Banking Law Archives - Page 6 of 6

Sensing Fears, Shifting Gears: Did the RBI Steer in the Wrong Way?

RBI’S Prudential Framework for Resolution of Stressed Assets – Modus Operandi, Analysis and Implications

NBFCs – Unravelling the Indian Shadow Banks

Depositing A Post-Dated Cheque During Moratorium

1 Comment / Banking Law, Insolvency Law / CBCL

[ Vatsal Patel ] The author is a 3rd year student of Nirma University. Introduction The Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as“Act”) augmented by its 2018 Amendment Act[1](hereinafter referred to as“Amended Act”) has received wide-spread positive response from different sides of corporate sector.[2]The bringing in of the Act resulted in immediate shifting form a debtor-in-control regime to a creditor-in-control regime and is buttressed by a stipulated time period of 180/270 days for the completion process which is adhered to strictly by the National Company Law Tribunals (hereinafter referred to as“NCLTs”) all across the country. The moratorium period stipulated under Sec. 14 is one of the prominent feature of this act which restricts the continuation of the mentioned proceedings against the corporate debtor in case of an admission and subsequently, commencement of the Corporate Insolvency Resolution Process (hereinafter referred to as“CIRP”). Moreover, it has already been established that the moratorium does not apply to all proceedings in light of the NCLAT judgement in the case of Canara Bankv. Decan Chronicle Holding,[3]which noted the absence of the word “all” in Section 14 of the Act. The moratorium as prescribed for by Sec. 14, inter-alia, provides for prohibiting: “…(1)(c). any action to foreclose, recover or enforce any security interest created by the corporate debtor in respect of its propertyincluding any action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002” It would be pertinent to note that by virtue of Section 3(31) of the Act, a “security interest” would include a claim to property. Moreover, the term “property” as defined under Sec. 3(27) would include money. Therefore, the question that arises for consideration in this article is whether a cheque, more specifically, a post-dated cheque, the date of beginning of which falls within the stipulated moratorium period could be deposited during the moratorium period or would it be against the moratorium? In terms of an Example – Consider that A (Operational Creditor) contracted with B (Corporate Debtor) on 01.01.2019 for the supply of goods/services. For the same, cheques were issued by B to A dated 02.07.19 (first cheque), 02.07.20, 02.07.21 and 02.07.22. All these cheques were delivered on 01.01.2019 to the Operational Creditor. Subsequently, CIRP was initiated against the Corporate Debtor and moratorium was granted between 01.07.19 to 01.10.19. Therefore, the question that arises is whether A can encash the first cheque in the instant case? The answer to the aforementioned question could be related to the proposition of law which governs the date of payment of a cheque i.e. if the date of payment by cheque is the date on which the cheque is delivered then the payment has already happened and therefore, there is no bar to encashment via cheque and vice-versa. Supreme Court On Delivery