DIRECTOR’S PERSONAL GUARANTEE - A VOID AGREE
1.
Evolution of concept of legal entity
2. Effect of Incorporation : Company as separate
legal person
3. Limited Liability
4. General Powers of
Board
5. Borrowing
6.
Finances
7. Directors as agents
8. Share Qualification
9. Directors, etc., with unlimited liability in limited company
10. Registration of charges
11.
Director’s personal guarantee
12. What agreements are contracts
12.1 “Free consent” defined
12.2 Object is lawful
13. “Undue Influence”
13.1 Position of dominance necessary for
presumption to arise
13.2 Inequality of bargaining power
13.3 Judicial intervention for rescuing parties
from unreasonable terms
13.4 Agreement should be reasonable for the contract to be
upheld legal
13.5 Serious terms of a contract must be
specifically brought to the notice of the parties
14. What considerations and objects are lawful,
and what not
14.3
Conclusion
15.
DRT Act, 1993 and
SARFAESI Act 2002
16.
SARFAESI Act 2002
17.
Conclusion
and Recommendations
18. DENA
BANK
– A CASE STUDY
1.
Evolution of concept of legal entity
A division bench of Delhi High Court in J B Exports Ltd and
another vs. BSES Rajdhani Power Ltd (2006 134 Comp cas 106 Del. decided on
3.3.2006) observed that “the concept that a company is a distinct legal entity
apart from its shareholders, vide Salomon vs. Salomon & Co. (1897 AC 22 HL) had
a historical purpose. Its main purpose was to encourage entrepreneurs to start
new business ventures and, thus, help in the process of industrialisation.” This
background is so important that it merits consideration in detail as follows.
1.1
Delhi High Court further observed that “In every business there is a risk that
the business may fail due to recession, competition, etc. Hence, businessmen
were reluctant to set up new industrial ventures out of fear that if it failed,
recovery would be issued in respect of the loans they had taken and thereupon
even their household and personal effects may be sold in connection with the
recovery. Hence, businessmen were reluctant to take risks and start new
industrial ventures. To get over this hurdle and to encourage industrialisation
the legal principle was created that if a company is incorporated under the Act,
the liability of the shareholders becomes limited because the shareholders,
directors, etc., are legally treated as being different from the company. A
company was held to be a distinct legal entity separate from its shareholders
and directors. This legal principle gave protection to businessmen who were
otherwise reluctant to start new industrial ventures due to the risk involved.
Thus, this legal principle was of great help to industrialisation in Eurpoe
(where industrialisation first began during the Industrial Revolution) and there
after all over the world. “
2. Effect of Incorporation : Company as separate
legal person
As per Section 34 of the Companies Act, 1956 one of the
characteristics of a company is that it is an incorporated body of persons. It
is constituted into a distinct and independent person in law and is endowed with
special rights and privileges. Hon’ble Supreme Court in TELCO Vs. State of
Bihar (1964) 34 Com Cases 458 : AIR 1965 SC 40 observed as follows :-
“ …..The Corporation in law is equal to a natural person and
has a legal entity of its own. The entity of the corporation is entirely
separate from that of its share holders; it bears its own name and has a seal
of its own; its assets are separate and distinct from those of its members; it
can sue and be sued exclusively for its own purpose; its creditors cannot obtain
satisfaction from the assets of its members; the liability of the members or
shareholders is limited to the capital invested by them; similarly the creditors
or the members have no right to the assets of the corporation. This position is
well established ever since the decision in case of Salomon V. Salomon & Co.
1897 AC 22 was pronounced in 1897 and indeed, it has always been the well
recognized principle of common law. ..”
3. Limited Liability
Section 13 (2) the Companies Act, 1956 provides that “The memorandum of a
company limited by shares or by guarantee shall also state that the liability of
its members is limited.” This means that no member can be called upon to pay
anything more than the nominal value of the shares held by him, or so much
thereof as remains unpaid; and if his shares be fully paid up his liability is
nil.
3.1
“ The privilege of limiting liability for business debts is one the principal
advantages of doing business under the corporate form of organization {Cadman,
THE CORPORATION IN NEW JERSEY , 327 (1949)}. ” The company, being a separate
person, is the owner of its assets and bound by its liabilities. Members, even
as a whole, are neither the owners of the company’s undertaking, nor liable for
its debts. Where the subscribers exercise the choice of registering the company
with limited liability, the members’ liability becomes limited or restricted to
the nominal values of the shares taken by them or the amount guaranteed by them.
No member is bound to contribute anything more than the nominal value of the
shares held by him {J.H. Rayner (Mincing Lane) Ltd V. Deptt. of Trade and
Industry, (1989) 3 WLR 969 HL }. In a partnership, on the other hand, the
liability of the partners for the debts of the business is unlimited. They are
bound to meet, without any limit, all the business obligations of the firm. The
whole fortune of a partner is at stake, as the creditors can levy execution even
on his private property. Speaking of the advantage of trading with limited
liability, BUCKLEY J observed {London & Globe Finance Corpn, Re (1903) 1 Ch 728,
731}:
“The statutes relating to limited liability have probably done more than any
legislation of the last fifty years to further the commercial prosperity of the
country. They have, to the advantage of the investor as well as of the public,
allowed and encouraged aggregation of small sums into large capitals which have
been employed in undertakings of great public utility largely increasing the
wealth of the country.”
4. General Powers of
Board
Sub Section (1) of Section 291 of the Companies Act, 1956
provides as follows:-
“Subject to the provisions of this Act, the Board of Directors of
a Company shall be entitled to exercise all such powers, and to do all such acts
and things, as the Company is authorized to exercise and do ….”
5. Borrowing
Section 292 (1) (c) of the Companies Act, 1956 provides that “(1)
The Board of directors of a company shall exercise the following powers on
behalf of the company, and
it shall do so only by means of resolutions passed at meetings of the Board :-
(a)……………………… ……………………
(aa) …………………….
