B.0.1. FINANCE LIMITED ETC.

A v.

THE CUSTODIAN AND ORS. ETC.

MARCH 19, 1997

[AM. AHMADI, CJ., S.P. BHARUCHA AND B.N. KIRPAL, JJ.] B

Banking Regulation Act 1949, ss. 21, 35-A, 36(1) (a) and (b) r/w Secwities Contracts (Regulation) Act 1956, s. 16 and Special Court (Trial of Offences relating to Transactions in Securities) Act 1992, s. ]()--Circulars issued by Reserve Bank of India under Banking Act prohibiting ready-f 01ward C transactions-Special Court holding ready forward contracts entered into by appellant banks in violation of circulars to be illegal (/Jld ordering retum of securities to Custodian-Held, non-compliance of circulars did not result in invalidation of contract by banks with third parties.

Contract Act 1872, ss.23 and 57-Ready-fonvard contracts entered into D by appellant banks with third parties in violation of Rese1ve Bank of India circulars-Whether ready leg of transaction severable from the forward leg-Held, yes; the ready leg having been pe1fonned, the f 01ward leg which alone was illegal, had to be ignored.

Trai1sfer of Property Act 1882, s.5, 6(11) r/w Sale of Goods Act 1930, ss.4, 19 and 20-Ready-forward contracts entered into by appellant banks with third parties in violation of Rese1ve Bank of India circular:.-Wliether illegality of agreement preceding transfer of title in securities could invalidate the transf e1-H eld, no; illegality off onvard leg could not affect transfers that had already taken place.

The appellant banks had prior to June 6, 1992, entered into readyfonvard contracts with different brokers for the purchase and sale of certain securities which were not listed on any stock exchange. These

transactions consisted of two inter-connected legs, viz., the first or the G ready leg, consisting of purchase or sale of certain securities at a specified price, and the second or fonvard leg, consisting of the sale or purchase of the same or similar securities at a later date at a price determined on the first date.

The ready leg of the transactions were completed with the appellants H 51

A paying the agreed price and receiving the delivery of securities agreed to be purchased. Before the forward leg could be completed, a Special Court (Trial of Offences relating to Transactions in Securities) Ordinance, 1992 was issued on June 6, 1992 which was subsequently replaced by the Act ('Special Court Act'). The Custodian, under the Special Court Act filed

B applications before the Special Court to the effect that the ready forward contracts entered into between the banks and the notified persons were in violation of the Banking Regulation Act, 1949 ('Banking Act') and the Securities Contracts Regulation Act, 1956 and therefore void. Consequently those securities which had been sold to the appellants in the ready leg continued to be, in law, the properties of the notified persons and stood C attached under s. 3 (3) of the Special Courts Act. The Custodian required the Special Court to direct the appellant banks to return the said securities.

Allowing the applications of the respondents, the Special Court held that the circulars issued under the Banking Act were binding and the ready D forward contracts being contrary thereto were illegal and void in respect of the third parties. The appellants were directed to return the securities to the Custodian. ·

In this Court the appellants contended that the violation of the E circulars issued under the Banking Act did not invalidate the contracts entered by them with their customers. Further, the forward leg of the transaction, which was alone illegal, was severable from the ready leg and had to be ignored. Even assuming that the transaction was not severable, the ready leg having been performed, the illegality of the agreements could

F not invalidate the transfers that had already taken place.

Allowing the appeals, this Court

Held : 1.1. Infringements of the instructions issued by the Reserve Bank of India under the Banking Regulation Act, 1956 prohibiting the G banks from entering into buy-back arrangements did not invalidate such contracts entered into between the banks and it's customers. The instructions which were issued by the circulars were meant to be complied with by the banking companies only and did not purport to, nor could they, be binding on third parties. [87-A-B, 70-A-B]

H 1.2. It would be unjust and inequitable if such transactions entered

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B.O.I. FINANCE LTD. v. CUSTODIAN 53

into by the bank with a customer were to be regarded as void because the A bank did not follow the directions or instructions of the Reserve Bank of India. [ 69-G-HJ

Seth Banarsi Das v. The Cane Commissioner, [1963) SCR Supp. 760, referred to.

Yango Pastoral Company Pvt. Limited v. First Chicago Australia Limited, (1978) 139 C.L.R. 411, referred to.

2.1. The ready forward contract was 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 was illegal, had to C be ignored. [87-B]

2.2. In the case of a ready-forward contract the stipulation to retransfer the securities, on a later date, could only be regarded as condition precedent and it was only this part or condition which would fail. Thus, the securities purchased by the appellants from the notified persons could not D be attached. [76-C-D, 76-G]

Asaram v. Ludheshwar, AIR (1938) Nag 335 and Ram Santp v.

Mussumat Bela, XI Indian Appeals 44 and Sec. v. Drysdale Secwities, 785 F2d 38, referred to.

