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TMI Blog1994 (6) TMI 217X X X X Extracts X X X X X X X X Extracts X X X X ..... e Banking Regulation Act, 1949 prescribing the structure of interest to be charged on loans/advances made from time to time, and if yes, to what extent? 3. Whether in view of the insertion of Section 21A in the Banking Regulation Act, 1949 by Banking Loans (Amendment) Act, 1983 (Act No. 1 of 1984), Courts are precluded from the subjecting transactions entered into between Banks and borrowers from scrutiny under the provisions of the Usurious Loans Act, 1918 or any other similar State law, with a view to giving relief thereunder, and, if yes, whether relief under such laws is wholly impermissible? and 4. Whether the directives/circulars issued by the Reserve Bank of India under Section 21 of the Banking Regulation Act, 1949 can be termed as a 'special circumstance within the meaning of Explanation 1 to Section 3 of the Mysore Usurious Loans Act, 1923 (Mysore Act No. IX of 1923)? If yes, what is its effect? These questions which have a bearing on the day to day transactions of loan/advance entered into by the Banks arise in the following background. 2. In Bank of India v. Rao Saheb Krishna Rao Desai (1980) 2 Karnataka Law Journal 495, the Bank had advanced a loan for purc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , and which must be held to have been paid when placed to the debit of the account as an additional advance by the bank for the convenience of the obligations. Relying on the above passage, the Division Bench observed that the custom of charging compound interest by Banks would be normally applicable in the matter of over-draft facilities only and that too, when there exists relationship of banker and customer, which relationship has not been transformed into that of mortgagee and mortgagor, Sabhahit, J., speaking for the bench, observed: Compound interest or the practice of quarterly or half-yearly rest is something strange to agricultural financing where the loans are either short-terms, middle-term or long-term, Short-term financing is done for growing the annual crops. They are termed as 'crop loans'. Middle term financing is done for improvements in the lands and the period would be about three years to five years. Long-term financing is given for clearing off old debts and for the long-term investment. That being so, in agricultural financing, the question of the normal commercial banking conditions as in overdrafts would not come into play and the Bank 'custom ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... execution of the said document. Under the terms of the mortgage, the borrower covenanted to repay the mortgage loan of ₹ 5 lacs with interest at 16.5% per annum subject to such rate of interest as may be prescribed within a period of two years. It was further agreed by the mortgagor that he will pay interest on the mortgage amount at the end of each calendar month without default and in the event of default over due interest may be charged. On November 7, 1975, he at the instance of the Bank executed a promissory note by way of collateral security undertaking to pay ₹ 5 lacs with interest at 16.5% per annum 'with quarterly rests'. By March 1, 1978, the amount payable with penal interest, service charges, etc., stood at ₹ 7,56,934.17 paise. The Bank instituted a suit for recovering the said amount with future interest and costs by the sale of mortgaged property under Order XXXIV of the CPC. The borrower admitted the execution of the equitable mortgage deed and the promissory note, but contended that the promissory note was executed as a collateral security and the provision of quarterly rest provided therein was not one of the conditions of the loan granted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing for payment of interest at 16.5% with monthly rests are valid under statutory directives of the Reserve Bank of India or could be supported by banking practice, and (2) whether the interest charged by the bank including penal interest and service charges was excessive and whether the Court could call into aid the provisions of the Mysore Act to mitigate the rigour of the loan transaction, and if so, what relief defendant is entitled to? The Division Bench thereafter examined the provisions of the Reserve Bank of India Act, 1934, the Banking Regulation Act, 1949 and the Banking Companies (Acquisition and Transfer of undertakings) Act, 1970 as amended from time to time and noticed the various directives/circulars issued by the Reserve Bank in exercise of power conferred by Section 21 of the Banking Regulation Act, 1949 and concluded as under: It is thus clear that the ordinary practice or custom of Banks was only to charge interest with yearly or half-yearly rests and that too only on over-draft amounts and unsecured loans. The monthly and quarterly rests, therefore, does not appear to be the recognised banking practice. The Division Bench next examined whether the Reserve Ban ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... August 17, 1978 which in turn referred to an earlier Circular of October 5, 1974. By the time this decision was rendered Section 21-A was introduced in the Banking Regulation Act, 1949 which reads as follows: 21A: Rates of interest charged by Banking Companies not to be subject to scrutiny by Court. - Notwithstanding anything contained in the Usurious Loans Act, 1918, or any other law related to indebtedness in force in any State, a transaction between a Banking Company and its debtor shall not be re-opened by any court on the ground that the rate of interest charged by the banking company in respect of such transaction is excessive. The Division Bench came to the conclusion that the loan in question was for agricultural purposes and, therefore, under the Reserve Bank's Circulars the Bank was precluded from recovering interest with quarterly rests. On