Of Cheque The First Casethat comes for consideration is CIT, Bombayv. Ogale Glass Works Ltd.,[4] wherein the Supreme Court while dealing with a cheque which was not subsequently dishonoured held that the cheque would be considered to be payed on the date of its delivery. However, had the cheque been dishonoured, the same would not be the case. In the words of Supreme Court: “…The position, therefore, is that in one view of the matter there was, in the circumstances of this case, an implied agreement under which the cheques were accepted unconditionally as payment and on another view, even if the cheques were taken conditionally, the cheques not having been dishonoured but having been cashed, the payment related back to the dates of the receipt of the cheques and in law the dates of payments were the dates of the delivery of the cheques.”[5] The same position of law was supported by a three-judge bench of the Supreme Court in the case of K. Saraswathyv. P.S.S. Somasundaram Chettiar.[6] The Second Casethat comes for consideration is the case of Jiwanlal Achariyav. Rameshwarlal Agarwalla,[7]wherein themajority of the three-judge bench of the Supreme Court distinguished between a conditional and an unconditional payment while dealing with Section 20 of the Limitation Act, 1908. It was held that an ordinary cheque amounted to an unconditional payment if the cheque was subsequently honoured.[8]However, the court also considered a post-dated cheque to be a conditional payment for which the date of payment would not be the date of delivery but the date on which it was dated to begin. The case also distinguished from Ogale’sCase,[9]by stating that the issue before that court was not specifically in relation to a post-dated cheque and as such the court was not bound by that case. However, it is pertinent to note that the minority opinion by Justice R. S. Bachawat did not distinguish Ogale’scase from the instant case and as such held that Ogale’scase applied even to a post-dated cheque.[10]Thus, according to the minority opinion, even payment by a post-dated cheque related back to the date of delivery of the cheque in terms of payment. One would expect that the courts would rely on the aforementioned two cases for the payment in terms of delivery all types of cheque i.e. ante-dated, date of the delivery and post-dated. However, the Supreme Court has deviated from its established position of law. The Third Casethat arises for our consideration is the recent case of Director of Income Tax, New Delhiv. Raunaq Education Foundation,[11]wherein the Supreme Court dealt with an issue pertaining to a cheque which was delivered on 31.03.2002 and dated 22.04.2002. The court herein again relied on Ogale’s Case.[12]However, in doing so it did not distinguish between an ordinary cheque and a post-dated cheque and the payment of a post-dated cheque was also considered to be completed on the date of the delivery of the cheque. Conclusion Thus, on perusal of the aforementioned judgements it can be distinctly observed that the position of law in terms of the ordinary cheques is clear i.e. the date of delivery of cheque is the date of payment via cheque if the cheque is subsequently honoured. However, as far as post-dated cheques are concerned,