(b)……………………….
(c) the power to borrow moneys otherwise than on debentures;
A company cannot borrow money unless it is so authorized by its
memorandum. In the case of a trading company, it is not, however, necessary that
the objects clause of its memorandum should expressly authorise it to
borrow. As borrowing is incidental to trading, such a company has implied power
to borrow. Other companies must have a borrowing power clearly specified in the
memorandum.
6.
Finances
The company is the only medium of organising business
which is given the privilege of raising capital by public subscriptions either
by way of shares or debentures. Further, public financial institutions lend
their resources more willingly to companies than to other forms of business
organisation. The facility of borrowing and giving security by way of a floating
charge is also an exclusive privilege of companies. In New Horizons Ltd. v Union
of India, (1997) 89 Comp Cas 785 at 802 (Delhi) the hon’ble Delhi high court has
observed that “Capital in many cases is the life-blood of a concern, and it is
always a great misfortune where the development of a business is arrested or
restricted by want of capital.”
7. Directors as agents
It was clearly recognized as early as 1866 in Ferguson v Wilson (1866) LR 2 Ch
LR 77: 36 LJ Ch 67 : 15 LT 230. that directors are in the eyes of law, agents of
the company. The Court said:
“The company has no person; it can act only through directors and
the case is, as regards those directors, merely the ordinary case of principal
and agent.”
The general principles of agency, therefore, govern the relations of
directors with the company and of persons dealing with the company through its
directors. Where the directors contract in the name, and on behalf of the
company, it is the company which is liable on it and not the directors.
8. Share Qualification
Section 270 (1) of the Companies Act, 1956 provides as follows
“ Without prejudice to the restrictions imposed by section 266, it shall be
the duty of every director who is required by the articles of the company to
hold a specified share qualification and who is not already qualified in that
respect, to obtain his qualification within two months after his appointment as
director.”
By necessary implication it follows that a director may not hold
any share qualification at all, if he is not required by the articles of the
company to hold a specified share qualification.
9. Directors, etc., with unlimited liability in limited company
Section 322 (1) of the Companies Act, 1956 provides as follows
“ In a limited company, the liability of the directors or of any director or
manager may, if so provided by the memorandum, be unlimited. “
By necessary implication it follows that a director’s
liability is limited. As aforesaid, in para no. 3 above, section 13 (2) the
Companies Act, 1956 provides that “The memorandum of a company limited by shares
or by guarantee shall also state that the liability of its members is limited.”
Further, section 270 (1) of the Companies Act, 1956 provides that if not
required by the articles a director may not hold any share qualification.
Therefore, a director may not have at all even a limited liability for the debts
of the company, as a member as provided in section 13 (2) the Companies Act,
1956. This view has already been upheld by Delhi high court in Indian Overseas
Bank v. R. M. Marketing and Services Pvt Ltd (2001) 107 Comp Cas 606. The court
observed, inter alia, that “ ……. simply because they were directors of defendant
No. 1 they could not be fastened with the liability as defendant No. 1 which is
a company incorporated under the Companies Act is a separate legal entity.”
10. Registration of charges
Section 125 of the Companies Act, 1956
(hereinafter referred to as ‘the Act’)
is reproduced below for ready
reference:
125. Certain charges to be void against liquidator or creditors
unless registered
:
(1) Subject to the provisions of this part, every charge
created on or after the 1st day of April, 1914, by a company and being a charge
to which this section applies shall, so far as any security on the company's
property or undertaking is conferred thereby, be void against the liquidator and
any creditor of the company, unless the prescribed particulars of the charge,
together with the instrument, if any, by which the charge is created or
evidenced, or a copy thereof verified in the prescribed manner, are filed with
the Registrar for registration in the manner required by this Act within thirty
days after the date of its creation.
10.1
As per Section 125 of the Act the power to borrow includes the
power to mortgage the company’s assets or to create a charge upon them. The
reason is that lenders always insist on some security and the only security that
a company can give is to charge its assets. Any charge or mortgage created on
certain specified assets of a company must be registered with the Registrar of
Companies under Section 125 of the Act.
10.2
Section 139 of the Act is reproduced below for ready reference:
139. Power of Registrar to make entries of satisfaction and
release in absence of intimation from company.
The Registrar (i.e. the Registrar of Companies) may, on evidence
being given to his satisfaction with respect to any registered charge, -
(a) that the debt for which the charge was given has been paid or
satisfied in whole or in part; or
(b) that part of the property or undertaking charged has been released from
the charge or has ceased to form part of the company's property or undertaking;
enter in the register of charges
a memorandum of satisfaction in whole or in part, or of the fact that part of
the property or undertaking has been released from the charge or has ceased to
form part of the company's property or undertaking, as the case may be,
notwithstanding the fact that no intimation has been received by him from the
company.
By necessary implication it follows that
any charge / mortgage created by the
Banks on the Director's personal property / property of a third party,
even if unconsciously registered by ROC, is illegal being without
the authority of the Act, and therefore unenforceable at law.
11.
Director’s personal guarantee
Since long the banks and public financial institutions (hereinafter
collectively referred to as ‘the Banks’) have unilaterally and arbitrarily
developed a practice, without authority of law, to execute personal guarantee
agreements with the directors of a company to secure the debts of the company.
This view is supported by the
following latest judgment of the Supreme Court.
Recently, the Supreme Court in the case of Karnataka State Financial
Corporation vs N. Narasimahaiah & Ors. (2008 AIOL 348
Civil Appeal No. 610-612 of 2004 Decided on 13/03/2008) has observed as
follows (in para 18):
“18. Banking practice
may enable a financial corporation to ask for a collateral security. Such
security, we would assume, may be furnished by the Directors of a Company
but furnishing of such security or guarantee is not confined to the
Directors or employees or their close relatives. They may be outsiders also.
