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TMI Blog1997 (3) TMI 457X X X X Extracts X X X X X X X X Extracts X X X X ..... tley, Ram Jethmalani, P.K. Mullick, V. Tulzapurkar, Anand Bhatt, Sandeep Mittal, R.N. Karanjawala, Ms. Ruby Ahuja, N. Gore, Mrs. M. Karanjawala, E.C. Agrawala, Mahesh Aggrawala, Atul Sharma, M. Himayatullah, S. Ganesh, S. Sukumaran, T.K. Cooper, U.A. Rana, S. Tripathi, T. Cooper, Neeraj Sharma, Mrs. Kiran Neena Gupta, Vineet Kumar, D. Khambatta, J.D. Das, Ms. Anjali Seth, Ms. Mona Bhide, Dr. A.F. Julian, G.R. Joshi, A. Subba Rao, P. Parmeshwaran, Sunil Dogra, Monica Sharma, S.S. Shroff, Mahesh Jethmalani, S.B. Jaisingham, Anand Desai, Ms. Lata Krishnamurti, Jay Salva and J.K. Das, H.S. Parihar, Subrat Birla, K.S. Harihar, S.K. Mehta, Dhruv Mehta, Fazlin Anam, Ms. Monika Mehta, K.J. John, P.H. Parekh and Ms. Sunita Sharma for the appearing parties. JUDGMENT Kirpal, J. These appeals, under section 10 of the Special Court (Trial of Offences Relating to Transactions in Securities) Act, 1992 ('the Special Court Act') arise from the judgment of the Special Court at Bombay which decided common questions of law relating to certain transactions of purchase of securities by the appellant-banks from some of the brokers to whom the Special Courts Act had been made applicabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on the 6th June, 1992. Ordinance provides for the establishment of a Special Court with a sitting Judge of a High Court for speedy trial of offences relating to transactions in securities and disposal of properties attached. It also provides for appointment of one or more Custodians for attaching the property of the offenders with a view to prevent diversion of such properties by the offenders. We will now refer to some of the provisions of the said Act which are relevant for the purpose of this matter. 4. Section 2 of the Special Courts Act contains definitions. The term 'securities' is defined in section 2( c ) and is as follows: ( c ) 'securities' includes ( i )shares, scrips, stocks, bonds, debentures, debenture stock, units of the Unit Trust of India or any other mutual fund or other marketable securities of a like nature in or of any incorporated company or other body corporate; (ii) Government securities; and ( iii )rights or interests in securities; 5. Section 3 of the said Act relates to appointment and functions of Custodian and reads as follows: Appointment and functions of Custodians. (1) The Central Government may ap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rriding 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, or in any decree or order of any Court, Tribunal or other authority. As is evident from the above the intention of framing the aforesaid Act was to protect the interest of the banks and financial institutions from irregu-larities and mal practices which had been committed by some brokers in collusion with employees of various banks and financial institutions. The important feature of the Act was the attachment of the properties of the offenders with a view to prevent its diversion. The Special Court is required to pass orders directing the disposal of the properties under attachment. Sub-section (2) of section 11 provides for the priorities in which the liabilities of the notified person are to be discharged from out of the attached properties. Considering that the Act has been passed because of the diversion of funds from the banks and financial institutions to the individual accounts of certain brokers, the implication of section 11(2)/(3) clearly is that after the discharge of the li ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the appellants that, except for the power exercisable under section 4, the position of the Custodian is the same as that of the notified person himself. Pursuant to the promulgation of the Ordinance in 1992, Mr. Justice Variava of the Bombay High Court has been constituted as a Special Court at Bombay. This Court has been hearing several matters brought before it by the Custodian as well as other parties. Initiation of proceedings and decision of the Special Court 9. The Custodian filed applications before the Special Court to the effect that the abovementioned contracts entered into between the banks and the notified persons were void. It was contended that such ready-forward transactions were illegal under the provisions of the Banking Regulation Act, 1949 and the Securities Contracts (Regulation) Act, 1956. It was, therefore, contended that as the contracts were void those securities which had been sold to the appellants in the ready leg continued to be, in law, the properties of the notified persons on the date they were so notified and the same stood attached under section 3(3) of the Act. The applications required the Special Court to direct the appellant-banks t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eady-forward transactions. It took note of the concession on behalf of the counsel for the Custodian that if a transfer had already taken place prior to the date of the notification then the concerned property could not be properly regarded as belonging to the notified persons and would not stand attached. It allowed the applications of the respondents holding that the circulars issued under the Banking Act were binding and, since the transactions were contrary thereto, the same were illegal and