Director’s Personal Guarantee - A Void Agreement

Index to Parawise Contents

1. Evolution of concept of legal entity

2. Effect of Incorporation: Company as a separate legal person

3. Limited Liability

4. General Powers of Board   

5. Borrowing

6. Finances

7. Director's as agents

8. A member of an association registered as a company shall not be personally liable for any liabilities incurred in such business

9. A director shall not be personally responsible for any debts of the company unless the business of the company has been carried on for any fraudulent purpose and declared as such by the Tribunal under Section 339

10. Director's, etc., with unlimited liability in limited company

11. Registration of charges

12. Director’s personal guarantee

13. What agreements are contracts

13.1 “Free consent” defined

13.2 Object is lawful

14. “Undue Influence”

14.1 Position of dominance necessary for presumption to arise

14.2 Inequality of bargaining power

14.3 Judicial intervention for rescuing parties from unreasonable terms

14.4 Agreement should be reasonable for the contract to be upheld legal

14.5 Serious terms of a contract must be specifically brought to the notice of the parties 

15. What considerations and objects are lawful, and what not

15.1 Defeat any Law

15.2 Undercutting of Statutory Privileges

Conclusion

16. DRT Act, 1993 and SARFAESI Act, 2002

17. SARFAESI Act, 2002

18. Conclusion and Recommendations

19. 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, director's, 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 director's. 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 9 of the Companies Act, 2013 (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 4(1)(d)(i) the Companies Act, 2013 provides that “the memorandum of a company shall state, in the case of a company limited by shares, that liability of its members is limited to the amount unpaid, if any, on the shares held by them”. 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 for business debts of the company is nil.

3.1  “The privilege of limited liability for business debts is one of 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 creditor's 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 Power's of Board   

Sub Section (1) of Section 179 of the Companies Act, 2013 provides as follows:-

“The Board of Director's 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 179 (3) (d) of the Companies Act, 2013 provides that “(3) The Board of director's of a company shall exercise the following powers on behalf of the company by means of resolutions passed at meetings of the Board namely:-

(a)……………………… ……………………
(b)……………………….

(c)…………………………..
(d) to borrow moneys;

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. directo'r 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 directo'r are in the eyes of law, agents of the company. The Court said:

“The company has no person; it can act only through director's and the case is, as regard's those director's, merely the ordinary case of principal and agent.”

The general principles of agency, therefore, govern the relations of director's with the company and of persons dealing with the company through its directo'r. Where the director's contract in the name, and on behalf of the company, it is the company which is liable on it and not the director's.

 

8. A member of an association registered as a company shall not be personally liable for any liabilities incurred in such business

Section 464 of the Companies Act, 2013 provides as follows

“(1) No association or partnership consisting of more than such number of persons as may be prescribed shall be formed for the purpose of carrying on any business that has for its object the acquisition of gain by the association or partnership or by the individual member's thereof, unless it is registered as a company under this Act or is formed under any other law for the time being in force: Provided that the number of persons which may be prescribed under this sub-section shall not exceed one hundred.

(2) …….xxx…….xxx….

(3) Every member of an association or partnership carrying on business in contravention of sub-section (1) shall be punishable with fine which may extend to one lakh rupees and shall also be personally liable for all liabilities incurred in such business. “

By necessary implication it follows that a member of an association registered as a company under the Companies Act shall not be personally liable for any liabilities incurred in such business by the company.

9. A director shall not be personally responsible for any debts of the company unless the business of the company has been carried on for any fraudulent purpose and declared as such by the Tribunal under Section 339

Section 339 of the Companies Act, 2013 provides as follows

“(1) If in the course of the winding up of a company, it appears that any business of the company has been carried on with intent to defraud creditor's of the company or any other persons or for any fraudulent purpose, the Tribunal, on the application of the Official Liquidator, or the Company Liquidator or any creditor or contributory of the company, may, if it thinks it proper so to do, declare that any person, who is or has been a director, manager, or officer of the company or any person's who were knowingly parties to the carrying on of the business in the manner aforesaid shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the Tribunal may direct:”

     By necessary implication it follows that a director, manager, or officer of the company shall not be personally responsible for any of the debts or other liabilities of the company incurred in such business by the company unless the business of the company has been carried on with intent to defraud creditor's of the company or any other person's or for any fraudulent purpose and declared as such by the Tribunal under Section 339 of the Companies Act, 2013.

