TaxTMI 
TaxTMI 
2008 (10) TMI 594
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.... details. PRELUDE ABOUT DERIVATIVES 3. Derivatives are time bombs and financial weapons of mass destruction said Warren Buffett, one of the world s greatest investors, who overtook Microsoft Maestro in 2008 to become the richest man in the world and who is known as the Sage of Omaha or Oracle of Omaha . Derivatives, according to him, can push companies on to a spiral that can lead to a corporate melt down. He compared derivatives business to hell, easy to enter and almost impossible to exit. In response to a query as to whether a nuclear war would be the worst case scenario, a famous daily web log commented that the economic collapse triggered by the popping of the derivatives bubble presented the worst case scenario. 4. True to the above criticism, the world of finance and investments, was swept by many a tsunami in the past decade and a half. Some of the derivatives disasters which plunged several institutions and millions of investors into severe crisis (and even led to the homicide by a 46 year old former IITian of his entire family followed by his suicide in US) are as follows:- (i) The bankruptcy of Orange County, CA in 1994, the largest municipal bankruptcy in U.....
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....to changes in market conditions; and (c) that is settled at a future date." Actually, derivatives are assets, whose values are derived from values of underlying assets. These underlying assets can be commodities, metals, energy resources, and financial assets such as shares, bonds, and foreign currencies. 6. Derivatives can be used as insurance cover against certain types of business risks such as fluctuations in the rate of foreign exchange, fluctuations in the rate of interest on borrowings, fluctuations in the value of specified assets etc. To take an example, it is common knowledge that the price of gold keeps fluctuating. If a manufacturer of gold jewellery anticipates that he would require a particular quantity of gold at a specified distance of time, he may enter into a contract with the seller of gold bars for the supply of the same at a future date, at the rate specified in the contract. This contract reduces the risk for the buyer, against a possible steep rise in the price of gold. It equally reduces the risk of the seller against a steep fall in the price. Thus the contract acts as an insurance cover. When the transaction goes through without any dispute, the c....
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....al instrument (underlying instrument), to the seller (or writer) at a certain time (the expiration date) for a certain price (strike price). We have a variety of options such as American and European options, depending upon the time of exercise of the right. Both call option and put option can be combined to achieve "zero cost option." 8. Trading in these markets are regulated internationally by Commodity Futures Trading Commission (CFTC) and International Swaps and Derivatives Association (ISDA) and the National Futures Association (NFA). Experts in the field of economics, finance and investment feel that derivatives are valuable because they provide efficient ways to manage and transfer risk. A business owner who is exposed to changes in market prices can enter into an appropriate derivatives contract and the risk can be assumed by a trader or speculator who is prepared to live with uncertainty in return for the prospect of achieving an attractive return. A large financial institution can withstand more risk than a small corporate and thus may choose to engage in derivatives products for a reasonable compensation. Nobel Laureate Kenneth Arrow predicted that this would increase....
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....ng Law and Jurisdiction" found in Section 13(b) of the Master Agreement was replaced with the following provisions:- With respect to any suit, action or proceeding relating to this Agreement ("Proceedings") each party irrevocably: (i) submits to the jurisdiction of the High Court of Mumbai in India (ii) waives any objection which it may have at any time to the laying of the venue of any Proceedings brought in any such Court and waives the right to object, with respect to such Proceedings, that such Court does not have jurisdiction over such party. Nothing in this Agreement precludes either party from bringing Proceedings in any other Court, tribunal or appropriate forum in India nor will bringing of Proceedings in any one or more jurisdictions preclude the bringing of Proceedings in any other jurisdiction. 11. The aforesaid ISDA Master Agreement dated 14.5.2004 was signed for and on behalf of the plaintiff, by their Chief Financial Officer and Company Secretary by name Mr.P.K.Viswanathan, by virtue of the resolution of the Board of Directors dated 24.3.2004, authorising him for the purpose. The authorisation given to Mr.P.K.Viswanathan was not merely to sign the agre....
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....reply dated 7.1.2008, the Bank challenged the claim and contended that the contract was still alive and that the Bank was prepared to work out suitable risk mitigation structures. 14. Not satisfied with the stand taken by the Bank, the plaintiff has come up with the present suit seeking the following reliefs:- (i) To declare that the deal confirmation of U.S. Dollar V/s Swiss Franc structure dated 22.06.2007 in OPT contract No.727 with the schedule thereon purportedly made by the CFO on behalf of the plaintiff with the defendant is void ab-initio, illegal, violative of RBI Guidelines, opposed to public policy and unenforceable and not binding on the plaintiff company. (ii) To declare that the deal confirmation of U.S. Dollar V/s Swiss Franc contract dated 22.06.2007 in OPT Contract No.727 with the schedule thereon purportedly made by the CFO on behalf of the plaintiff with the defendant Bank is voidable at the instance of the plaintiff and the plaintiff has therefore avoided the contract and therefore the contract is not binding or enforceable against the plaintiff. (iii) To declare that in the alternative to prayers (a) and (b), this Hon'ble Court be pleased to declare....