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The Law of Bank Guarantees: Important Tools of Modern Day Commercial Transactions

Banking Law / CBCL

The Law of Bank Guarantees: Important Tools of Modern Day Commercial Transactions. [Rangeet Poddar] The author is a 4th year B.A.LLB(Hons.) student of WBNUJS, Kolkata. Introduction According to Section 126 of the Indian Contract Act, a contract of guarantee is a contract to perform the promise, or discharge the liability of a third person in case of his default.[1] A bank guarantee is a contractual assurance that is given by the bank to a third party creditor. By virtue of this commercial instrument, the concerned bank undertakes liability on behalf of the principal debtor to fulfill his contractual obligation in the event of default. This secures the transaction by ensuring that no detriment is caused to the creditor. The nature of obligations of the principal debtor is primary while the obligations of the bank are secondary. By issuing a guarantee, a bank ordinarily undertakes to pay the amounts specified in the guarantee agreement to the beneficiary on demand made by him in accordance to predetermined terms and conditions.[2] The object of a bank guarantee is to ensure the due performance of certain works contracts. The guarantee can also be towards security deposit for a contract or of any kind.[3] In the case of State Trading Corp. of India Ltd. v. Jainsons Clothing Corp.[4], the Supreme Court held that the bank guarantee is a trilateral contract in which the bank has undertaken to unconditionally and unequivocally abide by the terms of the contract. It is an act of trust with full faith to facilitate free flow of trade and commerce in domestic or international trade or business. It creates an irrevocable obligation to perform the contract in terms thereof. On the occurrence of events mentioned in the guarantee contract, the bank guarantee becomes enforceable.[5] There are two types of guarantees: A conditional performance guarantee is one where the surety becomes liable to the party, claiming under the guarantee upon proof of breach of terms of the underlying contract, or on proof of both breach as well as the loss occurring from the breach. Under unconditional guarantee, the guarantor becomes liable to pay the beneficiary the stated amount whenever the demand is made in the manner provided for in the guarantee, without the need for that beneficiary to prove any breach or loss; the guarantor is bound to immediately perform the contract of guarantee without further requirements. The object of unconditional bank guarantees or on demand bank guarantees are to secure hassle-free commercial transactions. Where the bank unconditionally and irrevocably promises to pay on demand, the amount of liability undertaken in the guarantee without ‘demur or dispute’ under the terms of the guarantee, the liability of the bank is considered to be absolute and unequivocal.[6] An on-demand bank guarantee consists of three separate and substantially independent but formally accessory agreements, namely: The underlying transaction or main agreement The indemnity agreement between the account party or principal and the guarantor The on-demand instrument between the guarantor and the beneficiary[7] The question whether the guarantee is a conditional or an unconditional one payable on demand, is a matter of construction in each case from the terms of the bond.[8] Independent nature and encashment of the bank guarantee In Ansal Engineering Projects v Tehri Hydro Development Corporation[9], it was held by the Supreme Court of India that the bank guarantee is an independent and distinct contract between the bank and the beneficiary and is not qualified by the underlying transaction and the validity of the primary contract between the person at whose instance the bank guarantee was given and the beneficiary.[10] The question whether the express terms of the guarantee give rise to the contract of guarantee to be enforced will be the limited enquiry for deciding the rights and obligations flowing from such a guarantee. Bank guarantees are independent in nature.[11] It is a separate autonomous contract between the bank and the beneficiary and is not qualified by the underlying transaction and the primary contract between the beneficiary and the person at whose instance the bank guarantee is given.[12] In a bank guarantee it is not necessary to go beyond the guarantee contract between the creditor and the surety bank and one must not look at any other contract including the underlying or primary one. However the underlying contract comes into the picture only if the guarantee itself makes its encashment, subject to proof of performance of underlying contract as it happened in the Hindustan Construction case[13]. In that case, the bank guarantee was for securing mobilization advance given by State of Bihar and it was provided in the terms of the guarantee that the beneficiary would not have the unfettered right to invoke the guarantee in the event the obligations expressed in the clause of the original contract were not fulfilled by the contractor. In such exceptional scenarios, the bank guarantee loses its autonomous character and depends upon the result of inquiry to the underlying contract. [14] Besides such cases, the court does not interfere with the enforcement of bank guarantees and guarantee contracts are not qualified by underlying transactions.[15]Where the bank guarantee is unconditional and payable on demand or demur, the liability of the bank is absolute and does not depend on the ultimate decision of a pending case in a court or tribunal. The bank only has to ascertain the amount claimed within the terms of the guarantee.[16]The question of encashment of the bank guarantee is entirely upto the beneficiary to invoke the guarantee at any time as he deems to be proper.[17] The National Highways Authority v Ganga Enterprises and Another[18] case laid down that that bank guarantees furnished in the form of security for not withdrawing a bid is fundamentally different from withdrawal of offer before acceptance as per the statutory provisions of the Indian Contract act. In such cases, when a person withdraws his offer within a stipulated time, he has no right to claim the earnest money that he has given in the form of a bank guarantee.

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Bail-In Clause in the FRDI Bill: Is the Hysteria Justified?

