Legal and Regulatory Aspects

1. Legal and Regulatory Aspects ICAI Indore Dt.24.01.2014

2. Contents • Banking Law & Practice • Banking Regulation Act • Banking Laws (Amendment) Act, 2012 • Types of charges over securities ( Transfer of Property Act, Indian Contract Act, SARFAESI) • Credit Information Companies (Regulation) Act, 2005 • Negotiable Instruments Act • Anti Money Laundering & Know Your Customer • Key Aspects and elements of AML KYC

3. Banking Law and Practice • Several enactments • Banking Regulation Act, 1949 • Reserve Bank of India Act, 1934 • Banking Companies (Acquisition and Transfer of Undertakings) Act,1970 & 1980 • SBI Act, 1955 & SBI (Subsidiary Banks) Act, 1959 • RRB Act, 1976 • Companies Act, 1956 • Negotiable Instruments Act, 1881 • Prevention of Money Laundering Act, 2002 • Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 • Credit Information Companies Act • Recovery of Debts due to Banks • Transfer of Property Act • Regulations • Widely accepted practices

4. Banking Regulation Act, 1949

5. Banking Regulation Act, 1949 • Definition of banking & banking company • Licensing • Permitted business • Prohibited business • RBI’s powers • Control over management

6. Definitions • Banking means “ accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise” {Section 5(b)} • Banking company “means any company which transacts the business of banking in India” • Explanation excludes manufacturing and trading company {Section 5 (c)} • Use of the word “bank”, ”banker”, “banking” or “banking company” - Section 7

7. Permitted business • Can carry on business permitted u/s 6 • Borrowing, lending, bill discounting, etc. • Buying, selling and dealing in bullion • Buying and selling of foreign exchange • Traveller’s cheques • Letters of credit • Underwriting and dealing in shares, debentures, etc. • Safe deposit • Collecting and transmitting of money and securities • Undertaking/ executing trusts • Activities that are incidental/ conducive to the promotion/ advancement of its business • Central Govt. empowered to notify permitted business • Act overrides memorandum, articles, etc.

8. Prohibited business • Trading prohibited vide Sec 6 • Non-banking assets – Sec 9 • Immoveable property can only be held for own use • Other – disposed within 7 years • RBI can give additional 5 year extension • Restriction on nature of subsidiary companies – Sec 19 • Permitted business u/s 6 • Carrying on banking outside India • Credit information business • Other business with RBI and CG approval

9. Licensing • RBI empowered to issue & cancel licences • Section 22 criteria • Solvency • Affairs/ management not detrimental to depositor and public interest • Adequate capital structure and capital prospects • Public interest will be served • Grant of licence not prejudicial to operation and consolidation of banking system • Foreign banks – home country does not discriminate against Indian banks • Other conditions specified by RBI • New bank licencing requirements • Branch licencing u/s 23

10. Returns • Section 24 • Monthly return of assets in India • DTL on reporting Friday • Section 25 • Quarterly return of assets and liabilities at the close of business on the last Friday of every quarter • Section 27 • Monthly return on Asset & Liability position as on last Friday • RBI empowered to direct banks to furnish information within a specified time frame • RRBs also need to submit a copy to NABARD • Section 26 • Return of unclaimed deposits • Section 31 • Three copies of annual returns to be submitted to RBI

11. Inspection • Section 35 • Inspect books • Also on direction of CG • Copy of report to be given to bank • Empowers RBI Inspecting officer to examine bank officials under oath • Also empowers RBI to carry out a scrutiny

12. Powers of RBI • Sec 35A – Power to give directions • Sec 35B – Prior RBI approval required for appointment of Chairman, MD, CEO or director • Sec 36 – Further powers and functions of RBI • Caution/ give advice regarding certain transaction/ class of transactions • Call for meeting of directors, depute its officer to board meeting, appoint observer, etc • Report on Trend and Progress in Banking in the country

13. Powers of RBI – Control over management • Sec 36AA – Power to remove managerial and other persons from office • Appeal lies with Central Government • Sec 35B – Power to appoint additional directors