void in respect of the third parties. It rejected the contention that the contract was severable and that the first leg was not hit by the illegality. It further came to the conclusion that the contracts were also illegal under the provisions of the Securities Regulation Act, and the notification issued under section 16 thereof. It also came to the conclusion that the principles of in pari delicto did not come into play in the present case as the Custodian was not making any claim in the applications but was merely bringing to the attention of the Court the fact that third parties were in possession of properties which stood attached under the provisions of the Special Court Act. The fact ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns are clearly mandatory. On the other hand, section 36(1)( a ) and (1)( b ) gives power to the RBI to give advice or lend assistance and any action taken thereunder cannot be regarded as mandatory. It was submitted that the language of the circulars dated 14-4-1987 and 1-12-1987, which prohibit the banks from entering into buying back arrangements, clearly shows that the said circulars were only in the nature of advice and must be regarded as having been issued under section 36(1)( a ) and (1)( b ). 17. At this juncture, it will be appropriate to refer to the said circulars dated 15-4-1987 and 1-12-1987. The circular dated 15-4-1987 was marked 'confidential' and was issued to all scheduled commercial banks and dealt with the question of buy-back arrangements in the Government and other approved securities entered into by commercial banks. The relevant portion of this circular reads thus: Buy-back arrangements in Government and other approved Securities entered into by commercial banks. Please refer to paragraph 10(a) of Governor's letter No. CPC.BC.84/279- A-87 dated 31st March, 1987. 2. It has been observed that banks often enter into buy-back arrange ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... k arrangements in terms of the instructions contained in our Circular DBOD. No. DIR.BC.42/C.347-87, dated 15th April, 1987. 2. Please acknowledge receipt. [Emphasis supplied] Referring to the language used in the said Circulars dated 15-4-1987 and 1-12-1987, it was contended by Mr. Cooper that the banks were mainly advised to follow the guidelines contained in the said letters and that the contents thereto were not binding on the banks. 19. Section 21 of the Banking Companies Act, and sub-section (2) in particular, entitles the RBI to give directions to the banking companies with regard to the matters specified in the said section. Sub-section (3) provides that every banking company shall be bound to comply with any directions given to it under the said section. Section 35A(1) also contains the power of the RBI to give directions and the same reads as under: (1) Where the Reserve Bank is satisfied that ( a )in the [public interest]; or ( aa )in the interest of banking policy; or] ( b )to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the ba ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the circular dated 15-4-1987 states that the banks are 'advised' to follow the guidelines given thereunder, but para- graph 2 A of the said circular clearly contains the prohibition relating to the buy-back arrangements. Similarly, under paragraph 28, which is appli- cable in the present case, by use of the words 'should be' the circular clearly implies that the direction contained thereunder is meant to be binding. The word 'advised' used in paragraph 2 of the first circular cannot be read in isolation. Reading the said circular, as a whole, it can leave no doubt in any one's mind that what was stated in the said document was ment to be binding on the banking companies and, was not merely an 'advice' or a 'caution' which could be ignored. 22. It was then submitted that even if it is held that the said circulars were binding they could only bind the banks and not the third parties. The submission was that by contravening the direction contained in the said circulars, the contracts which were entered into between the banks and the third parties could not be invalidated and the only result of such contravention would be the levy of pen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... owed no valid contract could come into existence and, consequently, the Cane Commissioner had no jurisdiction to proceed in the matter for appointment of an arbitrator. While repelling the contention, this Court observed as follows: (19) This rule has been applied in many cases both in India and in England. In State of U.P. v. Manbodhan Lal Srivastava 1958 SCR 533, this Court observed that no general rule can be laid down but the object of the statute must be looked at and even if the provision be worded in a mandatory form, if its neglect would work serious general inconvenience or injustice to persons who have no control over those entrusted with the duty and at the same time would not promote the main object of the Legislature, it is to be treated only as directory and the neglect of it though punishable would not affect the validity of the acts done. These observations have been followed in other cases and recently in Bhikraj v. Union of India AIR 1962 SC 113 at p. 119 it was observed that where a statute requires that a thing shall be done in a particular manner or form but does not itself set out