the question whether the contractual rate of 13% was excessive, the Division Bench ruled against the borrower. However, on the question of applicability of Section 21A it observed that the said provisions had no bearing on the question of court's jurisdiction to give relief to an aggrieved partly if the bank in any particul ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Code Civil Procedure as also to the Reserve Bank of India with a direction to inspect the accounts and submit a report. Accordingly the report came to be submitted on June 7, 1985. That report disclosed that the Bank had debited interest to the crop loan account thrice with half yearly rest before the due date of payment of the loan and had also compounded the interest. The Division Bench observed as under: The Bank, however, could not add interest outstanding to the principal and compound the interest when the crop loan becomes overdue keeping in view what has been stated in the Circular dated March 14, 1972, As such the Bank's compounding of interest at half yearly intervals after the loan amount has become overdue cannot be questioned. Reference was made to as many as six circulars issued by the Reserve Bank between March 14, 1972 and September 15, 1984. The Division Bench held that Banks were bound to follow the directives or circulars issued by the Reserve Bank prescribing the structure of interest to be charged on loans and any interest charged in excess of the prescribed limit would be illegal and void. Following its earlier decisions it was further held that Banks co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AIR1986AP291 , a learned Single Judge of the said High Court, however, held that Section 21A cannot have overriding effect over the Usurious Loans Act, 1918, as amended by the Madras Amendment Act No. VIII of 1937, in its application to agriculturists. According to the learned Judge, the use of the generic word 'debtor' in Section 21A was not intended to refer to agriculturists. The learned Judge also held Section 21A ultra vires the power of Parliament on the ground that it was not a law relating to Banking but was intended to deny relief to agriculturists from indebtedness which was beyond the legislative competence of Parliament. He felt that the said provision could not be saved by the application of even the pith and substance doctrine. Further, the learned Judge found Section 21A ultra vires Article 14 on the plea that a law which requires or compels courts to implement harsh, unequal and unconscionable transactions providing for payment of compound interest or usurious rates of interest by depriving the debtors of their right to claim relief under the provisions of the Usurious Loans Act or similar State laws would offend Article 14 inasmuch as it permits discrimina ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... apart from the punishment that can be imposed on the officers, Section 47A empowers the Reserve Bank to penalise the banking company also. These, in brief, are the powers and functions of the Reserve Bank. 11. We may now notice the directives/circulars issued by the Reserve Bank relating to charging of interest on advances. The first circular, by far the most important, is dated March 14, 1972. It takes note of the fact that agricultural finance stands on a different footing for the reason that agriculturists do not have any regular source of income other than the sale proceeds of their crops. They would, therefore, be in a position to pay interest only when they receive the sale proceeds of their crops. Taking note of the said position, the circular proceeds to state as under: Having regard to the special characteristics of agricultural finance, banks are advised to bear in mind the following principles in the matter of application of interest on such advances. (i) Repayment period of agricultural advances, whether short-term or medium-term, should be so fixed as to coincide with the period when the farmer is fluid i.e., after harvesting and marketing of his crops. Payment of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erest shall be charged with quarterly rests. It is clarified that this aspect of the directive will not apply to agricultural advances in respect of which the instructions issued in our letters dated the 14th March, 1972 and...dated the 5th October, 1974 will continue to prevail. In other words, payment of interest on agricultural advances should be insisted upon only at the time of repayment of principal/installment of principal and interest on current dues should not be compounded. The circular makes it clear that the circular dated March 13, 1976 would not apply to agricultural advances which would continue to be governed by the first two circulars dated 14th March, 1972 and 5th October, 1974. The fifth circular dated February 28, 1978 was issued in supersession of the third circular dated March 13, 1976. By this circular the maximum rate of interest prescribed under the third circular was reduced from 16.5% to 15%. In regard to compounding of interest it is directed that interest, shall be charged with quarterly or longer rests. The sixth circular dated September 15, 1984 restates the general guidelines laid down in the previous circulars in regard to the procedure for chargin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns have become overdue. Thus this circular draws a distinction between loanees other than agriculturists and advances made to agriculturists in the matter of charging interest. It is, therefore, quite clear that agricultural loans stand on a different footing from other loans including a loan or advance secured for construction of flats, as in the case of D.S. Gowda. So far as agricultural loans are concerned, having regard to its special characteristics and the time factor relating to the farmer's capacity to meet his financial obligations, it was realised that farmers would