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SC ruling on validity of amended Section 45-S of RBI Act

R.N. Sahai

The prohibition on partnership firms to carry on their business like that of shroffs cannot be regarded as being an unreasonable restriction on the fundamental right of the appellants to carry on their trade. They can continue lending money as long as th ey do not borrow from the public. Section 45-S does not violate Articles 19(1)(g) or 14 of the Constitution.

It is open to the appellants to organise their business within the permissible legal set up by forming non-banking financial corporations and functioning in accordance with Chapter III-B of the Reserve Bank of India Act, 1934 (`the RBI Act') and the dire ctives issued by the RBI from time to time.

The impugned Section 45-S does not in any way prohibit or restrict any unincorporated body or individual from carrying on the business that it likes. It is open to unincorporated bodies to carry on their financial business either from their own funds or the funds borrowed from their relatives or from financial institutions.

That was the judgment of the Supreme Court in Bhavesh D. Parish vs. Union of India (Writ petition (c) no. 168 of 1997 decided on May 12, 2000) dismissing the writ petition of the shroffs. The judgment was by a Division Bench comprising Mr. Justice B.N. K irpal and Mr. Justice M.B. Shah.

In this case, the background facts are that the trade of business of shroffs in India has been in existence for a long time. This trade is carried on not only in cities but also in small towns and villages in parts of India.

The appellants are shroffs engaged in the business of providing credit to the members of the public. The traditional mode of organising the business of shroffs over the past several decades had been by way of partnership firms.

The nature of the services practiced by the appellants generally involved maintaining a mutual current account where the customer may either place deposit on call or withdraw money on call, without security. The financing activity of the shroff firms was through capital contributions of the partner/proprietor and deposits made by members of the public.

The Reserve Bank of India (`RBI'), which is constituted as the Central Banking Authority by the RBI Act is, inter alia, vested with various powers to regulate the currency and the credit system of the country. It includes the power to issue directions to non-banking institutions receiving deposits and to financial institutions.

In order to place some restrictions on the acceptance of deposits by unincorporated bodies, by the Banking Laws (Amendment) Act, 1983 Chapter III-C and Section 58-B(5A) were inserted into the RBI Act. The relevant portion of principal restrictions in Cha pter III-C was contained in Section 45-S. The Constitutional validity of Section 45-S of the Act was upheld by the Delhi High Court and the Supreme Court.

Section 45-S as originally incorporated did not have the desired effect. The non-corporate sector was virtually free from all disciplines. So to rectify this imbalance, an ordinance was issued which sought to completely prohibit any receipt of deposits b y unincorporated associations in the non-corporate sector. When certain hardships were pointed out the Act which replaced the ordinance, watered down the rigour to some extent.

But the appellants, who carry on the business of `shroffs', challenged the validity of Section 9 of the Reserve Bank of India Act as amended by the Amendment Act, 1997 (`the Act') on the ground that the said provision is violative of Articles 14 and 19(1 )(g) of the Constitution of India. This meant challenge to newly incorporated Section 45-S.

The case of the appellants was that the firms of shroffs or individual shroffs as a result of amendment to Section 45-S, will not be allowed to accept any deposit from the public for the purposes of their business activities. The shroffs will now be comp elled to convert from partnership firms into limited companies. Further, the shroffs provided the facility of deposit loan transactions 24 hours a day to customers such as agriculturists, such as cotton farmers, tobacco farmers, vegetable producers etc. who had a seasonal need for finance. They will now be deprived of the same.

The following points emerge from the judgment which upholds the validity of amended Section 45-S of the RBI Act:

I Section 45-S no doubt prohibits the conduct of banking business by an unincorporated non-banking entity like a shroff, but this prohibition has come about, inter alia, in the interest of unwary depositors and borrowers (from shroffs) and with a view t o prevent them from committing financial suicide.

I Earlier attempts having failed to achieve the desired result of protecting large number of depositors from unincorporated financial institutions which would suddenly mushroom overnight and then vanish without a trace, but taking with it depositors mone y left the RBI with no alternative but to prohibit such unincorporated entitles from conducting financial business which was more than akin to banking.

I It cannot be denied that shroffs have played an important roll in providing finance in the rural sector and in small towns. But, despite the service which they may have rendered, it is difficult to accept the contention that the RBI was not justified i n imposing ban on unincorporated bodies accepting deposits from public while carrying on financing business.

I In the path of economic progress, if the informal system was sought to be replaced by a more organised system, capable of better regulation and discipline, then this was an economic philosophy reflected by the legislation in question.

I It is necessary that while dealing with economic legislations, the Supreme Court, while not jettisoning its jurisdiction to curb arbitrary action or unconstitutional legislation, should interfere only in those few cases where the view reflected in the legislation is not possible to be taken at all.

(By arrangement with Corporate Law Adviser, New Delhi.)