the consequences of non-compliance the question whether the prescrip ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at p. 37, per Denning, L.J., and that it would be a curious thing if the offender is to be punished twice, civilly as well as criminally (St. John Shipping Corporation v. Joseph Rank Ltd. [1957] 1 Q.B. 267, at p. 292 per Devlin, J.). The main considerations from which the principle ex turpi causa arose can be seen in the reluctance of the courts to be instrumental in offering an inducement to crime or removing a restraint to crime: Beresford's case [1938] A.C. at pp. 586, 599; Amicable Society v. Bolland [1830] 4 Bligh (N.S.) 194 at p. 211. However, in the present case Parliament has provided a penalty which is a measure of the deterrent which it intends to operate in respect of non-compliance with section 8. In this case it is not for the court to hold that further consequences should flow, consequences which in financial terms could well far exceed the prescribed penalty and could even conceivably lead the plaintiff to insolvency with resultant loss to innocent lenders or investors. In saying this I am mindful that there could be a case where the facts disclose that the plaintiff stands to gain by enforcement of rights gained through an illegal activity fa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the directions or instructions issued by the RBI. 25. The instructions which were issued by the said circulars were meant to be complied with by the banking companies only and did not purport to, nor could they, be binding on the third parties. This being so, even if the appellant-banks had been prohibited from entering into the buy-back arrangements in question, that by itself, would not invalidate the contracts though the infringement of the said directions may lead to action being taken under section 46. Submission of the parties 26. On 27-6-1969 the Government issued a notification under section 16(1) of the Securities Contracts (Regulation) Act, which is as follows: S.O. 2561. In exercise of the powers conferred by sub-section (1) of section 16 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) the Central Government being of opinion that it is necessary to prevent undesirable speculation in securities in the whole of India, hereby declares that no person in the territory to which the said Act extends, shall save with the permission of the Central Government enter into any contract for the sale or purchase of securities other than such spot deli ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he notified person and, therefore, the same could not be attached. 28. On behalf of the Custodian it was submitted by Mr. A.M. Setalvad that the said contracts were composite and unseverable, the illegality attached to the forward element of the contract rendering the contract wholly void. While relying upon the Halsbury Law of England, Fourth end., Vol. 19, paragraph 430, it was contended by Mr. Setalvad that in such a case there can be no question of severing the illegal part from the legal part. The Court, it was submitted, will not re-write or re-arrange the contract. Furthermore, even if the part of the compromise could be struck off, the Court will not do this if to do so would alter entirely the scope and intention of the agreement. 29. It is not necessary to refer to other submissions which were advanced by the counsel for the parties as, in our opinion, the above-stated submis-sions on behalf of the appellants merit acceptance. Are the ready-forward transactions severable? 30. We will first deal with the submission that the agreements in question were severable and the illegality attached to the forward leg cannot affect the ready leg of the transacti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f legal and illegal parts Mr. Justice Vivian Bose observed as under: Therefore if this transaction had consisted of a single consideration for the two objects contemplated, namely, the sale of the proprietary rights (as distinguished from the occupancy rights) together with the occupancy rights (which we usually somewhat inaccurately call cultivating rights in these Provinces), then the whole would have fallen to the ground under this section unless the transferee had been content to accept the proprietary rights alone for the entire consideration and forgo the occupancy rights. But since the transaction consists of two separate considerations for two severable objects we are left with a contract consisting of legal and illegal ports in which the lawful is separable from the unlawful. In such a case it is always possible to give effect to the lawful and reject the unlawful; in fact that is what the courts are bound to do unless the whole transaction is prohibited by statute or unless it involves serious moral turpitude or is otherwise against public policy - See sections 57 and 58, Contract Act. This rule was applied and in my opinion rightly, to this very class of cases in 2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e a broker entered into sale and re-purchase agreements (more commonly known there as 'Repos'). These agreements were structured as sales of securities by the broker subject to an agree- ment to re-purchase them, from the other party, at a fixed price at a later date. The broker also entered into reverse sale and purchase agreement ('reverse repos') whereby he