not be in a position to pay interest at short periodical rests and if their inability to do so is visited with compounding of interest it would be too harsh and unjust on the farmers. The Reserve Bank, conscious of this difficulty of the farmers, directed the banks that repayment period should be so fixed as to coincide with the period when the farmer is fluid and payment of interest should also be insisted upon only at the time of repayment of the loan or installment. Further it directed that interest on current dues should not be compounded but if and when the crop loans or medium-term loans become overd ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e effect is to add the interest to the principal, in which case it loses its quality of interest and becomes capital. From the above note, which by and large corresponds to Pagets' opinion extracted earlier, it is evident that although there may be no common law right to charge interest on an overdraft, by universal custom or bankers a reasonable rate of interest on overdrafts is permissible. So also charging of interest with periodical rests or compounding of interest would be allowed if there is evidence of the customer having acquiesced therein, provided the relation of banker and customer is subsisting. However, if the relationship undergoes a change into that of mortgagee and mortgagor by the taking of a mortgage, the charging of interest would be governed in accordance with the terms of the mortgage. The taking of a mortgage to secure the fluctuating balance of an overdrawn account, being not inconsistent with the relationship of banker and customer, would displace earlier right to charge compound interest. Thus, the practice of bankers to debit the accrued interest to the borrower's current account at regular periods is a recognised practice. The circulars issued by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at 16.5% with quarterly rest. The trial Court also held that since he had admittedly not paid any interest on the overdraft as agreed under terms of the promissory noted dated 26th November, 1973 till the date of the execution of the mortgage deed, the Bank was perfectly justified in adding the outstanding interest of ₹ 78,000 to the actual loan amount to constitute the principal or mortgage money. The calculation of interest due on the overdraft facility at the specified rate with quarterly rest perfectly justified as the relationship of banker and customer subsisted till the date of the execution of the mortgage deed. After the relationship changed to mortgagee and mortgagor on the execution of the mortgage deed, interest had to be charged as agreed under the terms of the mortgage which was 16.5% per annum to be paid monthly failing which the Bank was permitted 'overdue interest'. The learned trial judge rightly notes that if interest is charged with monthly rest under the mortgage instead of quarterly rest as claimed the same would prove disadvantageous to the borrower. On the question of the transaction being 'unfair' or the interest being 'excessive&# ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that Paget's opinion and the statement of law in para 160 of Halsbury clearly show that it has been the practice of bankers to debit accrued interest to borrowers' account at regular periods usually half yearly. The High Court notices that banks in India were not following a uniform practice and some banks charged interest with monthly or quarterly rests while others charged with yearly or six monthly rests and hence the Reserve Bank had to issued directives to bring about uniformity in that behalf. What is important is to realise that the normal practice was yearly or half yearly rests but shorter rests also prevailed. Secondly, the High Court was wrong in going behind the circulars/directives of the Reserve Bank on the plea that the Reserve Bank did not pay 'adequate attention' to the question of rests or compound interest to be charged from borrowers other than agriculturists. As pointed out earlier, under the Banking Regulation Act wide powers are conferred on the Reserve Bank to enable it to exercise effective control over all banks. Sections 21 and 35A enable it to issue directives in public interest to regulation the charging of interest on loans or advances ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion by empowering the courts to grant relief if the interest charged is excessive rendering the transaction substantially unfair. Such laws would not have been necessary if an agreement providing for excessive rate of interest was per se violative of Section 23 of the Contract Act. Besides it is difficult to say that the Reserve Bank did not pay adequate attention to the question of "rests" when it is evident from the directives referred to earlier that it was the precise question of bringing about uniformity in that behalf to which the Reserve Bank addressed itself. The High Court has not put down the policy but has merely condemned it. Unless the directives lying down the said policy are declared illegal and unenforceable Banks would be bound to follow them for otherwise they would be penalised. We, however, find it difficult to agree that adequate attention to the question of 'rests' was not paid by the Reserve Bank. 17. The real question, therefore, is whether the charging of interest at 16.5% per annum with quarterly rests is so obnoxious as would attract the provisions of the Usurious Loans Act, in this case the Mysore Act. Section 3(1) indicates that if i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... te would be 12.5% per annum with annual rests. Penal interest was refused on the ground that the mortgage-deed did not provide for it. 19. The point boils down to whether interest rate of 16.5% per annum with quarterly rest on a secured loan can be said to be so excessive as to render the transaction substantially unfair? Now, as we have pointed