3.1. With the ready leg having been performed the illegality of the forward leg contained in the agreements could not affect the transfers which had already taken place. [87 -CJ

3.2. The validity of the transfer of the securities had to depend on the F provisions of the Transfer of Property Act and the Sale of Goods Act relating to transfer and not to the validity of the agreement preceding the transfer. [86-E]

SajanSingh v.SardaraAli, (1960) A.C.167 andSmt. Surasaibalii1iDebi

v. Phanindra Mohan Majmudar, [1965] 1 SCR 860, relied on.

Alexander v. Rayson, (1936) 1KB169 and Tinsley v. Millingan, (1993) 3 All ER 65, referred to

CIVIL APPELLATE JURISDICTION : Civil Appeal No. 1753 of 1994 Etc. Etc.

A From the Judgment and Order dated 14.12.93 of the Bombay High

Court in Misc. Application No. 11/93 and 23/93.

T.R. Andhyarujina, Solicitor General of India, Shanti Bhushan, K.

Parasaran, Soli J. Sorabjee, S.K. Cooper, I.M. Chhagla, D.A. Dave, S.K.

Dholakia, A.M. Setalwad, Arnn Jaitley, Ram Jethmalani, P.K. Mullick, V.

Tulzapurkar, (Anand Bhatt, Sandeep Mittal, R.N. Karanjawala, Ms. Ruby Ahuja, N. Gore) for 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, Ms. Kiran, Neena Gupta for Vineet Kumar, D. Khambatta, J.D. Das, Ms. Anjali Seth, C Ms. Mona Bhide, Dr. A.F. Julian, Arputham Aruna & Co., 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, J.K. Das, H.S. Parihar, Subrat Birla, K.S. Parihar, S.K. Mehta, Dhruv Mehta, Fazlin Anam, Ms. Monica Mehta, K.J. John, P.H. Parekh

D and Ms. Sunita Sharma for the appearing parties.

' The Judgment of the Court was delivered by

KIRPAL, J. These appeals, under Section 10 of the Special Court (Trial of Offences relating to Transactions in Securities) Act, 1992 E (hereinafter referred to as 'The Special Court Act') arises 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 Court's Act, 1992 had been made applicable.

F The appellant banks had prior to 6th June, 1992, entered into contracts with different brokers for the purpose and sale of certain securities which were not listed on any stock exchange. For the purpose of this case these contracts have been regarded as ready-forward transactions or buy-back transactions. The parties are agreed, and it is on G this basis that the High Court also 'proceeded, that the nature of such a transaction is that it consists of two inter-connected legs, namely, the first or the ready leg, consisting of purchase or sale of certain securities at a specified price, and the second or forward leg, consisting of the sale or purchase of the same or similar securities at a latter date at a price determined on the first date. Such ready-forward transactions H have, in most cases, been entered into either by execution of a single

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B.0.1.FINANCELTD. v. CUSTODIAN[KIRPAL, J.] 55

document or by execution of two documents contemporaneously, one A representing the first or ready leg and the other the forward or second leg.

On such contracts being entered into the ready leg of the transactions were completed with the appellants paying the agreed price and receiving the delivery of the securities which were agreed to be purchased.

Before the forward leg of the transactions could be completed, a B Special Court (Trial of Offences relating to transactions in securities) Ordinance 1992 was issued on 6.6.1992 which was subsequently replaced by the Act.

Special Courts Act, 1992 :

. The necessity for issuance of the said Ordinance is contained in the Statement of objects and reasons which reads as follow : c

"In the course of the investigations by the Reserve Bank of India, large scale irregularities and malpractices were noticed in transactions in both the Government and other securities, indulged D in by some brokers in collusion with the employees of various banks and Financial institutions. The said irregularities and malpractices led to the diversion of funds from banks and financial institutions to the individual accounts of certain brokers.

2. To deal with the situation and in particular to ensure the E speedy recovery of the huge amount involved to punish the guilty and restore confidence in and maintain the basic integrity and credibility of the banks and fmancial institutions the Special Court (Trial of Offences Relating to Transactions in Securities) Ordinance, 1992 was promulgated on the 6th June 1992. The Or- F dinance 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 cine or more Custodians for attaching the property of the offenders with a view to prevent diversion of such properties by the offenders."

. G

We will now refer to some of the provisions of the said Act which are relevant for the purpose of this matter.

Section 2 contains defmitions. The term "securities" is defined in Section 2( c) and is as follows : H

"securities includes -

(i) shares, scrips, stocks, bonds, debentures, debenture stock, units of the Unit Trust of Indin 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."

Section 3 of the said Act relates to appointment and functions of C Custodian and reads as follows :

"3(1) The Central Government may appoint one or more Custodians as it may deem fit for the purposes of this Act.

(2) The Custodian may, on being satisfied on information received that any person has been involved in any offence relating to transaction in securities after the 1st day of April, 1991 and on and before the 6th June, 1992 notify the name of such person in the Official Gazette.