purchased Government securities subject to an agreement to re-sell them, to the other party at a fixed price at a later date. The 'repos' and 'reverse repos' were thus description of the same transaction viewed from different sides. One of the questions which came up for consideration was whether such a transaction could be regarded as being a funding agreement or was it in the nature of a loan against collateral security. It was held by the US Court of Appeal that there was a significant different between repos and standard collaterised loans. It was observed that in the latter transaction, the lender holds pledged collateral for security and may not sell it in the absence of a default. In contrast, repo 'lenders' take title to the securities received and can trade, sell or pledge the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the aforesaid property by Hearsey was, inter alia, challenged by suits being instituted by the decree holder challenging the gifts by Hearsey on the ground that the said transaction was invalidated by the immorality of the consideration. If the transaction was invalidated then the property would have continued to belong to Hearsey and would have been available in order to satisfy the decree against him. It was contended before the Privy Council that by reason of Hearsey's descent and religion the case was to be governed by rules of English law and that the Begum could not be his lawful wife; that the stipulation as to her continuing to act as his wife was immoral; though she was under the Mohammedan law, which allowed sexual relations forbid-den to Christians; and that the gift was so thoroughly vitiated as to leave Hearsey, the grantor, still the owner of the property in which a sense that the plaintiff could treat it as his right, title and interest liable to be sold under an attachment. While upholding the decision of the Courts below in treating the gift to the Begum as resting on the valid and moral considerations, it was observed by the Privy Council as follows: T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... made to the decision of the Privy Council in Sajan Singh v. Sardara Ali 1960 AC 167. In that case the regulations which had been framed provided that no person could use or sell a motor vehicle for the carriage of goods without a haulage permit. Six motor vehicles were purchased by the appellant. The respondent paid a part of the consideration towards the cost on the understanding that one of the vehicles, a dodge motor lorry, would become his property. The appellant executed a document of sale stating that he had sold the motor lorry jointly to the respondent and his friend, whose share the respondent subsequent- ly purchased. Although the lorry was owned and operated by the respon-dent for the carriage of goods on his own account, the appellant registered the lorry in his own name and obtained a haulage permit which authorised its use by himself and his employees. The policy of the authority at that time was to restrict the issue of permits to persons who had them before the war. The respondent did not fall within that category, whereas the appellant did and that is why the permit was in the name of the appellant but the lorry was paid for and operated by the respondent. In 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the securities. In support of this submission, reliance was placed on the following observations in Alexander v. Rayson [1936] 1 KB 169 where it was observed as follows: The distinction between an action brought to enforce an unlawful agreement and one brought to assert a right of property already acquired under such an agreement is further illustrated by Taylor v. Chester (4) . The defendant in that case was the keeper of a brothel and as such had supplied wine and supper to the plaintiff 'for the purpose of being consumed there by the plaintiff and divers prostitutes in a debauch there, to incite them to riotous, disorderly and immoral conduct'. When the debauch was over there followed in due course the reckoning. Being unable or unwilling to pay it at once, the plaintiff deposited with the defendant the half of a 501 note as security. He subsequently repented of this action, and instituted proceedings against the defendant for the purpose of obtaining the return of the half bank note. It was held that he was not entitled to recover. The property of the half note had passed to the defendant, and in spite of the illegality of the agreement under which it had pa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nded that applying the equitable principle that he who came to equity had to come with clean hands, the Court ought to leave the estate to lie where it fell since the property been conveyed into the name of one party for a fraudulent purpose which had then been carried out and in those circumstances the Court ought not to enforce a trust in favour of the other party. Tinsley's claim was dismissed by the trial Judge, who upheld the counter-claim of Millingan. The appeal filed by the appellant was dismissed by the Court of Appeal. The House of Lords (Lord Keith and Lord Goff dissenting) upheld the decision of the Court of Appeal. Lord Jauncey in his speech, observed that: At the outset it seems to me to be important to distinguish between the enforcement of executory provisions arising under an illegal contract or other transaction and the