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....n restraining the plaintiff from alienating, encumbering, dealing with, disposing of, creating or extending any third party interests in or over the assets of the plaintiff. (ii) O.A.No.527 of 2008 seeking an interim order of injunction restraining the plaintiff from entering into any transactions with other Banks/Financial Institutions and thereby creating any third party interests in the assets of the plaintiff. (iii) A. No.1926 of 2008 to revoke the leave granted under Clause 12 of the Letters Patent. (iv) A. No.1927 of 2008 seeking rejection of the plaint on the ground that the plaint does not disclose any cause of action to have arisen within the jurisdiction of this Court. (v) A. No.2446 of 2008 seeking a direction to the plaintiff to give an undertaking to pay such sum by way of damages as the Court may award as compensation in the event of the defendant getting prejudiced by any adverse order passed by this Court and (vi) A. No.2447 of 2008 seeking a direction to the plaintiff to furnish Bank Guarantee to the defendant in a sum of Rs.40 crores, to cover the monetary liability of the plaintiff under the transaction in question. 18. All the above application....
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....he threshold before delving deep into the nature of derivative transactions and their validity with respect to the statutory provisions. Therefore I shall first take up the issue of maintainability of the suit. 22. It is contended by the learned Senior Counsel for the defendant-Bank that the defendant is a Banking Company within the meaning of the Banking Regulation Act, 1949 and hence it is a Bank within the meaning of Section 2(d) of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, hereinafter called 'Act 51 of 1993'. Consequently, if the contingency provided in the contract in question gives rise to a claim for money by the Bank upon the plaintiff, it would come within the definition of the word "debt" under Section 2(g) of Act 51 of 1993. Therefore the learned Senior Counsel contended that the defendant will be entitled to file an application for recovery of such a debt before the appropriate Tribunal, as and when the contingency arises. It is only when an application is filed by the Bank against the plaintiff before the Tribunal, that the plaintiff would be entitled, by virtue of the provisions of Section 19(6), 19(7), 19(8) and 19(9) of Act 51 of 19....
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....ansaction falls within any one of the forms of business covered by Section 6(1) of the Banking Regulation Act, 1949, it would certainly be a business activity undertaken by the Bank. Consequently, a claim that arises during the course of such a business activity undertaken by the Bank, would come within the definition of the word "debt" in Section 2(g). 25. Transactions in derivatives, fall within the category of "business activity undertaken by the Bank" as they are covered by Section 6(1) of the Banking Regulation Act, 1949. Therefore I have no difficulty in coming to the conclusion that if the transaction in question gives rise to a claim by the Bank, of any liability, on the part of the plaintiff, the defendant-Bank may certainly be able to invoke the provisions of Act 51 of 1993. Since the word "debt" is defined to include any claim arising out of the business activity of the bank, it is not necessary that only in those cases where there is an act of lending and borrowing that the provisions of Act 51 of 1993 could be invoked by the Bank. Therefore I have no difficulty in accepting the first limb of the argument of Mr.V.Ramachandran, learned Senior Counsel appearing for the....
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....nd that the present claim of the plaintiff cannot be tried independently as a suit, with multiple forums adjudicating upon the same dispute in multiple proceedings. In support of his said contention, the learned Senior Counsel relied upon the provisions of Sections 19(6) to 19(9) of Act 51 of 1993 and also the decisions of the Supreme Court in Union Bank of India Vs. Abhijit Tea Co. Pvt. Ltd {2000 (7) SCC 357}, State Bank of India Vs. Ranjan Chemicals Ltd {2007 (1) SCC 97}, Industrial Investment Bank of India Vs. Marshal's Power and Telecom (I) Ltd {2007 (1) SCC 106} and Durga Hotel Complex Vs. Reserve Bank of India {2007 (5) SCC 120}. 29. In Abhijit Tea Co. case, the Supreme Court referred to the provisions of Sections 19(6) to 19(11) of the Act and concluded that when the pleas raised by the borrower are inextricably connected with the claim of the bank, they would fall within the categories of set off or counter claim and that therefore the suit filed by the borrower should be transferred to the Tribunal. But in ABS Marine case, the Apex Court explained the ratio in Abhijit Tea Co., case, in paragraph-25 as follows:- "Suffice it to clarify that the observations in Abhijit ....