14. Other important provisions • Sec 14 – Prohibition of charge on unpaid capital • Sec 15 – Prohibition on payment of dividend unless intangible assets written off • Sec 17 – Creation of reserve fund • Sec 18 – Maintenance of cash reserve ratio • Sec 20 – Restrictions on loans and advances • Sec 24 – SLR

15. Applicability of BR Act • Nationalised Banks • Banking Companies (Acquisition and Transfer of Undertakings) Act,1970/1980; • Section 51 of BR Act makes specific sections applicable • Regional Rural Banks • Regional Rural Banks Act, 1976 • Section 51 of the BR Act • Cooperative Banks • Cooperative Societies Act. 1912 or the respective Co-operative Socieities Act of the state concerned • Part V of the B R Act – BR (AACS) Act

16. Some important RBI instructions in context of BR Act • Master Circular • Loans & Advances – Statutory and other restrictions • Branch authorisation • Cash Reserve Ratio and Statutory Reserve Ratio • Others • Restriction on drawdown of reserves • Guidelines on declaration of dividend

17. Banking Laws (Amendment) Act • Passed by Parliament in Dec 2012 • Some highlights • Voting rights • 26% from existing 10% in private sector banks • 10% from existing 1% in public sector banks • Prior approval for voting rights/ shareholding more than 5% • Power to RBI to supersede entire board of banks • Power to call for information from associate and group companies • Depositor Education and Awareness Fund • Primary cooperative societies to be licenced by RBI • Preference shares • Naionalised banks can issue bonus shares • Joint inspections of associates with sectoral regulator

18. Laws relating to securities and modes of charging Transfer of Property Act, 1882 Indian Contract Act, 1872 SARFAESI

19. Overview of charges • Creation of a right in favour of the creditors

20. Kinds of charges – Fixed v/s Floating • Fixed charge • created on properties such as land and buildings, plant and machinery • Identity does not change • Credit consent required for disposal • Debtor retains ownership and possession • Floating charge • Created on assets that undergo change • Security allowed to be used in ordinary course of business unless charge crystallises

21. Kinds of charges • PariPassucharge • Several creditors- typically in consortium accounts • Equal priority • Exclusive charge • To one creditor • No intervention of other creditors • First charge • First right over the proceeds from the security charged • Second charge • Rights subject to those of first charge holder

22. Mortgage • Dealt with in Transfer of Property Act, 1882 • “A mortgage is the transfer of interest in specific immoveable property, for the purpose of securing the payment of money advanced or to be advanced by way of loan, on existing or future debt or the performance of an engagement which may give rise to pecuniary liability”- Section 58 • Types • Simple • Conditional sale • Unsufructuary mortgage • English mortgage • Equitable Mortgage • Anomoalousmorgage

23. Simple Mortgage “Without delivering possession of the mortgaged property, the mortgager binds himself personally to pay the mortgage money and agrees, expressly or impliedly, that in the event of his failing to pay according to his contract, the mortgagee shall have a right to cause the mortgaged property to be sold by a decree of the court in a suit and the proceeds of the sale to be applied so far as may be necessary in payment of the mortgage money” [Sec 58(b)] • Intervention of court required • Mortgagee has no right to get any payments out of the rents and produce of the mortgaged property • Mortgagee not put in possession of the property • Registration is mandatory

24. Conditional Sale “The mortgager ostensibly sells the mortgaged property on the condition that: (a) on default of payment of the mortgage money on a certain date, the sale shall become absolute, or (b) on such payment being made the sale shall become void, or (c) On such payment being made, the buyer shall transfer the property to the seller” [Sec 58(c)] • Sale is ostensible – not real • If money not paid ostensible sale shall become absolute – Court decree required • No personal liability for repayment of the loan

25. Unsufructuary mortgage “mortgage transaction in which • the mortgager delivers possession expressly, or by implication binds himself to deliver possession of the mortgaged property to the mortgagee, and • Authorises the mortgagee to retain such possession until payment of the mortgage money and to receive the rents and profits accruing from the property or any part of such rents and profits and to appropriate the same in lieu of interest, or in payment of the mortgage money, or partly in lieu of interest and partly in payment of the mortgage money” [Sec 58(d)] • Mortgagee in actual legal possession of the property, till dues are repaid • Mortgage has the right to receive rents and profits accruing from the property • No personal liability of the mortgager • No time limit specified