enforcement of rights already acquired under the completed provisions of such a contract or transaction. Your Lordships were referred to a very considerable number of authorities, both ancient and modern, from which certain propositions may be derived: First: it is trite law that the court will not give its assistance to the enforcement ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rved as follows: I find this a very narrow question but I have come to the conclusion that the transaction whereby the claimed resulting trust in favour of the respondent was created was the agreement between the parties that, although funds were to be provided by both of them, nevertheless the title to the house was to be in the sole name of the appellant for the unlawful purpose of the defrauding the Department of Social Security. So long as that agreement remained unperformed neither party could have enforced it against the other. However, as soon as the agreement was implemented by the sale to the appellant alone she became trustee for the respondent who can now rely on the equitable proprietary interest which has thereby been presumed to have been created in her favour and has no need to rely on the illegal transaction which led to its creation. (p. 83) Speaking for the majority, Lord Browne Wilkinson first observed as follows: Neither at law nor in equity will the court enforce an illegal contract which has been partially, but not fully, performed. However, it does not follow that all acts done under a partially performed contract are of no effect. In particular ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he aforesaid decisions in England is restricted in its application to cases where the illegal contract has been performed and does not apply to an illegal contract which has been performed only in part. He contended that inasmuch as the ready-forward contract had only been performed in part, namely, as securities had been transferred under the first leg but the second leg was still to be performed, the principle laid down in the English cases would have no application. This contention of Mr. Setalvad cannot be accepted because the ratio of the said decisions is applicable even where an illegal contract is partially performed as would be evident from the following observation of Lord Browne Wilkinson: Neither at law nor in equity will the Court enforce an illegal contract, which has been partially but not fully performed. However, it does not follow that all acts done under a partially performed contract are of no effect. In particular, it is now clearly established that at law (as opposed to equity) property, goods or land can pass under or pursuant to such a contract. [Emphasis supplied] 43. It was contended by the learned counsel for the respondent, and Mr. Jethmalani ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n service, and by showing that the business income from the suit property belonged to the defendant and, therefore, the Court should not countenance his claim and assist him in attaining possession of the suit property because that transaction had been entered into with a view to circumvent or defeat the provisions of the Income-tax Act, 1961. The plaintiff, while denying that the transaction was illegal, in the alterna-tive, placed reliance on the aforesaid decision of the Privy Council in Sajan Singh's case ( supra ) and contended that he had equitable interest in the property and that the possession of the property should be restored to him. Gajendragadkar, CJ. and Shah, J. referred to the decision in Sajan Singh's case ( supra ) but, while dismissing the appeal, held that the transaction of running the Boarding House was not entered into with a view to circum-vent or defeat the provisions of the Income-tax Act and was, therefore, not illegal. Rajagopala Ayyangar, J. by a separate judgment, agreed that the appeal should be dismissed but he held that from the evidence on record it was clear that the object of the agreement, entered into by the plaintiff, was to de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... #39;, inter alia, means an act by which a person conveys property to another person. Section 6 of this Act deals with what property may be transferred. What is relevant in section 6( h ) according to which no transfer can be made; ( 1 ) insofar as it is opposed to the nature of the interest affected thereby, or ( 2 ) for an unlawful object, or consideration within the meaning of section 23 of the Indian Contract Act, or ( 3 ) to a person legally disqualified to be transferee. According to section 23 of the Indian Contract Act, the consideration or object of an agreement will be unlawful if it is forbidden by law; or is of such a nature that, if permitted, it would defeat the provisions of any law; or is fraudulent; or involves or implies injury to the person or property of another; or the Court regards it as immoral or opposed to public policy. In the instant case the object of the contracts entered into between the banks and the notified parties was for the transfer and, subsequently, re-transfer of the securities. The transfer took place on delivery of securities on payment of market price as consideration. The consideration for the transfer of the securities, in the ready leg, ..... X X X X Extracts X X X X X X X X Extracts X X X X
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