The rights and liabilities of a surety and the principal borrower are
different and distinct.” (emphasis supplied)
Therefore, it
stands concluded, without any doubt, that the banks have developed the
practice to execute personal guarantee agreements with the directors of a
company to secure the debts of the company without the authority of law.
This
practice is against the principle of limited liability of the shareholders
as well as directors of the company as provided in the Companies Act, 1956.
Accordingly, it is clearly against the letter and spirit of the Companies
Act and therefore unlawful.
12. What agreements are contracts
Section 10 of the Indian Contract Act, 1872 provides that - An
agreement between two or more parties becomes a contract when the following
conditions are satisfied:
(1) ……………………….
(2) ……………………….
(3) The parties’ consent is free.
(4) The parties’ object is lawful.
12.1 “Free consent” defined
“Consent is said to
be free when it is not caused by:
(1) ……………………
(2) undue influence, as defined in Section 16, or
(3) …………………...
(4) …………………...
(5) ……………………
Consent is said to be so caused when it would not have been given but for the
existence of such coercion, undue influence, fraud, misrepresentation or
mistake.”
12.2 Object is lawful
In P Ramanatha Aiyar’s The Law Lexicon 2nd
Edition 2007 the term “Object” is defined “As a noun, the end aimed at; the
thing sought to be accomplished (as) object aimed at; the aim or purpose (as)
object not authorized by law; the thing sought to be attained (as) object of the
law.”
The Hon’ble Supreme Court in the case of Gurmukh Singh v.
Amar Singh (1991) 3 SCC 79 has held that the word “object” would mean
the purpose and design which is the object of the contract. If it is opposed to
public policy which tends to defeat any provision of law or purpose of law, it
becomes unlawful and thereby it is void under Section 23 of the Contract Act.
Further, in P Ramanatha Aiyar’s The Law Lexicon 2nd
Edition 2007 the term “lawful” is defined as “By lawful, it means not contrary
to law, public policy or void ab-initio, or unlawful. (Order 23, Rule 3 C.P.C.
S.G. Thimmappa v. T. Anantha, AIR 1986 Kant 1, 4)
13. “Undue Influence”
Section 16 of the Contract Act provides that-
“(1) A contract is said to be induced by “undue influence” where the
relations subsisting between the parties are such that one of the parties is in
a position to dominate the will of the other and uses that position to obtain an
unfair advantage over the other.
(2) …………………………….
(3) Where a person who is in a position to dominate the will of
another, enters into a contract with him, and the transaction appears, on the
face of it or on evidence adduced, to be unconscionable, the burden of proving
that such contract was not induced by undue influence shall lie upon the person
in a position to dominate the will of other.” (Italics supplied)
13.1 Position of dominance necessary for
presumption to arise
The Privy Council in Raghunath Prasad v Sarju Prasad AIR 1924 PC 60 pointed out
the conditions for presumption to arise. Referring to sub-section (3) of Section
16, which provides for presumption of undue influence, Lord SHAW observed as
follows:
“By this sub-section three matters are dealt with. In the first
place, the relations between the parities to each other must be such that
one is in a position to dominate the will of the other. Once that position is
substantiated the second stage has been reached, viz., the issue whether
the contract has been induced by undue influence. Upon the determination of this
issue a third point emerges, which is that of onus probandi. The burden
of proving that the contract was not induced by the undue influence is to lie
upon the person who was in a position to dominate the will of the other.
Error is almost sure to arise if the order of these propositions be
changed. The unconscionableness of the bargain is not the first thing to be
considered. The first thing to be considered is the relations of these
parties. Were they such as to put one in a position to dominate the will of the
other?” (Emphasis supplied)
13.2 Inequality of bargaining power
The presumption
of undue influence may also arise from the fact that there is such an inequality
of bargaining power between the parties that one can cause economic duress to
the other. The decision of the Court of Appeal in Lloyds Bank v. Bundy (1975) 1
QB 326. is a remarkable illustration of the concept of inequality of bargaining
power.
A contractor borrowed a sum of money from a bank. He could not pay back in
time. The banker pressed for payment or for security. He suggested that his
father might mortgage the family’s only residential house. The bank officer
visited the father and obtained his signatures upon readymade papers. The
contractor still could not pay and the banker sought to enforce the mortgage
which might have meant throwing out of the family from its only residence.
Accordingly, Mr Bundy relied upon the unfair character of the mortgage. He was
allowed to set aside the mortgage.
13.3 Judicial intervention for rescuing parties
from unreasonable terms
In Central Inland Water Transport Corpn vs. Brojo Nath Ganguly ( 1986 3 SCC 156,
206 ) the Supreme Court has noted that the word “unconscionable” means
something as shows no regard for conscience and which is irreconcilable with
what is right or reasonable. The matter before the court was a service contract.
A clause in the contract empowered the employer (a Govt. undertaking) to remove
an employee by three months’ notice or pay in lieu. The employee, who contested
the validity of this clause, was removed by handing him over a three months’ pay
packet. The Supreme Court regarded the clause to be constitutionally as well as
contractually void. The court added that any term which is so unfair and
unreasonable as to shock the conscience of the court would be opposed to public
policy therefore also void under section 23 of the Contract Act. The
contract was not based upon a real consent. It was
rather an imposition upon a needy person. The term was unconstitutional because
it was so absolute that any officer could be made a target irrespective of his
conduct, good or bad. (Emphasis supplied)
13.4 Agreement should be reasonable for the
contract to be upheld legal
13.4
Commenting upon this expanding power of the court to relieve a
party from the consequences of his own contract, a learned writer J H Baker says
that “freedom of contract turns out to be a misleading guide when so many
contracts are not free in the economic sense. The notion of contract as
private legislation appears less attractive when legislation is always drawn up
one-sidedly. Judges are empowered to read in terms which are not there, or read
out terms which are there. They are to impose reasonableness.