26. English mortgage “mortgagee binds himself to repay the mortgaged property absolutely to the mortgagee, but subject to the provision that he will retransfer it to the mortgagee upon payment of the mortgage money as agreed” [Sec 58(e)] • Personal covenant to pay on a specified date notwithstanding the absolute transfer of property to the mortgagee • Absolute transfer • Subject to reconveyance in event of repayment • Court decree for sale

27. Equitable mortgage “where a person delivers to a creditor or his agent documents of title to immoveable property, with the intent to create a security thereon, the transaction is called a mortgage by deposit of title deeds” [Sec 58(f)] • Deposit of title deed with intention to secure debt • Original deed not required but recommended • Saves on stamp duty • Deposit at notified places only • Independent of location of the property

28. Anomalous mortgage “a mortgage which is not a simple mortgage, a mortgage by conditional sale and Unsufructuary mortgage and English mortgage or a mortgage by deposit of title deeds within the meaning of this section” [Sec 58(g)] • Should satisfy the basic definition of mortgage • Should not fall in the earlier categories • Usually a combination of two mortgages

29. Mortgages- Other key aspects • Registration requirements • Registration required for mortgages other than equitable mortgage – Sec 59 • Indian Registration Act- Sec 23 - required within 4 months of execution • Companies Act, 1956-Sec 125- within 30 days of execution • Priority of mortgages • First in point of time has better title – Sec 48 • Amongst registered instruments- date of execution • Registered has priority over unregistered • Exception is deposit of title deeds

30. Mortgages-Other key aspects • Enforcement • Code of Civil procedure • Jurisdiction based on location of property • Preliminary decree • Final decree • Sale

31. Which Mortgage would you prefer?

32. Assignment • Transfer of actionable claim • Claim to debt other than debt • secured by mortgage of immoveable property • Hypothecation/ pledge of moveable property not in possession • Key features • Should be in writing • Due notice to be given to the debtor • Assignor cannot give better title • Eg LIC policies used as security

33. Pledge “Pledge is the bailment (delivery) of goods as security for payment of a debt or performance of a promise” (u/s 172 of Indian Contracts Act) • Key aspects • Delivery of goods • Need not be physical delivery • May be constructive delivery – eg handing over keys of godown • Can only be on existing goods- not on future goods • Pawnor – borrower who gives the goods as security • Pawnee- lender who takes the goods as security • Ownership retained with pawnor • Possession with pawnee • Possession may be parted with against Trust Receipt • Right to retain or sell goods where pawnor makes default in payment • Notice to sell required to be given • Right of pledge prevails over any other dues including Government dues except workers wages

34. Hypothecation • Defined in SARFAESI, 2002 (Sec 2(n)) • Charge upon moveable property • Existing/ future • Without delivery – possession with borrower • Drawbacks • Risk of fraud- multiple charges on same property • Erosion of security value • Precautions • Periodic stock statements • Registration of charge • Notice of charge • Insurance of property

35. Lien • General Lien • Creditor’s right to retain property of debtor • Possession in ordinary course of business • Limited to possession of property – not to sell • Banker’s lien • General lien+ right to sell • Applicable to negotiable instruments and credit balances • Not applicable to safe deposit, for sale

36. Other aspects relating to Contracts • Proposal and acceptance • Consideration • Exemption • Free consent • Capacity to contract • Sound mind • Not disqualified from entering into a contract • Minor contract

37. Stamping of documents • Stamp duty – tax levied on documents • Originated in Netherlands – 1624 • France (1654), Denmark (1657), Prussia (1682) • Key aspects • Amount of duty • Type of stamp used • Cancellation of stamp • Time of stamping and execution • Place of stamping and execution • Consequences • Admissibility as evidence • Adjudication

38. Law of limitation • Period within which suit can be filed • Bars to remedies • Original right may continue to be exercisable • Right of action revived by • Fresh set of documents • Acknowledgement of debt • Writing, signed, stamped and addressed to lender • Part payment authorised by the borrower