Banking Law / CBCL

Bail-In Clause in the FRDI Bill: Is the Hysteria Justified? [Ayushi Singh] The author is a third-year student at National Law University, Jodhpur. “I can assure you, my friends, that it is safer to keep your money in a reopened bank than it is to keep it under a mattress.” – Franklin D. Roosevelt (March 12, 1933) The Financial Resolution and Deposit Insurance Bill, 2017, approved by the Cabinet, has been in the ring of fire, drawing protests from the opposition, regulatory bodies and citizens. Mamata Banerjee has vociferously asked for the withdrawal of the Bill, currently under consideration by the Joint Parliamentary Committee, calling it “the biggest assault on the financial security of the poor and middle class of the country.” The point of contention is the bail-in clause under section 52 of the Bill. The said provision is aimed at rescuing a financial institution on the brink of failure by making its creditors and depositors take a loss on their holdings.[1] The Finance Minister, Arun Jaitley, has tried to allay the fears of the public and has hinted that review and correction of the Bill will take place post-release of the Parliamentary Report. The implications of this clause on the deposits made by citizens added with the lack of clarifications from the Government have inflamed the fears of the people as majority of their savings are deposited in banks. ASSOCHAM Secretary General DS Rawat has also asked for withdrawal of this clause due to chances of the trust in the banking system being eroded. He opined that the clause may induce citizens into making bank-runs or scare them into withdrawing their deposits and protecting them in unproductive avenues like real estate, gold, jewellery and even in the unorganised and informal financial markets run by unscrupulous persons.[2] The bail-in clause is not a new concept; in fact, it may have been introduced with a view to keep up with the trends in the World Bank’s financial resolution policies. The Financial Stability Board, which acts as a regulatory body for banking systems globally, have endorsed the bail-in clause as a tool for resolution of financial bodies.[3] In 2014, the EU introduced the bail-in clause in its Bank Recovery and Resolution Directive under which 8% of an institution’s liabilities must be wiped out before any taxpayer support can be provided. This wipe-out has to be done via bail-in of deposits according to a fixed hierarchy as given in article 34 of the Directive.[4] The objective behind introduction of the bail-in clause was to prevent the colossal failure of the bail-out resolution process used during the 2008 financial crisis. The bail-out of “too-big-to-lose” financial corporations shifted the burden of their failure on the taxpayers; this is what these bodies are trying to avoid through the bail-in clause. The drive to accommodate the bail-in clause was validated when it was used successfully during the 2011 economic crisis in Denmark. The resolution was successfully accomplished through a well-formulated bank-package such that the resolution was completed over a weekend with no negative effect on ordinary customers.[5] Failures of the Bail-In Clause However, the implementation of bail-in has not always been rosy. During the 2013 crisis in Cyprus, the insured deposits of citizens were transferred for resolution while the deposits of financial institutions and government entities were fully repaid back. Depositors lost almost 50 per cent of their savings when a bail-in was implemented.[6] Post introduction of bail-in clause in the EU Directive with the hierarchy of deposits, Portugal’s bail-in package for Banco Espirito Santo in 2016 used five of the 52 senior bonds for resolution of its liabilities. Investors who had to suffer losses had threatened lawsuits, accusing the country of discriminating against holders of the same level of bonds and violating the pari passu principle of equal treatment to protect domestic bondholders.[7] In May 2017, the Economy Minister of Italy Pier Carlo Padoan ruled out the recourse of bail-in tool, in spite of the Directive, for the rescue of its two ailing regional banks. This is to safeguard citizens’ confidence in other banks which are already suffering from bad loans caused during recession.[8] Implementation and Procedural Transparency The stark contrast in the above headings display a major difference in the nature of implementation of bail-in clause. Denmark implemented the bail-in clause within the framework of a bank-package wherein the cap of insured amount deposited in banks was increased and a safety net was set up.[9] In Cyprus, the bank holiday was declared and ATMs were shut down, cutting complete access of money to the citizens.[10] Even with the Directive, it is difficult to ensure that the hierarchy of deposits defined is upheld by countries during use of bail-in tool. The International Monetary Fund, which has endorsed the bail-in tool, has also pointed out the need to implement it in an orderly and clear manner-[11] “The legal framework needs to be designed to establish an appropriate balance between the rights of private stakeholders and the public policy interest in preserving financial stability. Debt restructuring ideally would not be subject to creditor consent, but a “no creditor worse off” test may be introduced to safeguard creditors’ and shareholders’ interests.” The RBI in its Report of the Working Group on Resolution Regime for Financial Institutions has suggested that the bail-in tool be used with due care, only as an interim measure which works along with a plan for permanent resolution like sale, merger, etc.[12] Therefore, it is reiterated that if the bail-in clause is to be used, its implementation must be clarified by a fixed set of rules and regulations which would include a system of hierarchy defining the order of volatility of deposits. Another concern is with respect to the insurance cover for the deposits that has remained at Rs. 1 lakh for over two decades. A revision and increase in insurance cover for deposits could help deter financial failure of weaker banks, as once the health of banks becomes well-defined and public, existing depositors may be induced to make bank-runs to protect their savings and pensions in safer banks. The All India Reserve

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