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....tio in ABS Marine was not expressly overruled by any subsequent decision. Therefore, it is clear that a civil suit is maintainable. But the question as to whether the civil suit is liable to be transferred to the Tribunal after an application is filed by the Bank before the Tribunal (in the light of the ratio laid down in Ranjan Chemicals case and Marshal's Power case), is actually premature at this stage, since the Bank has not filed any application before the DRT as on date. 33. That the present suit is vulnerable for an order of transfer, if and when the Bank files an application before the DRT, cannot make the suit non maintainable. In all the decisions of the Supreme Court relied upon by the learned Senior Counsel for the defendant-Bank, the suits were not thrown out as not maintainable. They were only transferred to the Tribunals for being treated as set off or counter claim and for being tried along with an application of the Bank. Therefore, I hold that the present suit is very much maintainable. 34. It is interesting to note that even if the defendant in an application before the DRT claims set off or makes a counter claim, it is not necessary for the Tribunal to dea....
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....ing recovery of any amount from the plaintiff and/or initiating any measures or proceedings to recover any amount, is not sustainable in view of Section 41(b) of the Specific Relief Act. 38. Section 41(b) of the Specific Relief Act, 1963 reads as follows:- "41. An injunction cannot be granted: (a) ***** (b) to restrain any person from instituting or prosecuting any proceeding in a Court not subordinate to that from which the injunction is sought;" 39. In Cotton Corporation of India Ltd Vs. United Industrial Bank Ltd {1983 (4) SCC 625}, a leading case on the scope of section 41(b), the Bank filed a suit for declaring certain transactions as null and void and not binding upon the Bank. Pending suit, the Bank moved an application for an interim injunction to restrain the Cotton Corporation from using the Bills of Exchange or Hundies involved in the dispute, for the purpose of any suit or other proceedings, including winding up proceedings. Though a limited injunctive relief was granted by the single Judge of the Bombay High Court, the Division Bench granted an injunction, forcing the Cotton Corporation to file an appeal before the Supreme Court. While over turning the d....
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....ior Court can regulate proceedings in a Court subordinate to it. It is implicit in this assumption and the language used in Section 56 (b) that the Court could not grant injunction under Section 56(b) of the repealed Act to stay proceeding in a Court superior in hierarchy to the Court from which injunction is sought. But by judicial interpretation, a consensus was reached that as injunction acts in personam while the Court by its injunction cannot stay proceedings in a Court of superior jurisdiction, it could certainly by an injunction restrain a party before it from further prosecuting the proceeding in other Courts may be superior or inferior in the hierarchy of Courts. To some extent this approach not only effectively circumvented the provision contained in Section 56 of the repealed Act but denuded it of its content. The Legislature took notice of this judicial interpretation and materially altered the language of the succeeding provision enacted in Section 41(b) replacing Section 56(b) of the repealed Act while enacting Specific Relief Act of 1963. The Legislature manifestly expressed its mind by enacting Section 41(b) in such clear and unambiguous language that an injunction ....
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....tments Ltd {(1963) 2 AII ER 940 : 1964 Ch 240 : (1963) 3 WLR 662 (CA)} and Bryanston Finance Ltd {(1976) 1 AII ER 25 : 1976 Ch 63 : (1976) 2 WLR 41 (CA)} would require these findings to be recorded before an interim injunction can be granted. The decision of the Appellate Bench is conspicuously silent on these relevant points and for this additional reason also the appeal must succeed." 40. In paragraph 8 of the same judgment, the Supreme court referred to the Constitutional goal that access to justice is a valuable right and that it cannot generally be curtailed. The Supreme Court also recorded that what was prescribed in Section 41(b) was an exception. This view of the Supreme Court is found in the following portion of paragraph-8 of the judgment:- " 8. ............ Now access to Court in search of justice according to law is the right of a person who complains of infringement of his legally protected interest and a fortiori therefore, no other Court can by its action impede access to justice. This principle is deducible from the Constitution which seeks to set up a society governed by rule of law. As a corollary, it must yield to another principle that the superior Cour....
