November 02 2010
In ICICI Bank India Ltd v Official Liquidator of APS Star Industries Ltd(1) the principal question for consideration by the Supreme Court in a batch of civil appeals was whether the assignment of debts between banks was an impermissible activity under the Banking Regulation Act 1949 and whether, as a result, all executed contracts of assignment of debts were illegal.
In Civil Appeal 8393/2010 a deed of assignment was executed between Bank A and Bank B, whereby Bank A, as the assignor, agreed to sell and assign to Bank B (the assignee) all debts, together with interest on an 'as is, where is' basis. Bank B, in turn, had agreed to acquire the said debts on an 'as is, where is' basis. In consideration of Bank B paying the purchase price to Bank A for the purchase of the debts, the assignor had agreed to assign absolutely to the assignee on an 'as is, where is' basis, without the assignee having any recourse to the assignor. Consequently, Bank B became the full and absolute legal owner of the debts and, as such, the only party legally entitled to receive the repayments of debts.
Pursuant to the execution of the deed of assignment, Bank B initiated a company application in certain winding-up proceedings pending before the Company Court against one of the borrowers of Bank A, with the aim of being substituted in place of the original secured creditor, Bank A. The company application for substitution was moved at a stage of the provisional/final winding-up proceedings. In its application, Bank B maintained that according to the Banking Regulation Act, read with the relevant Reserve Bank of India Guidelines of July 13 2005, the sale and purchase of debts could be sold by loaners and purchased by banks or financial institutions as assignees. Since winding-up proceedings were pending before the Company Court at various stages, including the stage of disposing of the properties of the liquidated company, Bank B submitted that it had approached the Company Court to be substituted in place of the original secured creditor for the purposes of claiming relief.
However, the borrower company contended that the deed of assignment had not lawfully given the assignee the right to step into the shoes of the secured creditor, Bank A. The Company Court held that the rights as claimed were not acquired by Bank B through any process known in law, and that therefore Bank B could not be permitted to be substituted in place of Bank A as the secured creditor of the company in liquidation. Aggrieved, Bank B appealed to the Division Bench of the High Court. The High Court upheld the order of the Company Court on the grounds that the assignment of debts by banks was not an activity permissible under the Banking Regulation Act, and that consequently, the impugned deed of assignment was illegal and Bank B was not entitled to substitution in the place of Bank A.
Before the Supreme Court, Bank A argued that neither the assignor bank nor the assignee bank had ever traded in the debts. The reasons advanced were that the assignor bank had never purchased debts in the first place and had merely advanced loans against security which was a part of its banking business. It was contended that the assignor bank had decided to dispose of the debts along with the underlying security only once the same had been adjudged as non-performing assets.(2) Insofar as the assignee bank was concerned, it was similarly argued that it had merely acquired the debt along with the underlying security and had not sold the same, as is characteristic of the aspect of trading.
It was also argued that as 'banking companies' that were still companies incorporated under the Companies Act 1956, they were juridical entities that were inherently entitled to assign their debts. Making reference to the Reserve Bank of India Guidelines, it was also argued that a perusal of its contents would clearly indicate that the activity of banking was not confined merely to the core activities enumerated in Section 5(b) of the Banking Regulation Act, but also the ancillary business of banking regarding the assignment of debts.
The borrower company, on the other hand, argued that the business of banking is founded on the definitions of 'banking' and 'banking company' under Sections 5(b) and (c) of the Banking Regulation Act, and which restrict the same to accepting for the purposes of lending or investment, deposits of money. Such banking business, it argued, could by no stretch include the activity of assigning debts by accepting deposits under Sections 5(b) and (c).
The borrower company further argued that the assignment of the debt to Bank B transferred not only the right to recover the debt, but also the obligations arising thereunder, "as if they were executed by the clients of [Bank A] in favour of [Bank B]". According to the borrower company, such an assignment could never carry with it the assignment of the corresponding obligations of the assignor, unless there was a novation of the contract by all parties. It was submitted that in the absence of any novation, the deed of assignment was legally unsustainable.
Business of banking
The court categorised the functions of a banking company into two parts: the core function of accepting deposits and lending, and miscellaneous functions and services.
Referring to Section 6(1) of the Banking Regulation Act, the court observed that it was clear that in addition to the core business of banking, a banking company can also engage in one or more of the forms of business enumerated in Section 6(1)(a) to (o), including:
"doing all such other things as are incidental or conducive to the promotion or advancement of the business of the company and any other form of business which the Central Government may notify."
The court held that it was clear that apart from the principal business of accepting deposits and lending, the provisions of the Banking Regulation Act leave ample scope for banking companies to venture into new businesses, subject to the regulatory oversight of the Reserve Bank of India.
The court classified the aspect of assigning non-performing assets/debts between banks as falling under Section 6(1)(a), read with Section 6(1)(n) of the Banking Regulation Act, and observed that such functions of banks are subject to the regulatory supervision of the Reserve Bank of India for the purpose of developing a healthy secondary market. The court also upheld the validity of the impugned Reserve Bank of India Guidelines issued under Sections 21 and 35A of the Banking Regulation Act, and observed that the assignment of non-performing assets between banks is a legitimate activity undertaken by banks with a view to cleaning up their balance sheets so as to raise the capital adequacy ratio.
Does assignment of debt result in assignment of corresponding obligations?
Dismissing the contention of the borrower company, the court emphasised that the debts were assets of the assignor bank, and as such could always be transferred without affecting the rights or interests of the borrower company. The court held that the High Court had erred in failing to appreciate that the assignor bank was only transferring its rights under a contract and its own asset (ie, the debt), without in any manner affecting the rights of the borrower in the contract or in the assets. On considering the relevant clauses in the impugned deed of assignment, the court held that it was manifestly clear that no obligations of the assignor were assigned to the assignee. In fact, only the account receivables in the books of Bank A were assigned.
In the circumstances, the High Court's order regarding the question of assignment of debts as an activity permissible under the Banking Regulation Act was set aside.
The judgment comes as a welcome step towards addressing some of the outstanding issues relating to the nascent asset-backed securitisation market in regard to the purchase of a pool of debts by one bank from another.
For further information on this topic please contact Manu Nair or Saanjh Purohit at Amarchand & Mangaldas & Suresh A Shroff & Co by telephone (+91 11 2692 0500), fax (+ 91 11 2692 4900) or email (email@example.com or firstname.lastname@example.org).
(1) Civil Appeal 8393/2010 (arising out of SLP(C) 2240/2009), with Civil Appeal 8394-8406/2010 (@ SLP(C) 2241-2253/2009), Civil Appeal 8407-8425/2010 (@ SLP(C) 2254-2272/2009), Civil Appeal 8426/2010 (@ SLP(C) 25151/2009), Civil Appeal 8427/2010 (@ SLP(C) 20617/2009).
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