Impact of RBI's master circular on willful defaulter


Court :
SUPREME COURT OF INDIA

Brief :
The facts very briefly are that the appellant-bank sanctioned Derivatives/Forward Contracts facility to respondent no.1 upto a limit of Rs.2,00,00,000/- (rupees two crores) only for the purpose of hedging foreign currency exposures by its letter dated 10.01.2006. On behalf of the respondent no.1-company, its Joint Managing Director acknowledged the receipt of the sanction letter dated 10.01.2006 of the appellant and accepted and agreed to be bound by the terms and conditions of the sanction letter as well as the annexures thereto being authorized by the resolution of the Board of Directors of the respondent no.1- company. Thereafter, on 17.01.2006 the appellant and the respondent no.1 entered into the International Swaps and Derivatives Association (ISDA) Master Agreement. Between January, 2006 to January, 2007 the appellant executed nine derivative transactions with the respondent no.1. On the request of the respondent no.1, the appellant enhanced the limit of Derivatives/Forward Contracts facility of the respondent no.1 to Rs. 10,00,00,000/- (rupees ten crores) only for the purpose of hedging adverse foreign exchange fluctuations and to enter into derivative transactions by letter dated 31.01.2007. During January, 2007 to August, 2007, the appellant executed various derivatives transactions with respondent no.1. In August, 2007, on the request of respondent no.1, the appellant once again increased the limit for Derivatives/Forward Contracts facility to Rs.20,00,00,000/- (rupees twenty crores) only for the purpose of hedging adverse foreign exchange fluctuations and entering into derivative transactions by letter dated 09.08.2007. On 06.09.2007, the appellant entered into derivative transactions FXOPT 20536, 20540 and 20544. Thereafter, on 05.03.2008 and 12.03.2008 the appellant informed the respondent no.1 that a sum of Rs.2,43,12,000/- (rupees two crores forty three lacs and twelve thousand) only had become due and payable on 10.03.2008 by the respondent no.1. The respondent no.1, however, did not pay the sum. On 01.07.2008 the Reserve Bank of India (for short ‘the RBI’) issued the Master Circular on Wilful Defaulters.

Citation :
Kotak Mahindra Bank Ltd. … Appellant Versus Hindustan National Glass & Ind. Ltd.& Ors. … Respondents

 

Reportable

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL No. 8916 OF 2012

 

(Arising out of SLP (C) NO. 29599 of 2009)

 

Kotak Mahindra Bank Ltd. … Appellant

Versus

Hindustan National Glass & Ind. Ltd.

& Ors. … Respondents

 

WITH

CIVIL APPEAL No. 8917 OF 2012

(Arising out of SLP (C) NO. 27730 of 2011)

 

Emcure Pharmaceuticals Ltd. & Anr. … Appellants

Versus

ICICI Bank Ltd. & Ors. … Respondents

AND

 

CIVIL APPEAL No. 8918 OF 2012

(Arising out of SLP (C) NO. 28477 of 2011)

 

Finolex Industries Limited & Anr. … Appellants

Versus

Reserve Bank of India & Ors. …

Respondents

 

J U D G M E N T

A. K. PATNAIK, J.

CIVIL APPEAL No. 8916 OF 2012

 

(Arising out of SLP (C) NO. 29599 of 2009)

 

Leave granted.

 

2. This is an appeal against the order dated 01.09.2009 of the Calcutta High Court in Writ Petition No. 7729(W) of 2009.

 