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....ef Act, 1963. Therefore these words have to be assigned only their natural meaning, in the absence of an indication in the statute about the sense in which the words are used therein. The Civil Procedure Code speaks of subordination of Courts in Section 3, in the following manner:- "3. Subordination of Courts:- For the purposes of this Code, the District Court is subordinate to the High Court and every Civil Court of a grade inferior to that of a District Court and every Court of Small Causes is subordinate to High Court and District Court". 45. Sections 23 and 24 of the Code of Civil Procedure, speak of "Court subordinate", while dealing with the general power of transfer and withdrawal. A reading of these provisions, gives a clue that unless two Courts fall in a line of hierarchy, one cannot be taken to be subordinate or superior to the other. 46. But de hors the principle of subordination of Courts or hierarchy of Courts, having any relevance to Section 41(b) of the Specific Relief Act, 1963, the Supreme Court appears to have taken a consistent view that anti suit injunctions are possible in respect of proceedings in foreign Countries. In one of the earliest decisions o....
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....i suit injunctions despite the principle of subordination of courts, found in section 41(b) of the Specific Relief Act, 1963. 48. Again the Supreme Court had an occasion to consider the power of the Court to grant anti suit injunctions to restrain the proceedings in a foreign Court, in Modi Entertainment Network vs. W.S.G. Cricket Pte. Ltd., {2003 (4) SCC 341}. In paragraph-24 of the said decision, the Supreme Court laid down the following principles:- "24. From the above discussion, the following principles emerge: (1) In exercising discretion to grant an anti-suit injunction the Court must be satisfied of the following aspects: (a) the defendant, against whom, injunction is sought, is amendable to the personal jurisdiction of the Court; (b) if the injunction is declined, the ends of justice will be defeated and injustice will be perpetuated; and (c) the principle of comity respect for the Court in which the commencement or continuance of action/proceeding is sought to be restrained must be borne in mind. (2) In a case where more forums than one are available, the Court in exercise of its discretion to grant anti-suit injunction will examine as to which is the....
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....on-exclusive jurisdiction is created, the proceedings in that Court cannot per se be treated as vexatious or oppressive nor can the Court be said to be forum non-conveniens. (7) The burden of establishing that the forum of choice is a forum non-conveniens or the proceedings therein are oppressive or vexatious would be on the party so contending to aver and prove the same." 49. The principles laid down in Modi's case, make it clear that an anti suit injunction cannot be granted when the jurisdiction of a Court is invoked on the basis of a jurisdiction clause contained in a contract, except to a limited extent. The question as to whether the proceedings were vexatious or oppressive or whether they could be initiated in a Forum non-conveniens were all said to be other relevent considerations, for the grant of such an injunction. 50. Therefore when the invokation of the jurisdiction of a court on the basis of a jurisdiction clause contained in an agreement, itself cannot be curtailed by an anti suit injunction, the question of injuncting a party from invoking the jurisdiction of a special Forum statutorily created to decide certain disputes, does not arise. In the case on hand....
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....r circulars and Regulations issued by the Reserve Bank of India and consequently hit by Section 23 of the Contract Act. It is the further contention of the plaintiff that since there was no underlying exposure, the contract was, per se, speculative and a wagering contract, hit by Section 30 of the Contract Act. Therefore, it is necessary to analyse whether the contract in question is hit by Section 23 and/or Section 30 of the Contract Act. 54. Though the Indian Contract Act, 1872 defines a "Contingent Contract" under Section 31, it does not define what a "Wagering Contract" is. But the consequences of a Wagering Contract are indicated in Section 30, which reads as follows:- "30. Agreements by way of wager, void. -- Agreements by way of wager are void; and no suit shall be brought for recovering anything alleged to be won on any wager, or entrusted to any person to abide by the result of any game or other uncertain event on which any wager is made. Exception in favour of certain prizes for horse-racing. -- This section shall not be deemed to render unlawful a subscription or contribution, or agreement to subscribe or contribute, made or entered into for or toward any plate,....
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....ere wagers, since it was only if the option was exercised that they would become genuine transactions of sale and purchase. But if one party to the transaction undertakes a real liability to give or take delivery, the mere fact that the other party intends by a subsequent transaction to arrange that delivery under the first transaction shall not take place, does not turn the transaction into a wager. A genuine purchase of shares followed by a separate and genuine sale, creates enforceable obligations, even though the original purchaser never intended to take delivery of the shares and was in fact merely speculating upon their value. Sales and purchases of stocks and shares are not wagering transactions unless there is an agreement between the parties to them that they shall not be actually carried out but shall end only in the payment of differences. If there is an agreement to this effect, the transaction will be a wager notwithstanding the fact that the ostensible terms of business give a right to insist on delivery (Chitty on Contracts- Volume II - 29th Edition Page 1119). 57. Until the enactment of the Gaming Act, 1845, wagering contracts were not prohibited by law in Englan....