out earlier, the said rate of interest with the duration of the rest was prescribed and claimed consistently with the Reserve Bank directions. Having regard to the powers and functions of the Reserve Bank to which we have drawn attention, can it be said that interest rates prescribed by the Reserve Bank with the minima and maxima fixed, are unfair particularly when they have been fixed in public interest? Can the Court have reason to so believe? Do the facts of the case warrant a conclusion of the interest rate being excessive? The term 'excessive' is a relative terms; what may be excessive in one case may not be so in another. Much will depend on the circumstances obtaining at the material date. In our view if the Reserve Bank, keeping in view the economic scenario of the country and the impact that interest rates would have on th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... esumably because he was an influential person, the bank granted him further indulgence on his agreeing to execute a mortgage. Till that date the building was not complete and did not yield any income. In the circumstances the Bank was justified in being cautions. The guidelines issued by the Reserve Bank permitted a maximum interest rate of 16.5% per annum with quarterly rests. The fluctuations in the rates of interest between 1973 and 1975 on borrowing in the mercantile community is not on record. There is also no evidence on record as to the rate at which loans could be had in 1975 on the security of Immovable property in the open market. The High Court has concluded that the rate of interest charged was excessive solely on the basis of rates of interest allowed by Banks on deposits and the interest charged by the Reserve Bank on borrowings by banking institutions. The High Court concludes as under: It is thus seen that as on today banks get advances from the Reserve Bank at 10% and pay the interest on deposits not more than 10% for deposits of three years and above. 21. On this finding the High Court thought that 12.5% interest with annual rest from the date of equitable mort ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... te of interest charged is excessive. It is not necessary for us to go into the question whether the provisions of the Banking Regulation Act would prevail or whether the newly added Section 21A would apply to pending cases as on the facts stated hereinbefore we are satisfied that the High Court fell into an error in holding that the rate of interest on the mortgage is question was excessive. 23. Insofar as Civil Appeal No. 544 of 1986 is concerned it relates to the bank's right to charge compound interest i.e. interest with periodical rests on agricultural advances. We have already referred to the various circulars issued by the Reserve Bank from time to time in exercise of power conferred by Section 21/35A of the Banking Regulation Act. We have pointed out that the said circulars/directives provide that agricultural advances should not be treated on par with commercial loans insofar as the rate of interest thereon the concerned because the farmers do not have any regular source of income except sale proceeds of their crops which income they get once a year. The question of recovery of interest with quarterly or six monthly rests from farmers is, therefore, not feasible. The f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ar State laws notwithstanding. In Krishna Reddy v. Canara Bank AIR1985Kant228 it was observed as under: The mandate of this section is that Court cannot re-open the account relating to a transaction between a Banking Company and its customers on the ground that the rate of interest charged, in the opinion of the Courts, is excessive or unreasonable. The Courts, in other words, cannot exercise jurisdiction under the Usurious Loans Act or any other law relating to indebtedness for the purpose of giving relief to any party, This appears to be the intent of the Legislature in enacting the Banking Laws (Amendment) Act. 1983. Section 21A has, however, no bearing on the jurisdiction of Courts to give relief to an aggrieved party when it is established that the Bank in a particular case has charged interest in excess of the limit prescribed by the Reserve Bank of India. Therefore, according to the High Court if, in any case, it is shown that the Bank was claiming interest in excess of that permitted by the circular/direction of the Reserve Bank, the Court could give relief to the aggrieved party notwithstanding Section 21A to the extent of interest charged in excess of the rate prescr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t arise in the present case. But if the Reserve Bank has fixed the maximum rate of interest in exercise of the powers conferred by Section 21/35A of the Banking Regulation Act, Section 21A would be attracted and the transaction would not be liable to be reopened on the ground that the rate of interest fixed is excessive even though not exceeding the ceiling determined by the Reserve Bank. In the case of agricultural loans/advances the position has been made amply clearly by the circulars referred to earlier which do not permit Banks to charge compound interest with quarterly rests. In such cases as observed earlier the interest can be fixed with annual rests coinciding with the time when the farmer is fluid and if thereafter the farmer fails to pay the interest it would be open to compound the interest on the crop loan or installments upon the term becoming overdue. In view of the above we do not see any flaw in the reasoning of the High Court so far as this appeal is concerned. We, therefore, must dismissed the appeal. 26. In the result Civil Appeal No. 4214 of 1982 is allowed and the decision of the High Court is restored, with this modification that the post-decree interest sha ..... X X X X Extracts X X X X X X X X Extracts X X X X
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