Whatever is not reasonable is not law. If the parties have
agreed to something unreasonable, they should be treated as if they have not
agreed at all and released”. (emphasis
supplied)
13.5 Serious terms of a contract must be
specifically brought to the notice of the parties
13.5 Serious terms of a contract must be specifically brought
to the notice of the parties
The Bombay High Court in Road Transport Corpn Vs. Kirloskar
Bros Ltd ( AIR 1981 Bom 299 ) said that it is for the carrier to plead and prove
that the print on the receipt was brought to the notice of the consignor and
that he had agreed to and accepted the same. The Court held that it is necessary
that serious terms of a contract must be specifically brought to the notice of
the parties whose rights are sought to be curtailed. In Oriental Fire and
General Insurance Co Vs. New Suraj Transport Co (AIR 1985 All 136) the consignment
note was not even signed by the booking party or his agent, the Allahabad High
Court held that the consignor was not bound by a printed term about the
exclusive jurisdiction. The Court said that something more must be done than
merely printing the terms on consignment documents. (emphasis supplied)
13.6
In Road Transport Organisation of India vs. Barunai
Powerloom Weaver’s Coop Society Ltd ( 1994 84 Cal LT 174 ) the Calcutta High
Court held that the law requires that before making a person bound by any such
term ( a clause in a consignment note as to exclusive jurisdiction ) it must be
proved that the same was brought to the knowledge of the consignor in such a way
that it should seem to be the result of a mutual assent. In Grandhi Pitchaiah
Venkatraju & Co vs. Palukuri Jagannadham & Co ( AIR 1975 AP 32 ) where a
consignment way bill contained the words “subject to Calcutta jurisdiction”,
the Andhra Pradesh High Court ignored it since it was not one to which the
plaintiff assented. Following these principles in East India Transport Agency
vs. National Insurance Co ( AIR 1991 AP 53 FB ) the Andhra Pradesh High Court
came to the conclusion that a term as to the place of suit was not binding on
the insurer who had paid out the consignee and who was then suing the carrier
for the negligent loss of the goods unless it could be proved that the insurer
too was made or was otherwise aware of the terms.
13.7
The law plays in this respect the role of a parent. It has
been opined by the learned author Anthony T Kronman, in Paternalism and the Law
of Contracts, (1988) 32 Yale Law Journal 763 “A person who would give away too
much of his own liberty must be protected from himself, no matter how rational
his decision or compelling the circumstances.” Therefore, it is expected that
the DRT / Courts shall take suo motu cognizance of the legal gimmick being
played by the Banks in drafting their documents regarding Director’s personal
guarantee agreement and if the borrower / director has agreed to something
unreasonable, he should be treated as if he has not agreed at all and released
(J. H. Baker, From Sanctity of Contract to Reasonable Expectation, Current Legal
Problems 1979).
14. What considerations and objects are lawful,
and what not
Section 23 of Contract Act provides as follows-
“The consideration or object of an agreement is lawful, unless-
it is forbidden by law; or
is of such a nature that, if permitted, it would defeat
the provisions of any law; or
……………………………………….”
14.1 Defeat any Law
Sometimes the object
of, or the consideration for, an agreement is such that though not directly
forbidden by law, it would, if permitted, defeat the provisions of any law. Such
an agreement is also void.
14.2 Undercutting of Statutory Privileges
A term in a contract of carriage requiring that notice of loss must be given
within 30 days of the arrival of the goods has been held by the Supreme Court to
be contrary to and defeating Section 10 of the Carriers Act, 1865, which
prescribes a period of six months for the purpose. {(M. G. Bras v Prasad
Textiles, (1983) 3 SCC 61.}
In V. Raghunadha Rao v State of A. P., (1988) 1 Andh.
LT 461. It was held that - the clauses in question were an attempt to relieve
the State of its liability and the court said that a
State is not free to impose arbitrary or unjust clauses in
a public contract. (Emphsis supplied)
14.3 Conclusion
In
view of above discussion the following inferences may be drawn.
(1) The Companies Act provides that the directors of a company are not
liable for the debts of the company. This view has been upheld by Delhi High
Court in Indian Overseas Bank v. R. M. Marketing and Services Pvt Ltd (supra)
and subsequently by a Division Bench of Delhi High Court in J B Exports Ltd and
another vs. BSES Rajdhani Power Ltd (supra).
(2) It stands concluded that the agreement of personal guarantee of a
director being executed by the banks as a prerequisite, amounts to making the
liability of a director unlimited towards the debts of a company, which is
absolutely prohibited by the provisions of Companies Act, 1956.
(3) Further, the consent of a director is not free being obtained by
the banks by undue influence, because the company is in need of funds for its
working capital requirements and the banks have made the execution of agreement
of personal guarantee by a director a prerequisite for obtaining the working
capital limits from the banks.
(4) Section 23 of the Contract Act provides that every agreement of which the
object or consideration is unlawful, is void. Therefore, the agreement of
personal guarantee executed by a director is a void agreement, because its
object is unlawful as it defeats the provisions of the Companies Act, 1956.
(5)
Public servant disobeying law, with intent to cause injury to any person
:
Section
166 of Indian Penal Code, 1860 provides as follows-
“Whoever, being a public servant, knowingly disobeys any
direction of the law as to the way in
which he is to conduct himself as such
public servant, intending to cause, or knowing it to be likely that he will, by
such disobedience, cause injury to any person, shall be punished with simple
imprisonment for a term which may extend to one year, or with fine, or with
both.” The insistence of the banks for execution of personal guarantee by a
director amounts to disobeying the provisions of Companies Act, 1956, and
therefore, the officers of the banks have committed an offence punishable under
section 166 of IPC.
15.