3. The facts very briefly are that the appellant-bank sanctioned Derivatives/Forward Contracts facility to respondent no.1 upto a limit of Rs.2,00,00,000/- (rupees two crores) only for the purpose of hedging foreign currency exposures by its letter dated 10.01.2006. On behalf of the respondent no.1-company, its Joint Managing Director acknowledged the receipt of the sanction letter dated 10.01.2006 of the appellant and accepted and agreed to be bound by the terms and conditions of the sanction letter as well as the annexures thereto being authorized by the resolution of the Board of Directors of the respondent no.1- company. Thereafter, on 17.01.2006 the appellant and the respondent no.1 entered into the International Swaps and Derivatives Association (ISDA) Master Agreement. Between January, 2006 to January, 2007 the appellant executed nine derivative transactions with the respondent no.1. On the request of the respondent no.1, the appellant enhanced the limit of Derivatives/Forward Contracts facility of the respondent no.1 to Rs. 10,00,00,000/- (rupees ten crores) only for the purpose of hedging adverse foreign exchange fluctuations and to enter into derivative transactions by letter dated 31.01.2007. During January, 2007 to August, 2007, the appellant executed various derivatives transactions with respondent no.1. In August, 2007, on the request of respondent no.1, the appellant once again increased the limit for Derivatives/Forward Contracts facility to Rs.20,00,00,000/- (rupees twenty crores) only for the purpose of hedging adverse foreign exchange fluctuations and entering into derivative transactions by letter dated 09.08.2007. On 06.09.2007, the appellant entered into derivative transactions FXOPT 20536, 20540 and 20544. Thereafter, on 05.03.2008 and 12.03.2008 the appellant informed the respondent no.1 that a sum of Rs.2,43,12,000/- (rupees two crores forty three lacs and twelve thousand) only had become due and payable on 10.03.2008 by the

respondent no.1. The respondent no.1, however, did not pay the sum. On 01.07.2008 the Reserve Bank of India (for short ‘the RBI’) issued the Master Circular on Wilful Defaulters.

 

4. The Master Circular on Wilful Defaulters (for short “the Master Circular”) contained instructions of the RBI to banks and financial institutions regarding reporting of wilful defaulters to other banks and financial institutions and the measures to be imposed on wilful defaulters by such banks and financial institutions. By letter dated 22.10.2008, the appellant intimated the respondent no.1 that it had classified the respondent no.1 as a wilful defaulter as it had defaulted to pay an amount of Rs.2,76,01,908.79 and interest thereon totalling to Rs.14,62,61,186.69 and respondent no.1 by its replies dated 04.11.2008 and 21.11.2008 through its Advocate contended that neither the appellant was a “lender” nor the respondent no.1 was a “borrower” within the meaning of “wilful default” in the Master Circular and, therefore, action under the Master Circular cannot be taken against the respondent no.1. By letter dated 02.02.2009, the appellant informed the respondent no.1 that the replies dated 04.11.2008 and 21.11.2008 of the respondent no.1 have been referred to the Grievance Redressal Committee of the appellant-bank for consideration and the Grievance Redressal Committee has fixed a meeting on 25.02.2009 at 10.00 A.M. at the office of the bank at Nariman Point, Mumbai, and that the respondent no.1 can represent its case in the hearing before the Grievance Redressal Committee.

 

The respondent no.1 then made a representation dated 06.03.2009 before the Grievance Redressal Committee of the appellant-bank contending that the Master Circular does not apply to foreign exchange derivative transactions and was restricted only to the acts of  ending by the bank and borrowing by the bank’s constituents and as there was no lending by the appellant-bank to the respondent no.1 in any manner from the appellant-bank, the entire proceedings against the respondent no.1 under the Master Circular should be dropped. While the matter was pending before the Grievance Redressal Committee, the respondent no.1 filed Writ Petition No.269 of 2009 before the Calcutta High Court and by order dated 27.03.2009 the Calcutta High Court dismissed the writ petition taking a view that the matter was pending before the Grievance Redressal Committee. Thereafter, on 07.04.2009, the Grievance Redressal Committee of the appellant-bank after hearing the respondent no.1, declared the respondent no.1 as a wilful defaulter under the Master Circular and further resolved that the respondent no.1-company and its directors be reported to the Credit Information Bureau (India) Ltd., RBI or such other institution/agency as may be required by RBI in terms of its Master Circular. The appellant accordingly intimated the aforesaid decision of the Grievance Redressal Committee of the appellant-bank to the respondent no.1 and the RBI by two separate letters dated 07.04.2008. Aggrieved, the respondent no.1 filed Writ Petition No.7729 (W) of 2009 in the Calcutta High Court and by the impugned judgment, the Calcutta High Court held that the Master Circular applied only to lending transactions of a bank or financial institution and as in the foreign exchange derivative transactions between the appellant and respondent no.1, there was no such lending transactions and the appellant was not the lender and the respondent no.1 was not the borrower, the respondent no.1 could not be declared as a wilful defaulter in terms of the Master Circular and accordingly no action could be taken against the respondent no.1 under the Master Circular. By the impugned judgment, the Calcutta High Court, therefore, set aside the decision dated 07.04.2009 of the appellant-bank and allowed the writ petition of the respondent no.1. Aggrieved, the appellant has filed this appeal.