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....ed them to have any effective legal operation. Where the documents show an ordinary commercial transaction, and, in conformity with them, one of the parties incurs personal obligations on a genuine transaction with third parties so that he himself is not a winner or loser by the alteration of price, but can only benefit by his commission, the inference of betting is irresistibly destroyed. In such cases the fact that no delivery is required or tendered is of practically no value." 60. In Gherulal Parakh Vs. Mahadeodas Maiya {AIR 1959 SC 781} a question arose as to whether a partnership formed for the purpose of entering into forward contracts for the purchase and sale of wheat so as to speculate in rise and fall of price of wheat in future, was a wager and whether it was hit by Section 30 of the Contract Act. But the Supreme Court held that such a partnership was not illegal, although the business for which the partnership was formed, was held to involve wagering. It was held therein as follows:- "(1) Under the Common Law of England a contract of wager is valid and therefore both the primary contract as well as the collateral agreement in respect thereof are enforceable; (....
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....ing wagering illegal. Indeed, some of the gambling practices are a perennial source of income to the State. In the circumstances it is not possible to hold that there is any definite head or principle of public policy evolved by Courts or laid down by precedents which would directly apply to wagering contracts. Even if it is permissible for Courts to evolve a new head of public policy under extraordinary circumstances giving rise to incontestable harm to the society, we cannot say that wager is one of such instances of exceptional gravity, for it has been recognized for centuries and has been tolerated by the public and the State alike. If it is has any such tendency, it is for the legislature to make a law prohibiting such contracts and declaring them illegal and not for this Court to resort to judicial legislation." 62. Keeping the above principles in mind, if we look at the transaction in question namely OPT 727, which is the subject matter of the present controversy, it is seen that the essence of the deal between the plaintiff and the defendant is as follows:- (a) Under Part-A of the deal, if during the period from 22.6.2007 (taken as ....
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....r payables. As stated above (in the paragraph narrating the facts of the case), the plaintiff is an exporter having foreign currency receivables. The plaintiff also has foreign currency payables due to External Commercial Borrowings. Therefore, when the value of USD appreciates against Indian currency, the value of their receivables go up in terms of Indian rupee. But at the same time, the value of foreign currency payables would also go up on account of ECB. A converse situation would arise if the value of USD depreciates. Therefore the payment of USD 100,000 prescribed under the deal is to hedge the plaintiff against the risk. It can be compared to the payment of the sum assured under a contract of insurance, though it may not exactly be the same. 64. The purchase of USD 20 million at the rate of 1.3300 CHF per Dollor, under OPT 727, would certainly make the plaintiff lose a huge amount, especially since the market rate on the crucial date would be lower than 1.3300 CHF. But that by itself would not make the contract a wager. The contract confers a right to seek actual delivery. In other words, the performance of the contract can always be compelled, by the plaintiff insisting....
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.... of USD weakening and CHF appreciating without touching KO Level. In worst case if USD/CHF weakens and touches levels of 1.1250 and 1.12 then the client is under obligation to deliver CHF and receive USD at 1.33 on the two fixing dates. This could be worse than market levels" (d) Again another e-mail was sent on the same day after a gap of nearly 45 minutes (filed as part of plaint document No.5) containing details of brief structure and also putting the plaintiff on notice of the risk. Thus the plaintiff was fore-warned, but they were not fore-armed. (e) Thereafter, a e-mail was sent on 22.6.2007 along with the "Deal Confirmation for USD-CHF Option Structure" by the defendant to the plaintiff, containing a draft of OPT727. This e-mail with the enclosure is filed as plaint document No.6. It is only in confirmation of the terms and conditions contained in plaint document No.6 that Mr.P.K.Viswanathan sent the letter of consent under plaint document No.7. It is this plaint document No.7 which is the subject matter of this litigation. Thus, the entire correspondence by e-mail between the parties discloses at least three fundamental facts viz., (i) that Mr.P.K.Viswanathan was d....