DRT Act, 1993 and
SARFAESI Act 2002
Now let us examine some provisions of the DRT Act, 1993 and
Securitisation Act, 2002
15. Recovery Of Debts Due To Banks And Financial Institutions
Act, 1993 (hereinafter referred to as ‘the DRT Act’ )
Act to have overriding effect.
Section 34.
(1) Save as provided under sub-section (2), the provisions of
this Act shall have effect notwithstanding anything inconsistent therewith
contained in any other law for the time being in force or in any instrument
having effect by virtue of any law other than this Act.
(2) The provisions of this Act or the rules made thereunder shall
be in addition to, and not in derogation of, the Industrial Finance Corporation
Act, 1948 (15 of 1948), the State Financial Corporations Act, 1951 (63 of 1951),
the Unit Trust of India Act, 1963 (52 of 1963), the Industrial Reconstruction
Bank of India Act, 1984 (62 of 1984) , the Sick Industrial Companies (Special
Provisions) Act, 1985 (1 of 1986) and the Small Industries Development Bank of
India Act, 1989 (39 of 1989)].
15.1
Section 2
(g) of the DRT Act provides as
follows: "debt" means any liability (inclusive of interest) which is claimed
as due from any person by a bank or a financial institution or by a
consortium of banks or financial institutions during the course of any business
activity undertaken by the bank or the financial institution or the consortium
under any law for the time being in force, in cash or otherwise, whether
secured or unsecured, or assigned, or whether payable under a decree or
order of any civil court or any arbitration award or otherwise or under a
mortgage and subsisting on, and legally recoverable on, the date of the
application;
Admittedly, by the letter and spirit of the DRT Act, 1993 it
means ‘a debt’ is
due from a company
and not from its director or promoter.
15.2
When does the overriding effect operate:
As per the rules of interpretation the provisions of an Act are
to be interpreted keeping in view the object of enactment of that Act. The
important aspect to notice is that
the overriding effect of the provisions of the Act, scheme or
rules made thereunder would be that only when there is anything inconsistent
in the said Act or rules or scheme vis-a-vis the other laws or provisions.
If the rules or schemes made under the Act are silent on any particular subject
matter and the other law requires any particular action being taken in respect
there of,
such a law would have to be complied with.
As held by Hon’ble Supreme Court in the important decisions rendered in
Karunanidhi vs. UOI (1979) 3 SCC 431; Hoechst Pharmaceuticals Ltd vs. State of
Bihar AIR (1983) SC 1019 and other cases, the
material test of inconsistency is that both the provisions under
consideration should not be able to stand together
i.e., if one is followed, the other, in the result, would be violated. This may
arise by reason of direct conflict or indirectly by the later law occupying the
same field, as the earlier one. It is in this context that in several schemes of
the BIFR where fresh issue of share capital in case of merger or other cases is
envisaged, the approval of the Controller of Capital Issues earlier required
under the Capital Issues (Control) Act, 1947 has been specifically put out of
the way.
15.3
Hon’ble Supreme Court in Maharashtra Tubes Ltd. Vs SICOM
(1993) 78 Comp Cas 803 (SC), held that the
special legislation SICA, 1985 was to prevail over the provisions
of the earlier special legislation State Financial Corporations Act, 1950.
Therefore, it would be a case of misdirecting oneself, if he assumes that DRT
Act,1993 shall override each and every law for the time being in force in India.
15.4
For example the mandate of Section 22 (1) of SICA,1985 had
always an overriding effect on the initiation or continuance of proceedings
before DRT under the DRT Act ,1993, whereas the DRT Act,1993 is a later special
Act than SICA,1985 and also has a non-obstante clause in section 34 of DRT Act,
1993. It is pertinent to note that subsequently SICA, 1985 has been included in
section 34 (2) of DRT Act, 1993 by the Amendment Act, 2000 with effect from
17-01-2000.
16. SARFAESI Act 2002
16.
The Securitisation And Reconstruction Of Financial Assets and
Enforcement Of Security Interest Act, 2002
(hereinafter referred to as ‘the SARFAESI Act’ )
Section 2(f).
"borrower" means any person who has been granted financial assistance by
any bank or financial institution or who has given any guarantee or
created any mortgage or pledge as security for the financial assistance
granted by any bank or financial institution and includes a person who becomes
borrower of a securitisation company or reconstruction company consequent upon
acquisition by it of any rights or interest of any bank or financial
institution in relation to such financial assistance;
Section 17.
Right to Appeal.
(1)
Any person (including borrower), aggrieved by any of the measures referred to in
sub-section (4) of section 13 taken by the secured creditor or his authorised
officer under this Chapter, may make an application, along with such fee, as
may be prescribed, to the Debts Recovery Tribunal having jurisdiction in the
matter within forty-five days from the date on which such measure had been
taken.
Sub-section (2) to (6)…………………………………………………………….
(7) Save as otherwise provided in this Act (i.e.
‘the SARFAESI Act’),
the Debts Recovery Tribunal shall, as far as may be, dispose of the application
in accordance with the provisions of the Recovery of Debts Due to Banks and
Financial Institutions Act, 1993 (51 of 1993) and the rules made thereunder.".
16.2. Section 37. Application of other laws not barred
–
The provisions of this Act or the rules made thereunder
shall be in addition to, and not in derogation of, the Companies Act,
1956 (1 of 1956), the Securities Exchange Board of India Act, 1992 (15 of 1992),
the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (51 of
1993) or any other law for the time being in force.
17. Conclusion and Recommendations
From a combined reading of paras 15 and 16 above the following inferences may
be drawn.
(1) The DRT, while hearing appeals under section 17 of the
SARFAESI Act, can not override
provisions contained
in any other law
for the time being in force, as the DRT has to act in accordance with Section
17(7)
of the
SARFAESI Act, which provides
“Save as otherwise provided in this Act ”. And
Section 37 of the SARFAESI
Act provides “Application of other laws not barred”.