 

5. Mr. C.A. Sundaram, learned senior counsel appearing for the appellant, submitted that the High Court has not correctly interpreted the Master Circular. He referred to the counter affidavit filed on behalf of the RBI before the High Court to show that the Master Circular had been issued by the RBI inter alia in exercise of its powers under the Banking Regulation Act, 1949 (for short ‘the 1949 Act’) and that Sections 21 and 35A of the 1949 Act make it clear that the directions/guidelines issued by the RBI are mandatory and binding on the clients. He argued that Paragraph 2.1 of the Master Circular defines the term “Wilful Default” as a default by a unit in meeting its payment/repayment obligations to the lender, but the word “lender” has not been defined in the Master Circular. He submitted that the RBI, which has issued the Master Circular, has in its counter affidavit before the High Court stated that the intention of the RBI while issuing the Master Circular was to cover all eventualities where “payment/repayment obligations” exist and therefore the Master Circular would cover all banking transactions including off balance-sheets transactions, such as, derivatives, guarantees, Letters of Credit, etc. He referred to Sections 45U of the Reserve Bank of India Act, 1934 (for short ‘the 1934 Act’), which defines in Clause (a) the word “derivative” and also to Section 45V of the 1934 Act which is titled “Transactions in derivatives” and submitted that the derivative transactions with banks had been declared to be valid by law. He submitted that the word “borrower” has been defined in Clause (b) of Section 45A of the 1934 Act to mean any person to whom any credit limit has been sanctioned by any banking company and has been still more widely defined in Clause (b) of Section 2 of the Credit Information Companies (Regulation) Act, 2005 (for short ‘the 2005 Act’) to mean not only a person who has been granted loan or any other credit facility by the credit institution, but also a client of a credit institution. He referred to the definition of “Client” in Clause (c) of Section 2 of the 2005 Act to show that “Client” includes a person who has not only obtained or seeks to obtain financial assistance from a credit institution, but also obtains assistance in any other form or manner. He submitted that Clause (d) of Section 2 of the 2005 Act defines the expression “credit information” more widely to include not only loans but any other non-funding based facility granted to all its borrowers as well as any other matter which the RBI may consider necessary for inclusion in the credit information to be collected. He submitted that the Foreign Exchange Management (Foreign Exchange Derivative Contracts) Regulations, 2000 (for short ‘the FEMA Regulations’) had been made by the RBI under Section 47 of the Foreign Exchange Management Act, 1999 (for short “the FEMA”) and Regulation 2(v) of the FEMA Regulations defines “foreign exchange derivative contract” to mean a financial transaction or an arrangement in whatever form and by whatever name called, whose value is derived from price movement in one or more underlying assets. He referred to Schedule-I of the FEMA Regulations to how that foreign exchange derivative contract was permissible for a person resident in India. Mr. Sundaram vehemently argued that as the purpose of the Master Circular is to ensure that the clients of the banks who had defaulted in their payment/repayment obligations of the dues to the banks are not given additional finance, a client of the bank who had defaulted in not paying its dues to the bank under a foreign exchange derivative transaction would also be covered under the Master Circular. He submitted that as the respondent no.1 had defaulted in making payment of Rs.1,56,08,084.70 as on 29.12.2008 on account of foreign exchange derivative transactions, the appellant was required by the instructions of the RBI in the Master Circular to report the case to the RBI as well as other banks and financial institutions as a wilful defaulter. He submitted that the High Court was, therefore, not right in setting aside the decision dated 07.04.2009 of the appellant-bank and allowing the writ petition of the respondent no.1.