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.... plaint document No.8. 67. Similarly, by yet another e-mail dated 31.10.2007, the Assistant Vice President of the defendant-Bank warned the plaintiff that the USD might weaken further and that if the plaintiff was interested in cutting their losses at the current level or taking any corrective structures, it should be intimated to the defendant. This e-mail message is filed as plaint document No.9. 68. There was also a spate of correspondence subsequently about restructuring the product. Such correspondence, copies of which are filed as plaint documents, went on till mid December 2007. Ultimately by a letter dated 12.12.2007 addressed by the plaintiff to the defendant-Bank, the plaintiff took a stand that the entire structure including Part-A and Part-B in OPT 727 stood knocked out with no subsequent liability to either party. A copy of this letter is filed as plaint document No.18. In this letter, the plaintiff acknowledged the fact that in the last couple of weeks, the defendant advised them about various options to mitigate the risks under OPT 727. Incidentally, this letter was signed by Mr.P.K.Viswanathan. 69. After the aforesaid letter dated 12.12.2007, one Mrs.Rajshr....
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.... like a contract of insurance, where, on the happening of an uncertain event, the sum assured becomes payable. 72. As per the decision of the Privy Council in Bhagwandas Parasram Vs. Burjori Ruttonji Bomanji {AIR 1917 PC 101} and followed by the Supreme Court in Firm of Pratapchand Nopaji Vs. Firm of Kotrike Venkata Setty & Sons and Others {(1975) 2 SCC 208} (stated in paragraph-64 above), every speculation will not fall under the category of wager. There must be a common intention to wager. In this case, there was certainly no intention much less a common intention to wager. The plaintiff attempts to project the transaction as a wager by contending that OPT 727 was not in respect of a specific underlying contract of import or export and that therefore it was only speculative in nature. But the plaintiff cannot be heard to raise such a contention in view of the covenant (or declaration) made by the plaintiff to the defendant in OPT 727 that there was an underlying exposure and that the transaction was not for the purpose of speculation. Even assuming for the sake of argument that there was an intention on the part of the plaintiff to speculate, no such intention on the part of t....
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....onsent of the Board. The plaintiff has further taken a stand that Mr.P.K.Viswanathan was not well versed in such transactions and that the defendant Bank made misrepresentations and lured him into this deal. 76. But the above stand of the plaintiff is wholly unjustified and far from convincing. Such a stand has been invented by the plaintiff only at the time of filing this suit and not before. Admittedly, (i) there was a Board resolution dated 24-3-2004 authorising Mr.P.K.Viswanathan to enter into derivatives transactions with the defendant Bank; (ii) a ISDA Master Agreement was entered into by Mr.P.K.Viswanathan on 14-5-2004 and the same is not challenged by the plaintiff as null and void; (iii) a series of about 10 transactions sprung out of the ISDA Master Agreement, all of which were signed and confirmed only by Mr.P.K.Viswanathan; (iv) 9 out of those 10 deals sailed smoothly to the shores, perhaps profitting the plaintiff and hence they are not questioned by the plaintiff; (v) the amount of USD 100,000 paid by the defendant Bank under OPT 727 (the deal in question), way back on 27-6-2007, was accepted and utilised by the plaintiff and never challenged as tainted; (vi) some ....
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....control. The fact that both parties had no control over the same, is also known to both parties. Therefore, even if the Bank had made any representation that the exchange rate would or would not reach a particular level, it cannot be termed as a misrepresentation, since no one had any control or even knowledge as to how the currency would behave. The prediction of the behavioural pattern of a foreign currency is much worse than a weather forecast and hence any representation with regard to the same cannot be termed as misrepresentation. 79. To paint the deal as nothing more than a wager, the plaintiff also contends that the payment of USD 100,000 by the Bank to the plaintiff, in pursuance of the contract, was actually a premium paid by the Bank. In an insurance cover, the insured pays premium to the insurer and not vice versa. Therefore, according to the plaintiff, the payment of the amount by the bank made it an unlawful deal. 80. The above argument of the plaintiff is to be stated only to be rejected. The claim made by the plaintiff in their letter dated 12-12-2007, filed as plaint document No.18, exposes the hollowness and untenability of this argument. The plaintiff claim....
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..... In order to test the veracity of this argument, it is essential to look into the historical background of the transactions in derivatives. HISTORY OF EVOLUTION OF DERIVATIVES 83. As we have seen in our prelude, derivatives are financial instruments used to transfer or hedge the risk. There are 4 types of derivatives contracts, namely (1) forwards (2) futures (3) options and (4) swaps. They had their origin, perhaps in "speculative trading in commodities" several centuries ago and later underwent a metamorphosis to become "futures trading" and "forward trading" a couple of centuries back. Some trace their history to 600 B.C., when a Greek purchsed an option to work on olive presses. Others trace it to the period of Wiliam and Mary in the 17th century. Their history has to be traced from 3 different perspectives namely (1) Forwards/Futures Trading in commodities (2) forwards/futures trading in stocks and securities and (3) forwards/futures trading in currencies. While the history of futures trading in commodities is fairly long, the history of futures trading in stocks and securities is shorter and the history of futures trading in foreign currencies is only a few decades old....