(2) The director should immediately file a declaratory suit in a Civil Court
to get
cancelled
the director’s personal guarantee, because Section 2(f)
of the SARFAESI Act provides that "borrower" means any person who
has been granted financial assistance by any bank or financial institution or
who has given any guarantee.
(3) Similarly, the director should immediately file an
application before the Registrar of Companies to get cancelled the charge
created on the personal property of director / any third party, because
Section 2(f) of the SARFAESI Act provides that
"borrower" means any person who has been granted financial assistance by
any bank or financial institution or who has given any guarantee or
created any mortgage or pledge as security for the financial assistance
granted by any bank or financial institution. And as per Section 139 of the
Companies Act, 1956 the Registrar has power to enter in the register of charges
a memorandum of satisfaction in whole or in part, or of the fact that part of
the property or undertaking has been released from the charge or has ceased to
form part of the company's property.
(4) However,
some grounds of defence may also be raised by the guarantors as per the
latest judgment of the Supreme Court in the case of
Karnataka State Financial Corporation vs N. Narasimahaiah & Ors.
(supra) in which the Court has observed as follows (in para 18):
“……….. Apart from the
defences available to a principal borrower under the provisions of the
Indian Contract Act, a surety or a guarantor is entitled to take
additional defence. Such additional defence may be taken by the
guarantor not only against the corporation but also against the principal
debtor. He, in a given situation, would be entitled to show that the
contract of guarantee has come to a not. Ordinarily, therefore, when a
guarantee is sought to be enforced, the same must be done through a court
having appropriate jurisdiction. In the absence of any express
provision in the statute, a person being in lawful possession cannot be
deprived thereof by reason of default on the part of a principal borrower.”
(5) The
Supreme
Court in the latest judgment in the case of Karnataka State Financial
Corporation vs N. Narasimahaiah & Ors. (supra) has further
observed as follows (in para 30):
“30. Right
of property, although no longer a fundamental right, is still a
constitutional right. It is also human right. In absence of any provision
either expressly or by necessary implication, depriving a person therefrom,
the court shall not construe a provision leaning in favour of such
deprivation.”
(6) Law declared by
Supreme
Court to be binding on all courts- Article 141 of the Constitution of India
provides that “the law declared by the Supreme Court shall be binding on all
courts within the territory of India.” Therefore, the ratio of the judgment
of Supreme Court in Karnataka State Financial Corporation vs N.
Narasimahaiah & Ors. (supra) given above, in para 4 and 5, is binding on
the Debts Recovery Tribunals and other authorities under the DRT Act, 1993
and the Securitisation Act, 2002 respectively.
18. DENA BANK – A CASE STUDY
(Letter of Guarantee)
(01).
An extract of paragraph no. 1 of Letter of Guarantee of Dena Bank is reproduced
below for ready reference –
“In consideration of Dena Bank (hereinafter called ‘the
Bank’) giving/having given credit accommodation or granting/having following
credit facilities viz : ……….to ‘M/s. P’ ………………by making, opening, continuing a
loan/overdraft/cash credit account or the discounting put on ……….and/or
negotiating bills with or without security and/or in consideration of Bank
opening and giving the credit and/or Trust receipt in favour of ________ on
terms and conditions that may be settled between you and the said _______ at any
time and from time to time with reference to me ‘Mr. K’ residing at
_______________ jointly and severally and irrevocably hereby agree with and
guarantee to you the due payment and discharge (within) two days after demand
and writing, without demur or protest of all amounts due and payable to you by
‘M/s. P’ (hereinafter called ‘the Principal’) at any time …………..”
(02).
An extract of paragraph no. 3 of Letter of Guarantee of Dena Bank is reproduced
below for ready reference –
“………… The Guarantee shall continue in force notwithstanding the discharge of
the Principal by operation of law
or my death or the death of any of us and
shall cease only on payment of the amount guaranteed hereunder either by me or
any of us.”
COMMENTS:
1. What considerations and objects are lawful, and what not-
Section 23 of Indian Contract Act, 1872 provides as follows-
“The consideration or object of an agreement is lawful, unless-
it is forbidden by law; or
is of such a nature that, if permitted, it would defeat the provisions of any
law; or ……………………………………….”
1.1 Defeat
any Law
Sometimes the object of, or the consideration for, an
agreement is such that though not directly forbidden by law, it would, if
permitted, defeat the provisions of any law. Such an agreement is also void.
The object of para 3 of the Letter of Guarantee is unlawful, because it seeks
to make the guarantor liable for payment of the amount guaranteed even if the
Principal is discharged by operation of law i.e. by operation of the Companies
Act, 1956 and any other applicable law. Therefore para 3 is void as per section
23 of Contract Act, because if permitted it would defeat the provisions of the
Companies Act, 1956.
(03).
An extract of paragraph no. 4 of Letter of Guarantee of Dena Bank is reproduced
below for ready reference –
“ …………. I/We also agree that I/We shall not be discharged from my/our
liability by your releasing the Principal or by any act or omission of yours the
legal consequence of which may be to discharge the Principal or by any act of
yours which would but for this present provision be inconsistent with my/our
rights as surety or by your omission to do any act, which, but for this present
provision your duty to me/us would have required you to do. I/We hereby consent
to each and every of the acts mentioned above as you may think fit. Moreover
though as between the borrower and me/us, I am/We are sureties only, I/We agree
that as between yourselves and me/us I am/We are borrowers jointly with him
accordingly I/We shall not be entitled to any of the rights conferred on
sureties by Section 133, 134, 135, 139 and 141 of the Indian Contract Act.
COMMENTS:
1. Surrender
of Rights
The consent of the Guarantor is obtained by undue influence by the Bank
therefore, Para 4 of the Letter of Guarantee is voidable.