39. Power of Attorney • Types • General v/s special • Registration of power of attorney • Precautions • Scope of powers • Agent acting within the scope of powers • Confirmation of validity

40. SARFAESI Act, 2002 • Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 • Coverage • Securitisation and reconstruction of financial assets • Enforcement of security interest without court intervention • Central Registry

41. SARFAESI - Coverage • Effective since June 21, 2002 • Retrospective coverage • Applicable to whole of India including J&K • Also covers notified Housing Finance Companies • Sec 31 • Lien and pledge • Aircrafts, shipping vessels • Conditional sale, hire purchase, contract where no security interest created • Financial asset<=Rs.1 lakh • Agricultural land • Amount due<20% of the Principal +Interest • Mardia Chemicals case – Supreme Court • Sec 17(2) – unconstitutional- arbitrary, oppressive and unreasonable • Subsequent amendment

42. SARFAESI – Securitisation/ Reconstruction Companies • Registration with RBI • Guidelines issued by DNBS • Minimum owned fund of Rs100 crore/ 15% of financial assets to be acquired – whichever is lower • Acquisition of financial assets • Scheme wise • Funded by investors – QIBs • Issuance of Security Receipts • Managed by trust

43. SARFAESI – Enforcement of security interest • No need for court intervention • Overriding effect over provisions of Transfer of property Act • Notice mandatory • 60 days notice • Details of amount payable and secured asset intended to be enforced • Borrower prohibited from transferring assets • SC Guidelines in Mardia case • Borrower can raise objections • Bank to apply mind while answering objections • Response to borrower within one week • Rejection of objections cannot be appealed to DRT • Can appeal to DRT – deposit of 50% of the amount due • Can seek help of District Magistrate/ Chief Metropolitan Magistrate

44. SARFAESI – Enforcement of security interest • Recourse available to lender • Possession of secured asset • Management of secured asset • Appoint person as manager of secured assets • Require from any person who has acquired the secured asset from the borrower to pay the amount due to the extent of the secured asset • Appropriation of proceeds • Expenses->Dues->Balance to debtor • If winding up – dues of workman have paripassu charge • Consortium accounts – multiple secured creditors • Creditors representing ¾ of outstanding dues have to agree • Recent amendment- bank may purchase at auction [13(5A)]

45. SARFAESI – Enforcement of security interest • Safeguards • Inventory of property taken into possession • Take care of property as owner of ordinary prudence – insure if necessary • Expedite sale if subject to speedy decay • Possession notice • affixation at outer door/ conspicuous place • Publication in 2 leading newspapers including one vernacular • Auction • 30 days notice – publication in 2 leading newspapers incl. vernacular • Valuation to fix reserve price • Appeal to DRT - Compensation • Within 45 days of measures being initiated • 50% to be deposited- DRT may reduce to 25%

46. SARFAESI - CERSAI • Sec 25 Company promoted by Government & PSU banks • Maintains registry of • Securitisation of financial assets • Reconstruction of financial assets • Creation of security interests • Registration additional – not substitute for existing requirements • Records available for search • Minimisation of frauds due to multiple borrowing on same security

47. Recovery of Debts due to Banks and Financial Institutions Act, 1993 • Coverage • Applicable to whole of India except J&K • Debt > Rs. 10.00 lakhs • Constituted Debt Recovery Tribunals for speedy recovery • Established by Central Government • Single member – Presiding Officer • Appeal against DRT order lies with DRAT • Chairperson • Jurisdiction of civil courts (other than HC/SC) barred

48. Credit Information Companies (Regulation) Act, 2005

49. Credit Information Companies(Regulation) Act, 2005 • Objective- regulation of credit information companies • Registration • Compulsory registration with RBI • Existing companies to apply within 6 months • Conditions • Minimum capital – Rs. 30 crore (authorised), Rs.20 crore(issued) • Management not prejudicial to interests of users, clients or borrowers, credit information companies • Additional conditions at discretion of RBI • RBI may determine cap on maximum number of credit information companies • RBI may cancel registration • Appeal lies with Central Government

50. RBI Powers • Registration and cancellation • Frame policy and regulations • Give directions • Inspection • Appoint observers • Supersede board – appoint administrator • Specify maximum fee • Recommend exemption and rules