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....on stock exchanges, so as to deal with them separately. As seen from the Statement of Objects and Reasons, options were prohibited altogether on the ground that they were an undesirable form of speculation. The Act divided the commodities into 3 categories with reference to the extent of regulation, viz (a) commodities in which futures trading can be organized under the auspices of recognized association (b) Commodities in which futures trading is prohibited and (c) commodities which were neither regulated nor prohibited, which were referred as Free Commodities. 86. In the seventies, most of the registered associations became inactive, as futures as well as forward trading in the commodities for which they were registered came to be either suspended or prohibited altogether. The Khusro Committee (June 1980) recommended reintroduction of futures trading in most of the major commodities. After the introduction of economic reforms since June 1991 and the consequent liberalization in both the domestic and external sectors, the Govt. of India appointed a committee on Forward Markets under the Chairmanship of Prof. K.N. Kabra. The Committee recommended that futures trading be introduc....
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....thing contained in any other law for the time being in force, contracts in derivatives shall be legal and valid if such contracts are - (a) traded on a recognised stock exchange; (b) settled on the clearing house of the recognised stock exchange, in accordance with the rules and bye laws of such stock exchange." The definition of the word "derivative" was also incorporated in Section 2 (ac) of the Securities Contracts (Regulation) Act, 1956, by the aforesaid amendment. The definition in Section 2(ac) is as follows:- "2(ac) "derivatives" includes - (A) a security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security; (B) a contract which derives its value from the prices, or index of prices, of underlying securities;" As is obvious, the above definition is only inclusive and hence the natural meaning of the word "DERIVATIVE" was not lost. 89. Following the above amendment to the Securities Contracts (Regulation) Act, with effect from 22.2.2000, the Reserve Bank of India notified certain regulations known as "Foreign Exchange Management (Foreign Exchange Derivative Co....
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....ation, the Reserve Bank started allowing a variety of products. They are (i) Cross Currency Options to hedge exposures arising out of trade (ii) Foreign Currency Interest Rate Swap / Forward Rate Agreements / Interest Rate Options / Swaptions/Caps to hedge interest rate and currency mismatches and (iii) Commodity Futures/Options to cover commodity exposures from overseas exchanges. 93. Keeping in mind the above developments, the Technical Committee (referred to above) recommended that at the inception, FC/INR Options market could start with some options and then proceed to introduce exotic features/options. 94. Thereafter, the Reserve Bank of India (Amendment) Act, 2006, was passed, legitimising the transactions in derivatives, with retrospective effect, with the introduction of Chapter III-D in the Act. By the said Amendment, Sections 45U, 45V, 45W and 45X were inserted in the Act. Section 45U contained definitions. Clause (a) of Section 45U defined a "derivative" as follows:- "(a) "derivative" means an instrument, to be settled at a future date, whose value is derived from change in interest rate, foreign exchange rate, credit rating or credit index, price of securities ....
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....Regulation) Act, 1973, permitting authorised dealers (of foreign exchange) to offer forward cover to resident customers in any currency of their choice. Normally customers used to require forward cover facilities in respect of the foreign currency, in which their receivables or payables are denominated, against the Indian Rupee. But these circulars acknowledged the fact that the customers may at times, wish to hedge against a third currency instead of the rupee. Therefore these circulars permitted the authorised dealers to provide forward sale or purchase facilities, in the currency of receivables or payables against a third currency, provided the latter currency is also a permitted currency and is actively traded in the market, if the customer wished to hedge against a third currency instead of the rupee. 97. The contents of the above circular are as follows:- "A reference is invited to A.D. (M.A. Series) Circular No.26 dated 23rd December 1994 whereby authorised dealers have been permitted to offer forward cover to resident customers to any currency of their choice. 2. Customers will ordinarily require forward cover facilities for the foreign currency in which their rece....
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....-1994 were followed by several circulars, 2 of which are relevant for our purpose. They are the Master Circular No.06/2006-07 dated 1.7.2006 and Master Circular No.6/2007-08 dated 2.7.2007. These Circulars had a validity period of one year with a sunset clause. Therefore, they are always replaced by new circulars every year. 100. Thus the transactions in derivatives are age old, in so far as commodities and stocks and securities are concerned. These transactions are atleast about a couple of decades old in so far as foreign currencies (and forex options) are concerned. Therefore it is futile on the part of the plaintiff to contend that the transactions are either prohibited by law or opposed to public policy. What is expressly permitted by law, cannot be held to be opposed to public policy. The Master Circulars issued by RBI from time to time and the Regulations framed by RBI under the FEMA, 1999 permit such transactions. Such transactions have the sanction of law the world over, despite the mishaps such as Orange County, Barings Bank, Long Term Capital Management, Lehman Brothers, AIG etc . Admittedly, the Nationalised Banks in our country also offer such products, though their....