1.1
In Muniammal v Raja, AIR 1978 Mad 103 hon’ble Madras High
Court held that a wife who is entitled to maintenance can give up her right in
consideration of a lump sum payment, but the surrender of the right to claim
revision of the amount in the context of rising prices would be opposed to
public policy and therefore, would be void under section 23 of the Contract Act.
1.2
In Bhaskar Tanhaji Dhokrat v Parwatbai, (1996) 1 Bom CR 311, hon’ble Bombay High
Court held that a custom to the effect that legal right to maintenance would
become surrendered would be contrary to law if it is destructive of those rights
without alternative security.
1.3
Ordinarily, an agreement to give up one’s legal right is
not hit by Section 23 of the Contract Act. The hon’ble Supreme Court in the case
of BOI Finance Ltd v Custodian, (1997) 10 SCC 488: AIR 1997 SC 1952: (1997) 89
Comp Cas 74: (1997) 25 CLA 115, held that what makes an otherwise legal
agreement to be void is that its performance is impossible except by
disobedience of law. It is submitted that, in author’s view,
performance of para
4 of Letter of Guarantee is not possible except by disobedience of the
provisions of the Companies Act, 1956; further the performance of para 4 of
Letter of Guarantee is not possible except by disobedience of the provisions of
the Contract Act, because it coerces the Guarantor to act in dual legal
capacity, firstly as surety, and, secondly as borrower jointly
with the Principal simultaneously.
1.4
Hon’ble Karnataka High Court in the case of City Municipal
Council v C. Ramu, ILR 1989 Kant 2138 and Suresh Mahajan v Myveneers, ILR 1990
Kant 2910 held that in order to attract section 23 of the Contract Act, it is
not necessary that the contract should be tainted with illegality. It would be
enough if it contains terms which are so unfair and unreasonable that they shock
the conscience of the court.
1.5
However, in a subsequent judgment the Karnataka High Court
in the case of T. Raju Shetty v Bank of Baroda, AIR 1992 Kant 108, held that
this general observation is not applicable where a guarantor agrees not to claim
the benefit of Sections 133, 134, 135, 139 and 141 of the Contract Act which
give to the guarantor certain protective rights. Such rights being variable with
the consent of the surety, there is no violation of the Contract Act if he
agrees not to claim any of those rights. (It is respectfully submitted that this
judgment is distinguishable and not applicable in the context of the case in
hand, because the initial consent of the guarantor is obtained by undue
influence and therefore, his rights as surety being variable only with his free
consent, however subsequent consent is also obtained by undue influence
and therefore, such terms of the Letter of Guarantee are voidable under section 23
of the Contract Act.)
1.6
The conduct of the Bank in inserting such onerous terms, which
are contradictory to each other, in the same para 4 of Letter of Guarantee
amounts to approbate and reprobate at the same time, which is unlawful and
therefore such terms of the Letter of Guarantee are void under section 23 of the
Contract Act. It contains terms which are so unfair and unreasonable that they
would certainly shock the conscience of the court.
(04).
An extract of later part of paragraph no. 4 of Letter of Guarantee of Dena Bank
is reproduced below for ready reference –
“ ……… And for all the purposes of this claim the Principal is
empowered to give consent on my/our behalf and any consent given by the
Principal shall be deemed to have been given by me/us in all respects as if the
same had been expressly given by me/us in writing.”
COMMENTS:
Surrender of
Rights
It is evident as the Day Light that the Principal is empowered to give
consent on behalf of surety, which appears quite illogical, the inescapable
conclusion is that the consent of the Guarantor is obtained by undue influence
by the Bank therefore, Para 4 of the Letter of Guarantee is voidable. It contains
terms which are so unfair and unreasonable that they would certainly shock the
conscience of the court.
(05).
An extract of paragraph no. 5 of Letter of Guarantee of Dena Bank is reproduced
below for ready reference –
“The Bank may recover against me/us to the extent herein before
mentioned notwithstanding that the Principal or his agents, partners, directors
or officers may have exceeded his or their powers or that the arrangements with
the Bank may have been ultra vires and without being bound to enforce its claim
against the borrower of any other person or other security held by the Bank. The
Bank shall not be bound to inquire into powers of the Principal or his agents or
partners, directors or officers purporting to act on behalf of the borrowers and
all moneys dues or liabilities incurred shall be deemed to form part of the
present guarantee notwithstanding that the Principal or his agents, partners,
directors and officers may have exceeded his or their powers or the arrangement
with the Bank may have been ultra vires.
COMMENTS:
Surrender of
Rights
The consent of the Guarantor is obtained by undue influence by the Bank
therefore, Para 5 of the Letter of Guarantee is voidable. Further, it is clearly
against the principles contained in section 13 (1) of the Companies Act, 1956,
as for ultra vires acts of his agents, directors and officers the Principal
itself is not liable. It contains terms which are so unfair and unreasonable
that they would certainly shock the conscience of the court.
(06).
An extract of paragraph no. 6 of Letter of Guarantee of Dena Bank is reproduced
below for ready reference –
“I/We waive in the Bank’s favour all or any of my/our
rights against the Bank or the Principal as may be necessary to give effect to
any of the provisions of this guarantee.”
COMMENTS:
Surrender of
Rights
The consent of the Guarantor is obtained by undue influence by the Bank
therefore, Para 6 (and also para 7) of the Letter of Guarantee is voidable. It
contains terms which are so unfair and unreasonable that they would certainly
shock the conscience of the court.
(07).
An extract of paragraph no. 10 of Letter of Guarantee of Dena Bank is reproduced
below for ready reference –
“…………. if the Principal shall become insolvent or go into
liquidation or compound with his creditors, the Bank shall be at liberty without
discharging my/our liability to make or assent to any compromises, compositions
or arrangements or prove and to rank as creditor in respect of the amount
claimable by the Bank or any items thereof ………………….. to the entire exclusion and
surrender of my/our rights as sureties in competition with the Bank (and) any
rule of law or equity to the contrary notwithstanding. And I/We shall not be
paying off the sum guaranteed or any part thereof or upon any other ground prove
or claim to prove in respect of the sum guaranteed or any part thereof or take
advantage of any securities held by the Bank until the whole of your claim
against the Principal has been satisfied.”