(3) Notwithstanding anything contained in the Code and any other law for the time being in force, on and from the date of notification under sub-section (2), any property, movable or immovable, or both belonging to any person notified under that sub-section shall stand attached simultaneously with the issue of the notification.

( 4) the property attached under sub-section (3) shall be dealt with by the Custodian in such manner as the Special Court may direct.

. (5) The Custodian, may take assistance of any person which exercising his powers or for discharging his duties under this section and Section 4."

The Custodian has been given power under Section 4 to order the cancellation of any contract or agreement entered into between 1.4.1991 H and 6.6.1992 which, in his opinion, has been entered into fraudulently or

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B.O.I.FINANCELTD. v. CUSTODIAN(KIRPAL, J.] 57

to defeat the provisions of the Act. On such cancellation being ordered, A the property stands attached under the Act.

Special Court is established under Section 5 by the Central Government issuing the notification to that effect. Section 11 deals with the discharge of liabilities and reads as follows :

"11(1) Notwithstanding anything contained in the Code and any other law for the time being in force, the Special Court may make such order as it may deem fit directing the Custodian for the disposal of the property under attachment.

(2) The following liabilities shall be paid or discharged in full, C as far as may be, in the order as under :

(a) all revenues, taxes, cesses and rates due from the persons notified by the Custodian under sub-section (2) of Section 3 to the Central Government or any State Government or any local D authority;

(b) all amounts due from the person so notified by the Custodian to any bank or financial institution or mutual fund;

( c) any other liability as may be specified by the Special Court E from time to time."

Section 13 provides that the provisions of the Act will have an overriding 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 F 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 irregularities and mal-practices which had been committed by some brokers in collusion with employees of various banks and financial institu- G

tions. 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 H

A 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)(b) clearly is that after the discharge of the liabilities under Section 11(2)( a), the amounts which are paid to. the banks would probably be those

B funds which were diverted from the banks by reason of mal-practices in the security transactions. In other words, the losses caused to the banks and the financial institutions were to be made from out of the assets of the notified persons.

At this stage, it will be relevant to see as to what is the position of C the Custodian.

Section 4 of the Act gives the custodian the power to cancel such contracts or agreements which have been entered into fraudulently. That apart, he is merely a custodian of the properties of the notified persons D which stand attached under the Act and such properties are to be dealt with by him in such manr ':r as the Special Court may direct.

The Act shows that the Custodian has three main functions to perform. Firstly; he has the authority to notify a person under Section 3(2) who has been involved in any offence relating to transactions in securities E during the period 1.4.1991 to 6.6.1992. Secondly; he has been given the authority by Section 4 to cancel contracts or agreements relating to the properties of the notified persons which, in his opinion, have been entered into fraudulently or for the purpose of defeating the provisions of the Act.

Lastly; he is required to deal with properties in the manner as directed by F the Special Court. To put it simply the Custodian is required to assist in the attachment of the notified person property and to manage the same thereafter. The properties of the notified persons, whether attached or not, do not at any point of time, vest in him. He is merely a Custodian and his position is not like that of a Receiver under Civil Procedure Code (Section 94 Order 44) or an official receiver under Provincial Insolvency Act or G official assignee under the Presidency Insolvency Act. There is no vesting of the attached properties of the notified persons in the custodian. This is in contrast with Section 28(2) of the Provincial Insolvency Act and Section 17 of the Presidency Insolvency Act. There is the vesting in the official receiver or official assignee. He is also not in a position of an official H liquidator under the Companies Act in whom not only the property vests

B.0.I. FINANCE LTD. v. CUSTODIAN [KIRPAL, J.] 59

but who is also in control thereof. This being so there is considerable force A in the contention of the counsel for the appellants that, except for 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 V ariava of the Bombay High Court has been constituted as a Special Court B 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

The custodian filed applications before the Special Court to the effect that the above mentioned 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 Regulation Act 1956. It was therefore, D 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 to return the said securities. E Similar applications were also filed, subsequently, by Sh. Harshad Mehta, one of the notified parties, with whom such transactions had been entered into by some other appellant banks.

Resisting the applications the appellant banks had, inter alia, contended that the transactions in question were not illegal and did not F contravene the provisions of Banking Regulation Act, 1949 and the circulars issued by the Reserve Bank of India thereunder and nor were they contrary to the provisions of the

1 Securities Contract Regulation Act, 1956 and the notification issued under Section 16 thereof. lt was further contended that in any case the contracts in question were severable and the illegality, if any, was attached only to the second leg and not to the first G leg. The transfer for title had taken place in favour of the appellant banks and the securities did not belong to the notified persons and as such they could not be regarded as being attached under Section 3(3) of the Act. It was also submitted that, assuming that the entire contract was illegal and void, neither the Custodian nor the notified parties could ask for the relief H

A sought for as both the parties to the contract were in pari delicto. It was also contended that in the event the court was to order the return of the securities then the notified parties should be directed to return the consideration received by them.

