1997 (3) TMI 457 - SC - Companies Law

Whether the banks can enter into buy-back arrangements in units of UTI under 1964 Scheme? Held that - Appeal allowed. Infringements of the instructions issued by the RBI under the Banking Regulations Act prohibiting the banks from entering into buy-back arrangements do not invalidate such contracts entered into between the banks and its customers. The ready-forward contract is severable into two parts, namely, the ready leg and the forward leg. The ready leg of the transaction having been completed, the forward leg, which alone is illegal, has to be ignored. With the ready leg having been performed the illegality of the forward leg contained in the agreements cannot affect the transfers which had already taken place.

Issues Involved:
1. Legality of ready-forward transactions under the Banking Regulation Act and Securities Contracts (Regulation) Act.
2. Binding nature of RBI circulars on banks and third parties.
3. Severability of the ready-forward transactions.
4. Validity of completed transactions under an illegal contract.

Detailed Analysis:

1. Legality of Ready-Forward Transactions:
The appeals arise from the judgment of the Special Court at Bombay, which addressed common questions of law relating to certain transactions of purchase of securities by appellant-banks from brokers. The appellant-banks had entered into contracts for the purchase and sale of securities, regarded as ready-forward transactions. The Special Court Ordinance was issued on 6-6-1992, subsequently replaced by the Special Court Act, 1992, due to large-scale irregularities and malpractices in securities transactions.

2. Binding Nature of RBI Circulars:
The Special Court held that the circulars issued under the Banking Regulation Act were binding, and since the transactions were contrary thereto, they were illegal and void. The appellant-banks contended that the transactions were not illegal and did not contravene the provisions of the Banking Regulation Act or the Securities Contracts (Regulation) Act. They argued that the circulars were advisory and not mandatory. The Court observed that the circulars dated 15-4-1987 and 1-12-1987 prohibited banks from entering into buy-back arrangements. However, the Court concluded that the instructions issued by RBI were meant to be complied with by banking companies only and did not purport to bind third parties. Thus, even if the appellant-banks were prohibited from entering into the buy-back arrangements, it would not invalidate the contracts.

3. Severability of Ready-Forward Transactions:
The Special Court rejected the contention that the contract was severable and that the first leg was not hit by the illegality. The appellant-banks argued that the contracts were severable, and the illegality was attached only to the second leg. The Court held that the ready-forward transaction consists of two parts: the ready leg (purchase or sale of securities at a specified price) and the forward leg (sale or purchase of the same securities at a later date). The ready-forward transaction is severable into two parts, each with separate consideration and object. The first set of promises or the ready leg would constitute a binding contract, while the second leg, the forward leg, would be void. The Court concluded that the valid part (the ready leg) of the transaction had been completed, while the invalid part (forward leg) had to be ignored.

4. Validity of Completed Transactions under an Illegal Contract:
The Special Court held that the contracts were also illegal under the provisions of the Securities Contracts (Regulation) Act. However, the Court observed that the principle of in pari delicto did not apply as the Custodian was not making any claim but merely bringing to the Court's attention that third parties were in possession of properties attached under the Special Court Act. The Court concluded that the claim of the banks for restitution would be dealt with as an ordinary claim against the property of a notified person at the stage of distribution under section 11. The Court directed the banks to return the securities to the Custodian. The appellant-banks challenged this decision, arguing that the ready leg had been performed, and the illegality of the forward leg could not affect the transfers already made. The Court referred to the decisions in Sajan Singh v. Sardara Ali and Tinsley v. Milligan, which held that property in goods or land could pass under an illegal contract, and the transferee could assert their title against all the world. The Court concluded that the appellants, having paid the market price and taken delivery of the securities, had become the owners of the same.

Conclusions:
(A) Infringements of RBI instructions do not invalidate contracts between banks and customers.
(B) The ready-forward contract is severable into two parts; the ready leg is valid, and the forward leg is void.
(C) The illegality of the forward leg does not affect the transfers already made under the ready leg.

Judgment:
The appeals are allowed, and the judgment of the Special Court dated 14-12-1993 is set aside. The applications filed by the Custodian and the notified persons for the return of the securities stand dismissed. No order as to costs.

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