 

10. Registration of charges

Section 77(1) of the Companies Act, 2013 (hereinafter referred to as ‘the Act’) is reproduced below for ready reference:

77. (1) It shall be the duty of every company creating a charge within or outside India, on its property or assets or any of its undertakings, whether tangible or otherwise, and situated in or outside India, to register the particulars of the charge signed by the company and the charge-holder together with the instruments, if any, creating such charge in such form, on payment of such fees and in such manner as may be prescribed, with the Registrar within thirty days of its creation:

 

10.1 The 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 77 of the Act.

10.2 Section 83 of the Act is reproduced below for ready reference:

83. Power of Registrar to make entries of satisfaction and release in absence of intimation from company. The Registrar 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 the authority of law, to execute personal guarantee agreements with the director's 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 directo'r of a Company but furnishing of such security or guarantee is not confined to the directo'r 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 directo'r 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 directo'r of the company as provided in the Companies Act, 2013. 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?” (Italics 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.  (Italics supplied)

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) (J. H. Baker, From Sanctity of Contract to Reasonable Expectation, Current Legal Problems 1979).

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 Ins 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. (Italics 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. (Italics supplied)

 

Conclusion

            In view of above discussion the following inferences may be drawn.

            (1) The Companies Act provides that the director's 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 (2001 107 Comp Cas 606) and subsequently by 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).

            (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, 2013.

            (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, 2013. (END)

 

Note: the views expressed are my personal and a view point only.

 

Author:

Narendra Sharma,

Consultant (Arbitration, DRT, Securitisation)

Expert (Director's Personal Guarantee) 

Mobile: 9229574214/8982321310
Land line: (07272) 421309

E-mail: nkdewas@yahoo.co.in

 

(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. The Securitisation And Reconstruction Of Financial Assets and Enforcement Of Security Interest Act, 2002 (hereinafter referred to as ‘the Securitisation Act, 2002’ )

 

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 Securitisation Act, 2002 ’), 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 Securitisation Act, 2002, 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 Securitisation Act, 2002, which provides  “Save as otherwise provided in this Act”. And Section 37 of the Securitisation Act, 2002 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 Securitisation Act, 2002 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 Securitisation Act, 2002 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. (2008 AIOL 348 Civil Appeal No. 610-612 of 2004 Decided on 13/03/2008) 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. (2008 AIOL 348 Civil Appeal No. 610-612 of 2004 Decided on 13/03/2008) has further observed as follows (in para 30 and 31):

“30. Right of property, although no longer a fundamental right, is still a constitutional right (Article 300A). 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.”

“31. A surety may be a Director of the Company. He also may not be. Even if he is a close relative of the Director or the Managing Director of the Company, the same is not relevant. A Director of the Company is not an industrial concern. He in his capacity as a surety would certainly not be. A juristic person is a separate legal entity. Its veil can be lifted or pierced only in certain situations. [See Salomon v. Salomon and Co. [1897 AC 22], Dal Chand and Others v. Commissioner of Income Tax, Punjab (1944) 12 ITR 458, Juggilal Kamlapat v. Commissioner of Income Tax, U.P. (1969) 1 SCR 988 = 1969 (73) ITR 702 and Kapila Hingorani v. State of Bihar (2003) 6 SCC 1]”

            (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. (2008 AIOL 348 Civil Appeal No. 610-612 of 2004 Decided on 13/03/2008) 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. (END)

 

Note: the views expressed are my personal and a view point only.

 

Author:

Narendra Sharma, Consultant (Legal)

E-mail: nkdewas@yahoo.co.in

 

 

 

                            *****************

 

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 u/s 19-A of Contract Act.

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 u/s 19-A of 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 u/s 19-A of Contract Act. 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 ment

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