B The Special Court heard the applications only on that points of law without going into the facts of any case. The case proceeded on the assumption that the appellants .had entered into ready-forward transactions. It was accepted by the parties before the Special Court that the ready-forward transaction (or as sometimes described as a buy-back transaction) had four ingredients; (i) there must be a present sale or purchase C with the commitment to repurchase or resale in future; (ii) the contract must be between the same parties; (iii) it must be in respect of some kind of securities and for the same quantum of securities and; (iv) the transaction must be entered into on the same day or contemporaneously and the price of resale and repurchase would be fixed at the stage of first leg itself.

The Special court by a common judgment proceeded to decide the general questions of law which arose by regarding the transactions in question to be ready-forward transactions. It took note of the concession on behalf of the counsel for the Custodian that if a transfer had already E 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 p 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 forth.er came to the conclusion that the contracts were also illegal under the provisions of the Securities Regulation Act, 1956 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 G case as the Custodian was not making any claim in the applications but was merely bringing to the attention to the court the fact that third parties were in possession of properties which stood attached under the provisions of Act of 1992. The fact that the Custodian had not exercised any power under Section 4 of the Special Courts Act, in respect of these transactions, H was also taken note of.

B.0.1.FINANCELTD. v. CUSTODIAN[KIRPAL, J.] 61

Having come to the conclusion that the contracts were void, the A Court held that the claim of the banks for restitution will have to be dealt with as an ordinary claim against the property of a notified person at the stage of distribution under Section 11. It accordingly directed the banks to return the securities to the Custodian. While giving this direction it further observed that if these securities had been transferred by the banks to third B parties then no right could be created in their favour as the banks had no right to transfer them and, therefore, the banks should purchase the securities of the same value from the market and deliver the same to the custodian.

The appellant banks have challenged, in these appeals, the correct- C ness of the aforesaid decision of the Special Court. The contentions raised before the Special Court were reiterated by the learned counsels for the appellant banks while Mr. Atul Setalvad, on behalf of the Custodian and Mr. Jethmalani on behalf of Harshad Mehta supported the decision of the Special Court. The Solicitor General, appearing on behalf of Reserve Bank of India addressed arguments with regard to the effect of the circulars D issued by the Reserve Bank of India on the contracts in issue.

Having heard very lucid arguments of the learned counsels for the parties, we now propose to deal with these contentions which are necessary for deciding these appeals.

RE : ALLEGED VIOLATION OF THE CIRCULARS ISSUED BY THE

RESERVED BANK OF INDIA

With regard to the finding of the Special Court that the transactions in question were illegal, as they were in contravention of the circulars which p were issued by the Reserve Bank of India under the provision of the Act, it was contended by Mr. Cooper, learned counsel, that the circulars issued were no more than guidelines which were required to be followed by the Bank and they were not mandaiory in nature. Elaborating this contention, Mr. Cooper submitted that the Banking Companies Act contains provisions which enable the Reserve Bank of India to issue directions which were G mandatory and also give advice to the banks. Our attention was drawn to Sections 21 and 35A of the said Act and it was contended that the directions which are issued by the Reserve Bank of India under these two provisions are clearly mandatory. On the other hand, Section 36(1)(a) & (l)(b) gives power to the Reserve Bank of India to give advice or lend H

A 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 B 36(1)(a) and (l)(b) of the Act.

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 Government and other C 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.

D Please refer to paragraph lO(a) of Governor's letter No.

CPC.BC.84/279A-87 dated 31st March, 1987.

2. It has been observed that banks often enter into buy-back arrangements in respect of Government and other approved Securities among themselves and with their large public sector and corporate clients. The banks are advised to follow the guidelines given hereunder in respect of their buy-back arrangements with banks and others.

A Prohibition against buy-back arrangements in respect of Corporate Securities and Bond issued by Public Sector Undertakings.

Bank should not enter into buy-back arrangement in respect of their holdings of public sector bonds or corporate shares and debentures.

B. Buy-back arrangements in Governmen~ and other Approved Securities with (non-bank) clients.

(i) The buy back deals should be exclusively confined to Government and other Approved Securities and the re-purchase date should be fixed after a minimum period of 30 days from the

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B.O.I.FINANCELID. v. CUSTODIAN[KIRPAL, J.] 63

date of sale of the securities in question.

(ii) The purchase/sale prices under the arrangement should be in alignment with the proximate market rates prevalent on the date of the original transaction for the relevant Government and other Approved Securities.

(iii) No sales of government and other Approved Securities under the arrangement should be effected by banks unless the same are actually held by them on their own investment portfolio either in the form of actual scrips or in SGL account maintained with Reserve Bank.

(iv) Immediately on sale, the corresponding amount should invariably be deducted from the investment account of the bank and its SLR assets for entire period (minimum 30 days) of holding by the purchaser/counter-party.

(v) Interest on the securities at COl!pon rates would be paid by D the banks after deduction of tax on the lines indicated in our circular No. DBOD.BP.BC 88/C.469(81-B)-86 dated 14 August, 1986.