COMMENTS:
1.
Surrender of Rights
The consent of the Guarantor is obtained by undue influence by the Bank
therefore, Para 10 (and also para 11) of the Letter of Guarantee is voidable. It
contains terms which are so unfair and unreasonable that they would certainly
shock the conscience of the court.
1.1
Further, section 28 of the Contract Act provides that
Agreements in restraint of legal proceedings void –Every agreement –
a)
by which any party thereto is restricted absolutely from
enforcing his rights under or in respect of any contract, by the usual legal
proceedings in the ordinary tribunals, or which limits the time within which he
may thus enforce is rights;
The use of the words “………………….. to the entire exclusion and surrender of
my/our rights as sureties in competition with the Bank (and) any rule of law or
equity to the contrary notwithstanding” in para 10 violates section 28 of the
Contract Act, hence Para 10 of the Letter of Guarantee is void.
(08).
An extract of paragraph no. 15 of Letter of Guarantee of Dena Bank is reproduced
below for ready reference –
“The guarantee hereby given is independent and distinct from any
security that the Bank has taken or may take in any manner whatsoever whether it
be by way of hypothecation/pledge and/or mortgage and/or any other charge over
goods, movables, ……………………………… and I/We (and) the Guarantor will not claim to be
discharged to any extent because of the Bank’s failure to take any of other such
security or in requiring or obtaining any or other such security or losing for
any reason whatsoever, including reasons attributable to its default and
negligence, benefit of any or other security or any of rights to any or other
such security that have been or could have been taken.”
COMMENTS:
1. Surrender
of Rights
The consent of the Guarantor is obtained by undue influence by the Bank
therefore, Para 15 of the Letter of Guarantee is voidable. It contains terms which
are so unfair and unreasonable that they would certainly shock the conscience of
the court.
1.1 Public Policy
An agreement is unlawful if the court regards it as opposed
to public policy. The term “public policy” in its broadest sense means that
sometimes the courts will, on considerations of public interest, refuse to
enforce a contract (Thomson- CSF v National Airport Authority of India, AIR 1993
Del 252). The normal function of the courts is to enforce contracts; but
considerations of public interest may require the courts to depart from their
primary function and to refuse to enforce a contract (See Lord Wright in Fender
v St John Mildmay, (1938) AC 1, at p. 38).
1.2
Explaining the scope of the expression “public policy” and the role of the
judge, C. Reddy J of the Andhra Pradesh High Court observed in Ratanchand
Hirachand v Askar Nawaz Jung, AIR 1976 AP 112:
“The twin touchstones of public policy are advancement of the public good and
prevention of public mischief and these questions have to be decided by judges
not as men of legal learning but as experienced and enlightened members of the
community representing the highest common factor of public sentiment and
intelligence.”
Indorsing this view, the Supreme Court in Ratanchand
Hirachand v Askar Nawaz Jung, (1991) 3 SCC 67 added that going by prevailing
social values, an agreement having tendency to injure public interest or public
welfare is opposed to public policy.
1.3
Unfair or Unreasonable Dealings
Where the parties are not economically on equal footing and there is a wide
gap in the bargaining
power
of the parties, where one of them is in a position to exploit and the other is
vulnerable and the contract made with that other is apparently unfair, it can in
circumstances be also regarded as opposed to public policy.
For example, the Supreme Court has laid down in Central
Inland Water Transport Corpn vs. Brojo Nath Ganguly ( 1986 3 SCC 156, 206 ) that
a Government corporation imposing upon a needy employee a term that he can be
removed just by three month’s notice or pay in lieu of notice and without any
ground is an exploitation and every ruthless exploitation is against public
policy.
In reference to the conduct of public financial
institutions holding shares in companies, it has been held by the
Supreme Court
in the case of N. Parhasarthi v Controller of Capital Issues, (1991) 3 SCC 153,
arising out of the L & T mega issue, that a surreptitious transfer of a bulk
shares in one company without caring to see whether it would result in the
creation of a monopoly adverse to public interest, if it is done with a mala
fide intention, the deal would be illegal.
1.4 The
officers of the bank have committed an offence punishable under sections 166 and
167 of IPC.
(i)
Section 166 of Indian Penal Code, 1860 provides - Public servant disobeying law,
with intent to cause injury to any person
“Whoever, being a public servant, knowingly disobeys any direction of the law
as to the way in which he is to conduct himself as such public servant,
intending to cause, or knowing it to be likely that he will, by such
disobedience, cause injury to any person, shall be punished with simple
imprisonment for a term which may extend to one year, or with fine, or with
both.”
(ii)
Further, Section 167
of Indian Penal Code, 1860 (hereinafter called ‘IPC’) provides -
Public servant farming an
incorrect document with intent to cause
injury – “
Whoever,
being a public servant, and being, as such public servant, charged with the
preparation or translation of any document or electronic record, frames,
prepares or translates that document or electronic record in a manner which he
knows or believes to be incorrect, intending thereby to cause or knowing it to
be likely that he may thereby cause injury to any person, shall be punished with
imprisonment of either description for a term which may extend to three years,
or with fine, or with both.”
1.5 Firstly, the
the preparation of illegal document by the bank for execution of personal
guarantee by a director amounts to disobeying the provisions of the Contract
Act, 1872 and therefore, the officers of the bank have committed an offence
punishable under section 167 of IPC. Secondly, the insistence of the bank
for execution of personal guarantee by a director amounts to disobeying the
provisions of Companies Act, 1956, and therefore, the officers of the bank have
committed an offence punishable under section 166 of IPC.