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....e customer. 104. Paragraph-A.1.c of Schedule-I of the aforesaid Regulations, makes it clear that even the currency of hedge and tenor are left to the choice of the customer. Therefore it is clear that hedging need not necessarily be in terms of US Dollars versus Indian currency. If a customer feels that the Indian currency is highly volatile and unstable as against US Dollars, he is entitled to opt for a more stable currency, so that his risks are minimised. But when a contra situation arises, he would stand to lose, but the same would be part of the game. Therefore, it is futile to contend that the transaction is prohibited by law, on account of a third currency (swiss franc) being used for hedging. 105. Ground No.2:: The contention of the plaintiff is that there was no underlying exposure in relation to OPT 727 and that by virtue of the Regulations, there was a prohibition from entering into such contracts without underlying exposure. According to the plaintiff the Bank (authorised dealer) also had a duty cast upon it, to satisfy itself, through verification of documentary evidence about the genuineness of the underlying exposure. 106. It is true that paragraph-A.1.(a) a....
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.... 727 that it was entering into this transaction solely for the purpose of hedging its foreign currency Balance sheet exposure. This declaration is binding on the plaintiff and this declaration was sufficient for the defendant bank to enter into the deal, in view of the provisions of the Master Circulars extracted in paragraphs 106 and 107 above. Moreover, it is the admitted case of the plaintiff (para 4 of the plaint) that they had export orders to the tune of Rs.111 crores for the period upto 31-12-2007 and that they had foreign currency loans to the tune of USD 30 million. It is only by showing their foreign currency receivables and payables that the plaintiff entered into the ISDA Master Agreement. Therefore, they cannot now contend that this particular deal alone had no underlying exposure. Hence the second ground of attack is rejected as untenable. 109. Ground No.3: Relying upon paragraph-A.7 of the very same circular, it was contended on behalf of the plaintiff that the authorised dealers are obliged to ensure that the Board of Directors of the Corporate had drawn up a risk management policy, laid down clear guidelines for concluding the transactions and institutionalised ....
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....ory Appeals" where there is a commitment by the plaintiff to the Bank that it is acting within the bounds of law and that derivatives transactions are entered into only to hedge the actual liabilities of the company. 111. Mr.P.K.Viswanathan, who signed the above Declaration and Risk Disclosure Statement, was duly authorised by the resolution of the Board of Directors of the company, filed as plaint document no.3, to enter into derivatives transactions. From the date of the deal namely 22-6-2007, till the date of institution of the suit, the plaintiff did not raise a little finger about the lack of authority on the part of Mr.P.K.Viswanathan. Even when the plaintiff made the earliest attempt to wriggle out of the deal, through a letter dated 12-12-2007 (plaint document No.18), they did not disown Mr.P.K.Viswanathan or his actions. On the contrary, the very letter dated 12-12-2007 claiming that the entire structure got knocked out, was signed only by Mr.P.K.Viswanathan. Even in the subsequent letters and the meeting that Mrs.Rajshree had with the officilas of the Bank at Delhi, the validity of the declaration signed by Mr.P.K.Viswanathan was never questioned. Having allowed its au....
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....ground of attack of the plaintiff is based upon a clause in Annexure-VII under paragraph-A.6 (a) of the above Master Circular, whereby customers are permitted to purchase call or put options subject to the condition that no premium is received by the customer. Clause (d) of Annexure-VII of the Master Circular reads as follows:- "(d) i. Customers can purchase call or put options. ii. Customers can also enter into packaged products involving cost reduction structures provided the structure does not increase the underlying risk and does not involve customers receiving premium. iii. Writing of options by customers is not permitted. However, zero cost option structures can be allowed." The argument of the plaintiff is that the defendant-Bank paid USD 100,000 under OPT 727 and that the same amounted to payment of a premium and hence violative of the above stipulation contained in the Master Circular. 114. At the outset, I do not agree that the payment of USD 100,000 under OPT 727 was by way of premium. Even as per the letter dated 12-12-2007 of the plaintiff (plaint document No. 18) it was a payment in terms of the structure. The OPT 727 was confirmed by the plaintiff on 2....