4. A copy of this circular may please be placed before the Board of Directors for their information, under advice to us.

5. Please acknowledge receipt."

(Emphasis added) F

The letter of December 1, 1987 issued by the Reserved Bank of India was also addressed to all scheduled commercial banks and was as follows :

"Buy-back arrangements in units of Unit Trust of India (UTI).

We have received inquiries from banks whether they can enter into buy-back arrangements in units of UTI under 1964 Scheme.

We have examined the matter and have to advise that the units are not approved security for buy-back 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 added)

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 B advised to follow the guidelines contained in the said letters and that the contents thereto were not binding on the banks.

Section 21 of the Banking Companies Act, and sub-section (2) in particular, entitled the Reserve Bank of India to give directions to the C 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(l) also contains the power of the Reserve Bank of India to give directions and the same reads as under :

"35A(l) 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 banking company; or.

( c) to secure the proper management of any banking company F generally;

It is necessary to issue directions to banking companies generally or to any banking company in particular it may, from time to time, issue such directions as it deems fit, and the banking companies or the banking company, as the case may be, shall be bound to comply with such directions."

There can obviously be no doubt, as is evident from the plain reading of the said provisions, that the directions issued under Sections 21 and 35A are binding on the banking companies, Section 36(1)(a) and l(b), on which H reliance is placed, reads thus :

B.O.L F1NANCE LTD. v. CUSTODIAN [KIRPAL, J.) 65

"(1) The Reserve Bank may -

(a) caution or prohibit banking companies generally or any banking company in particular against entering into any particular transaction or class of transactions and generally give advice to any banking company;

(b) on a request by the companies concerned and subject to the provisions of (section 44A) assist as intermediary or otherwise in proposals for the amalgamation of such banking companies." (Emphasis added)

Referring to Section 36(1)(a), we find that it empowers the Reserve C Bank to "caution or prohibit" the banking companies from entering into any particular type of transaction or generally to give advice to the said banking companies. This provision not only enables the Reserve Bank to assume an advisory role but it also gives it the power to prohibit a banking company against entering into any particular transaction/s or class of transaction. D The use of words "caution or prohibit" in Section 36(1)(a) clearly implies that when the Reserve Bank of India prohibits the banking companies from entering into any particular transaction then such a direction which is issued would be binding on the banks and has to be complied with. While the Reserve Bank of India has the power, under Section 36(1)(a) of the E Act, to give advice or to caution the banking companies which may not be binding on the banking companies, but when the Reserve Bank prohibits the banking companies against their entering into any particular transaction or class of transactions, the said prohibition has to be regarded as being binding. The power to prohibit, given by Section 36, will be meaningless if it was not meant to be binding on the banking companies.

It is no doubt true that the circular dated 15.4.1987 states that the banks are "advised" to follow the guidelines given thereunder, but paragraph 2A of the said Circular clearly contains the prohibition relating to the buy-back arrangements. Similarly, under paragraph 28, which is applicable in the present case, by use of the words "should be" the circular G 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 meant to be binding on the banking companies and, was not merely H

A an 'advice' or a 'caution' which could be ignored.

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 penalty under Section 46 of the said Act.

It is not in dispute that the said circulars which have been issued were not made public. The said circulars were confidential documents and C required the banking companies to transact their businesses in a particular manner namely they should not enter into any buy-back contracts which were not according to the terms of the circulars. The Act itself does not provide that, where the directions issued by the confidential circulars are violated by the bank, the contracts entered into with the third parties would D in any way be invalidated. The said circulars also, did not say that the consequence of the directions contained therein not being followed by the Banking Companies will result in such transaction being regarded as void.

Indeed, no such stipulation could be made which would adversely affect third parties to whom no directions have been or could be issued and who were not aware of such directions issued-to .the banks.

It will be appropriate at this stage, to consider the decision of this Court in the case of Seth Banarsi Das v. The Cane Commissioner & Another,

(1963) SCR (Supp.) 760. In that case an agreement was entered into between the appellant and the cane marketing society for supply of sugar p cane. The appellant claimed that there was short supply of sugar cane and the society moved the Cane Commissioner for arbitration. These proceedings were sought to be challenged by the appellant by contending that the Cane Commissioner had no right to assume the office of arbitrator in this dispute because no valid agreement had been entered into between the parties, as contemplated by Section 18(2) of the Uttar Pradesh Sugar G Factories Control Act, 1938 and in the form XII as prescribed under the rules made thereunder. It was also contended that there were some blanks which were left to be filled in the prescribed form and it also did not have the signature of any representative of the sugar mill. On behalf of the appellant it was contended in this Court that the provisions of Section 18(2) H of Uttar Pradesh Sugar Factories Control Act were mandatory and had to

