underwriting and dealing in stock, funds, shares, debentures, debenture stock, bonds, obligations, securities and investments of all kinds; the purchasing and selling of bonds, scrips or other forms of securities on behalf of constituents or others, the negotiating of loans and advances; the receiving of all kinds of bonds, scrips or valuables on deposit or for safe custody or otherwise; the providing of safe deposit vaults; the collecting and transmitting of money and securities; (f) managing, selling and rea....
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....h period not exceeding five years where it is satisfied that such extension would be in the interests of the depositors of the banking company. 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 the capital of the company consists of ordinary shares only or of ordinary shares or equity shares and such preferential shares as may have been issued prior to the 1st day of July, 1944 : Provided that nothing contained in this sub-section shall apply to any banking company incorporated before the 15th day of January, 1937. (2) No person holding shares in a banking company shall, in respect of any shares held by hi....
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....m the National Housing Bank or from the National Bank or from the Small Industries Bank by the banking company; (iii) in the case of a Regional Rural Bank, also any loan taken by such bank from its Sponsor Bank; (b) "fortnight" shall mean the period from Saturday to the second following Friday, both days inclusive; (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; (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; (e) the ex....
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....: 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 sub-section, 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. E....
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.... (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. 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. 23. Restrictions on opening of new, and transfer of existing, places of business. (1) Without obtaining the prior permission of the Reserve Bank- (a) no banking company shall open a new place of business in India or change otherwise than within the same city, town or village, the location of an existing place of business situated in India; and (b) no banking company incorporated in India shall open a new place of business outside India or change, otherwise than within the same city, town or village in any country or area outside India, the location of an existing place of bus....
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....nking companies; (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); (d) at any time, if it is satisfied that in the public interest or in the 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- (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; (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 requi....
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....nishable with fine which may extend to fifty thousand rupees or twice the amount involved in such contravention or default where such amount is quantifiable, whichever is more, and where a contravention or default is a continuing one, with a further fine which may extend to two thousand and five hundred rupees for every day, during which the contravention or default continues. 47A. Power of Reserve Bank to impose penalty. (1) Notwithstanding anything contained in section 46, if a contravention or default of the nature referred to in sub-section (3) or sub-section (4) of section 46, as the case may be, is made by a banking company, then, the Reserve Bank may impose on such banking company- (a) where the contravention is of the nature referred to in sub-section (3) of section 46, a penalty not exceeding twice the amount of the deposits in respect of which such contravention was made; (b) where the contravention or default is of the nature referred to in sub-section (4) of section 46, a penalty not exceeding five lakh rupees or twice the amount involved in such contravention or default where such amount is quantifiable, whichever is more, and where ....
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....rule or direction relating to any provision of this Act referred to in sub-section (1) shall, except where such rule or direction provides otherwise, be construed as referring also to the State Bank of India, a corresponding new bank, a Regional Rural Bank and a subsidiary bank." 11. For the purpose of deciding Issue No. (i), we are also required to quote relevant portion of RBI Guidelines dated 13-7-2005, which reads as under:- "Guidelines on purchase/sale of Non-Performing Financial Assets Scope 1. These guidelines would be applicable to banks, FIs and NBFCs purchasing/selling non-performing financial assets, from/to other banks/FIs/NBFCs (excluding securitisation companies/reconstruction companies). 2. A financial asset, including assets under multiple/consortium banking arrangements, would be eligible for purchase/sale in terms of these guidelines if it is a non-performing asset/non-performing investment in the books of the selling bank. 3. The reference to 'bank' in the guidelines would include financial institutions and NBFCs." Brief analysis of the BR Act, 1949 12. The BR Act, 1949 provides for the comprehensive definitio....
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....provisions shall not be treated to be in derogation of any other laws save and except to the extent of any activity which is prohibited or restricted (See : section 2). Section 12 says that no banking company shall carry on business unless it satisfies certain conditions. Section 17 refers to creation of Reserve Fund. Section 18 refers to creation of Cash Reserve. Section 20 refers to restrictions on loans and advances. Section 21 deals with the power of RBI to control advances by banking companies. Section 21 empowers RBI to frame policies in relation to advances to be followed by banking companies. It further says that once such policy is made all banking companies shall be bound to follow them. Section 21(1) is once again a general provision empowering RBI to determine policy in relation to advances whereas section 21(2) empowers RBI to give directions to banking companies as to items mentioned there i.e., in section 21(2). Under section 21(3) every banking company is bound to comply with directions given by RBI at the peril of penalty being levied for non-compliance. Section 35A says that where RBI is satisfied that in the interest of Banking Policy it is necessary to issue dir....