 

6. Mr. Bhaskar P. Gupta, learned senior counsel for the respondent no.1, on the other hand, submitted that under the Master Circular a wilful default can arise only out of a lender –borrower relationship between the bank and its constituent and, therefore, unless the bank has given a loan or an advance to its constituent, the question of wilful default under the Master Circular does not arise. He submitted that a reading of the Master Circular would show that a declaration of a wilful defaulter has severe consequences for the party declared as a wilful defaulter, such as squeezing of credit under clause 2.5(a) of the Master Circular and criminal liability under clause 4.3 of the Master Circular.

 

He argued that considering the severe consequences that follow a declaration of wilful defaulter, the definition of “wilful default” in the Master Circular which refers to defaults in repayment obligations to a “lender” has to be strictly construed. He cited the decisions of this Court in Bijaya Kumar Agarwala v. State of Orissa [(1996) 5 SCC 1] and Sakshi v. Union of India & Ors. [(2004) 5 SCC 518] for the proposition that a statute enacting an offence or imposing a penalty is to be strictly construed. He submitted that a derivative transaction does not involve lending of funds by way of a loan or an advance by the bank to its constituent and, therefore, the dues under a derivative transaction will not fall in any of the sub-clauses (a) to (d) of clause 2, which defines a wilful defaulter for the purpose of the Master Circular. He argued that there is a fundamental difference between a loan/advance and a derivative transaction and the fundamental difference is that in the case of a derivative transaction, either party could be required to effect payment depending on the change in interest rate, foreign exchange rate credit rating or credit index, price of securities as will be clear from Section 45U of the 1934 Act, whereas in the case of a loan or an advance, it is the borrower alone which has to effect payment. He submitted that in none other circulars issued after the Master Circular of 01.07.2008 there is any change in the definition of ‘wilful defaulter’ so as to bring in defaulters of payment of dues under the derivative transactions within the meaning of ‘wilful defaulters’. In this context, he referred to the Master Circulars dated 01.07.2009, 01.07.2010, 01.07.2011 and 01.07.2012. He vehemently argued that if the RBI intended to include defaulters of dues under the derivative transactions within the meaning of the expression “wilful defaulter”, the RBI could have changed the definition of “wilful defaulter” in the subsequent Master Circulars.

 

7. Mr. Bhaskar P. Gupta next submitted that the stand of the RBI before the High Court in the affidavits filed on its behalf was that the question as to whether there was a lender-borrower relationship between the appellant and the respondent no.1 under the contract between them and whether there was a legally enforceable obligation between the appellant and the respondent no.1 are issues which can be determined by a civil court in a properly instituted suit in accordance with law and it is not possible for the RBI to interpret the contract between the appellant and the respondent no.1 and express any opinion in that regard and that determination of such issues arising under a contract cannot be done in a proceeding under Article 226 of the Constitution and hence the writ petition of the respondent no.1 was liable to be dismissed. He submitted that the RBI cannot now take a stand before this Court in this appeal that the respondent no.1 was a wilful defaulter covered by the Master Circular inasmuch as it had not paid its dues to the appellant under the derivative transactions. He submitted that if the RBI was aggrieved by the finding in the impugned judgment of the Calcutta High Court that the Master Circular did not apply to dues under a derivative transaction, it could have filed a Special Leave Petition under Article 136 of the Constitution against the impugned judgment of the Calcutta High Court, but the RBI has not done so. According to him, therefore, the impugned judgment of the Calcutta High Court should be sustained by this Court in this appeal.

Please check the full judgment in the attached file....

 

Bijoy Paul
on 22 April 2013
Published in Corporate Law
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