B.O.I.F1NANCEL1D. v. CUSTODIAN[KIRPAL, J.] 67

be followed to the letter. Inasmuch as the Act and the Rules prescribed a A penalty for breach of the said Section, it could not but be regarded as mandatory in all its parts. Therefore, assuming that the appellant may be guilty and could be punished but, it was submitted, the mandatory provision not having been followed no valid contract could come into existence and, consequently the Cane Commissioner had no jurisdiction to proceed in the B matter for appointment of an arbitrator. While repelling the contention, this Court at page 780 observed as follows :

"This rule has been applied in many cases both in India and in England. In State of U.P. v. Manbodhan Lal Srivastava, this Court observed that no general rule can be laid down but the object of C 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 D 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, 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 E prescription of law shall be treated as mandatory or directory could only be solved by regarding the object, purpose and scope of that law. If the statute is found to be directory a penalty may be incurred for non-compliance but the act or thing done is regarded as good.

It is unnecessary to multiply these cases which are based upon the F statement in Maxwell which is quoted over and over again."

It will also be useful to refer to the decision of the High Court of Australia in the case of Yango Pastoral Company Pvt. Limited and Others

v. First Chicago Australia Limited and Others, (1978), 139 C.L.R. 411 where Mason, J. made observations in this regard. That was a case where Section G 8 of the Bdnking Act, 1959 prohibited a body corporate from carrying on the business of banking without a license. The question arose whether a mortgage and guarantees given to an unlicensed corporation in the course of carrying on business were void or unenforceable. The High Court unanimously held that nothing in the statute made them void and that the H

A separate question of illegal performance should be determined by examining the terms of the statute to determine the impact of illegality on the enforceability of the contract. At page 428, it was observed as follows :

"The weighing of considerations of public policy in this case and the decision in favour of enforcing the contract is influenced by the form of the particular legislation. In this case the Act, as I have mentioned, is to a large extent directed to aiding the Government in executing its fiscal policy rather than regulating the relationship between banker and customer per se, a feature which lends support for the view that the provision of a large recurrent penalty for offences against Section 8 is Parliament's determination of the consequences of breach of the section and as the only legal consequences thereof. 17zere is much to be said for the view that once a statutory penalty has been proi>ided

. ' for an offence the rule of the common law in determining the legal consequences of commission of the offence is thereby diminished-see my judgment in Jackson v. Haniso1; (1978) 138 C.L.R. 438, at p.

452. See also the suggestions that the principle cannot apply to all statutory offences (Beresford v. Royal 1hsurance Co. Ltd., in the C:::ourt of Appeal (1937) 2 K.B. 197, at p. 22, per Lord Wright; Maries v. Philip Trant & Sons Ltd., (1954) 1 Q.B. 29 at p. 37, per Denning L.J ., and that it would be a curious thing if the off ender 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

~..

B.O.I. FINANCE LTD. v. CUSTODIAN [KIRPAL, J.] 69

gained through an illegal activity far more than the prescribed A penalty. This circumstance might provide a sufficient foundation for attributing a different intention to the legislature. It may be that the true basis of the principle is that the court will refuse to enforce a transaction with a fraudulent or immoral purpose : Beresford v. Royal Insurance Co. Ltd., (1937) 2 K.B. 197 at p. 220. B On this basis the common law principle of turpi causa can be given an operation consistent with, though subordinate to, the statutory intention, dying relief in those cases where a plaintiff may otherwise evade the real consequences of a breach of a statutory prohibition." c (Emphasis added)

The aforesaid principles will clearly be applicable in the present case as well. The non-compliance of the directions issued by the Reserve Bank may result in prosecution/or levy of penalty under Section 46, but it cannot D result in invalidation of any contract by the bank with the third party. If the contention of the Custodian is accepted it will result in invalidation of agreements by the banks, even where the third parties may not be aware of the directions which are being violated. To give an example if the Reserve Bank by confidential circulars fixes the limit in excess of which the banks cannot give any Joan but, without informing the third party, the bank E while exceeding it's limit gives a loan which is then utilised by the bank's customer. It will be inequitable and improper to hold that as the directions of the Reserve Bank had not been complied with by the bank, the grant of loan cannot be regarded as valid and, as a consequence thereof, the customer must return the amount received even though he may have F utilised the same in his business. Yet another instance may be where the bank advances loan by charging interest at a rate lower than the minimum which may have been fixed by the Reserve Bank, in a direction issued under Section 36(1)(a). As far as the customer is concerned, it may not be aware of the direction fixing the minimum rate of interest. Can it be said, in such a case, that the advance of loan itself was illegal or that the bank would be G entitled to receive the higher rate of interest? In our opinion it will be wholly unjust and inequitable to hold that such transactions entered into by the bank with a customer, which transactions are otherwise not invalid, can be regarded as void because the bank did not follow the directions or instructions issued by the Reserve Bank of India.

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 bank has been prohibit--d 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 of the Act.