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....er clauses (a) to (o ) are shut down, the company would still be a banking company as long as it is in the core banking of accepting deposits and lending so that its main income is from the spread or what is called as "interest income". Thus, we may broadly categorise the functions of the banking company into two parts, viz., core banking of accepting deposits and lending and miscellaneous functions and services. Section 6 of the BR Act, 1949 provides for the form of business in which banking companies may engage. Thus, RBI is empowered to enact a policy which would enable banking companies to engage in activities in addition to core banking and in the process it defines as to what constitutes "banking business'. The BR Act, 1949 basically seeks to regulate banking business. In the cases in hand we are not concerned with the definition of banking but with what constitutes "banking business". Thus, the said BR Act, 1949 is an open-ended Act. It empowers RBI (regulator and policy framer in matter of advances and capital adequacy norms) "to develop a healthy secondary market, by allowing banks inter se to deal in NPAs in order to clean the balance sheets of the banks which guideline/p....
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....or any productive purpose. Continuous growth in NPAs threatens the repayment capacity of the banks. They have an adverse impact on the financial strength of the banks which in the present era of globalization are required to conform to International Standards. Thus, NPA means an asset or account receivable of a borrower, which has been classified by banks or financial institutions in terms of RBI Guidelines as sub-standard, doubtful etc. These guidelines are issued to improve quality of assets of the banks. The 2005 guidelines of RBI are not to eliminate NPAs but to restructure. The BR Act, 1949 vide section 21 empowers RBI in the interest of the Banking Policy to lay down guidelines in relation to advances to be followed by banking companies. The 2005 guidelines have been issued as "a restructuring measure" in order to avoid setbacks in the banking system. NPAs do not generate interest .85 per cent of the Indian Banks' income comes from interest. Thus, NPAs adversely impact profits of the banks and hence, as a matter of Banking Policy, RBI as Regulator seeks through its guidelines under section 21 read with section 35A to manage these NPAs and not to eliminate. The said guidelines....
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....he contentions raised in that regard. According to the borrower(s) assignment of Financial Instruments in possession of ICICI Bank Ltd. to Kotak Mahindra Bank Ltd., transfers not merely the right to recover the debt but also transfers the obligations under the Financial Instruments "as if they were executed by the clients of ICICI Bank in favour of the assignee", i.e., Kotak Mahindra Bank Ltd. According to the borrower(s), an assignment of a debt can never carry with it the assignment of the obligations of the assignor unless there is a novation of the contract by all parties. Therefore, according to the borrower(s), the impugned Deed of Assignment is legally unsustainable without novation of original contract between ICICI Bank Ltd., (assignor) and the borrower(s) (assignee). We find no merit in the above arguments. 18. As stated above, an outstanding in the account of a borrower(s) (customer) is a debt due and payable by the borrower(s) to the bank. Secondly, the bank is the owner of such debt. Such debt is an asset in the hands of the bank as a secured creditor or mortgagee or hypothecatee. The bank can always transfer its asset. Such transfer in no manner affects any right o....
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....en assignment of rights under a contract by a party who has performed his obligation thereunder and an assignment of a claim for compensation which one party has against the other for breach of contract. 19. In the case of Camdex International Ltd. v. Bank of Zambia [1998] Q.B. 22 (CA), the following observation which is relevant to the present case needs to be quoted :- "The assignment of a debt will not be contrary to public policy solely on the grounds that the assignee has purchased the debt for a considerably discounted price or because that price is only payable after a period of credit. Nor will the assignment be contrary to public policy simply because the assignee may make a profit on the transaction at the end of the day. If there was no prospect of a profit, Hobhouse LJ observed, commercial entities would never purchase debts." 20. Similarly, the following proposition in Chitty on Contracts, 27th edn. (1994) at para 19.027 is relevant to be noted. "It is also well established that a claim to a simple debt is assignable even if the debtor has refused to pay. The practice of assigning or 'selling' debts to debt collecting agencies and credit factors....