SUBMISSIONS OF THE PARTIES

On 27.6.1969 the Government issued a Notification under Section C 16(1) of the Securities Contracts (Regulations) Act, 1959 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 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 delivery contract or contract for cash or hand delivery or special delivery in any securities as is permissible under the said Act and the Rules, bye-laws and regulations of a recognised stock exchange :

Provided that a contract other than a spot delivery contact or contract for cash or hand delivery or special delivery in any securities on the Cleared Securities List of a recognised stock exchange may be entered into between its members or through or with any such member for the purpose of closing out or liquidating all existing contracts entered into upto the date of this notification and remaining to be performed after the said date, but such contract shall be subject to the rules, bye-laws and regulations of the recognised stock exchange that come into force when further new dealings are prohibited in any securities on the Cleared Securities List and subject also to such terms and conditions, if any the Central Government may from time to time impose.

H As a result of the aforesaid Notification, except for sale or purchase of

" I

B.0.1.FINANCELID. v. CUSTODIAN[KIRPAL, J.] 71

securities under a spot delivery contract or contract for cash or hand A delivery or special delivery, all other contracts were prohibited. As a consequence thereof entering into a forward transaction became illegal.

Proceeding on the assumption that the aforesaid notification applied to the securities in question even though they were not listed on the stock exchange, the counsel for the appellant submitted that each contract B between the parties, namely, the notified person and the appellant was in two parts. According to this, the securities were sold by the notified person to the appellant and market price in respect thereof, was paid. The contract further stipulate that after a period of 14 days on a fixed day, at a fixed price the transaction will be reversed i.e. to say the appellant will sell back C the securities, which had been purchased by it, to the notified person who would pay the price which was agreed to between the parties. Assuming the contract as a whole to be illegal, it was submitted that before the notified date the securities had already been sold by the notified person to the appellant when the same were delivered to the bank against payment of money. The bank had, thus, become the owner of the securities and on D the date the said brokers were notified the said securities did not belong to the notified person and, therefore, the same could not be attached.

On behalf of the Custodian it was submitted by Mr. A.M. Setalvad that the said contracts were composite and unseverable, the illegality E attached to the forward element of the contract rendering the contract wholly void. While relying upon the Halsbury Law of England IVth Ed.

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 F court will not do this if to do so would alter entirely the scope and intention of the agreements.

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- G sions on behalf of the appellants merit acceptance.

ARE THE READY-FORWARD TRANSACTIONS SEVERABLE :

We will first deal with the submission that the agreements in question were severable and the illegality attached to the forward leg cannot affect H

A the ready leg of the transaction.

Mr. Chagla, appearing for ANZ Grindlays Bank, while assuming that the ready-forward transaction was one composite transaction, submitted that the same was severable into two parts each of which had a separate consideration and a separate object. He submitted that provisions of Section 57 of the Contract Act were applicable to the present case and the first set of promises or the ready leg would constitute a binding contract while the second leg, namely, the forward leg would be void. In support of this contention reliance was placed on a decision of the Full Bench of the Nagpur High Court in Asaram and Ors. v. Ludheshwar and Ors., AIR C (1938) Nagpur 335. In that case a joint family was indebted to the defendants. It had prparatory share in land to which the provisions of the Central Provinces Tenancy Act applied. According to Section 49 of the said Tenancy Act alienation of 'sir' land, that is home farm land in cultivation, was ineffective unless the sanction of appropriate official had D first been obtained. Section 49 of the said Tenancy Act postulated that if a proprietor lost his right to occupy any portion of the sir land as a proprietor he shall, as from the date of the loss, become an ocwpancy tenant of such 'sir' land. In order to alienate the interest in the said land a device was adopted to circumvent the provisions of Section 49 of the said Act. On 14th April, 1923 two deeds were executed by the father of the E appellants. By the first deed the proprietory right in the said land was sold for a sum of about Rs. 7367. On that very date a second document, a deed of surrender, was executed. In consideration a sum of about Rs. 7367 the appellants, predecessor in interest relinquished their occupancy rights in the 'sir' land. The appellants challenged the validity of the aforesaid deeds F executed by their predecessors in interest and filed a suit for transfer of the land in question, inter alia, on the ground that the said transactions were contrary to the provisions of Section 49 of the Tenancy Act and was, therefore, void. Taking note of the fact that the Act did not prohibit the transfer of the proprietory interest, because on such transfer the proprietor becomes an occupancy tenant of the 'sir', the Full Bench considered G whether, in such a case, Section 24 of the Contract Act became applicable, while dealing with the case where the contract consisted of legal and illegal parts Mr. Justice Vivian Bose at page 343 observed as under:

'Therefore if this transaction has consisted of a single consideration for the two objects contemplated, namely, the sale of the

Ji

B.O.I.FINANCELTD. v. CUSTODIAN[KIRPAL, J.] 73

proprietary rights (as distinguished from the occupancy rights) A together with the occupancy right (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. B But since the transaction consists of two separate considerations for two severable objects we are left with a contract consisting of legal and illegal parts 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 C or unless it involves serious moral turpitude or is otherwise against public policy. See S. 57 and 58, Contract Act. This rule was applied and in my opinion rightly, to this very class of cases in 27 N L R 113 at p. 115 and 22 NL R 136 at p. 141. As I have said the whole transaction in this case is not prohibited by statute; on the contrary D the part of it relating to the transfer of the proprietary rights is expressly allowed. Therefore under this rule since the considerations are separable that portion can, in my opinion, be enforced and it is only the surrender which is of no effect... .. "

Section 57 applies to cases where two sets of promises are distinct. E When the voici part of an agreement can be properly separated from the rest, the letter does not become invalid. The ready-forward transaction consists of two r :irts. In the ready leg there is a purchase or sale or securities at a stat. d price which is executed on payment of consideration for the spot delive; y of the security certificates together with transfer forms. F The full and absolute ownership of the title in securities vests in the purchaser, the entire property in the security passing immediately upon such delivery and payment. The seller is divested of all rights, title and interests in the said securities. The forward leg is to be performed at a later date on the stated price being paid. The securities are to be delivered back when the title in interest therein would pass to the original seller. It is clear G that such a ready - forward transaction consists of a set of reciprocal promises. The first set of promises were fully executed, but the second set remained executory. Section 57 of the Contract Act would thus be attracted to the present case, the effect of which would be that the first set of promises would constitute a binding contract but the second or the forward H

A leg would be void and unforceable. Neither the object nor the consideration of the ready leg is illegal, unlawful or prohibited under Section 23 of the Contract Act. The forward leg is neither the consideration nor the object for entering into the ready leg. At best it may be that the forward leg provided the parties with the motive for entering into the contract but

B that would not affect the severability of the forward leg, which alone is declared illegal under the Securities Control Regulation Act.

Mr. Chagla also relied on the decision in SEC v. Drysdale Securities, 785 F 2d 38 : FED SEC L Rep. p. 92, 487 at 92, Col. 2. The US Court of Appeal had an occasion to deal with such a ready - forward contract. In C that case 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 agreement 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") D 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 c -, ideration 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 E was held by the US Court of Appeal that there was a significant difference 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 them. The repo F merely imposes a contractual obligation to deliver identical securities on the settlement date set by the repo contract and then proceed to hold that the secured lender in the re po is free to deal the collateral".

In the present case also some of the banks which had purchased the securities had sold them. There was, at no point of time, any stipulation G between the parties that the banks could not trade in the securities which have been purchased by them. The obligation to re-sell the securities to the notified person, in the forward leg of the agreement, could be fulfilled by the purchase by the appellants of the securities from the market ancl then to sell them to the notified persons, in order to complete the forward H leg. The trading in the securities purchased by the banks in the ready leg

\1"

B.O.I. F1NANCE LID. v. CUSTODIAN [KIRPAL, J.] 75

was not in conflict with any law. The appellants were free to deal with them. A This would show that with the first or the forward leg of the transaction being completed the banks had become the absolute owners of the said securities and they could deal with them in any manner in which they liked.

There was nothing in the terms of ready-forward transaction which prohibited the bank, if they had sold the securities, from purchasing the B securities of the same value from the market and selling the same to the broker in order to complete the second or the forward leg of the transaction. This will itself show that the two legs of the transaction are severable.

It was contended by Mr. Setalvad that being a composite contract there can be no severance of the same. But the question of severance will C arise only in the case of a composite agreement consisting of reciprocal promises. It is only in such a case that the court has to see whether the contract is suc; h that the illegal or void part of the transaction can be severed. This is clearly evident from the decision in the case of Ram Samp

v. Mussumat Bela and Ors., (Vol. XI Indian Appeals 44). There the Privy D Council dealt with a case where a person - Hearsey - had gifted certain property owned by him to his second wife, generally c, 'l"d Vilayati Begum, and her three children on the condition of the wift. "'heyjo~ her husband and the children remaining faithful to their religion. There were decrees obtained by the predecessor in interest of the appellant against the said Hearsey. In execution thereof the transfer of the aforesaid property by E Hearsey was inter alia challenged by suits being instituted by the decree holder challenging the gift 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 p 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 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 forbidden to Christians; and that the gift was so thoroughly vitiated as to leave Hearsey, G the grantor, still the owner of the property in such 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 consideration, it was observed by the Privy Council as follows : H

A "Their Lordships are of opinion that the gift is in fact unconditional, because, as it was complete at the time when the actual transfer took place the parties could not afterwards import a condition; and the petition must be treated as inefficacious for that purpose. But even if it were otlwwise - assuming a condition, and B an immoral condition - it would be the condition that is immoral and not the consideration; and then the case would fall under the general rule of law that a gift to which an immoral condition is attached remains a good gift, while the condition is void."

c (Emphasis added)

In the case of a ready-forward contract the stipulation to re-transfer the securities, on a later date, can only be regarded as condition precedent and it is only this part or condition which will fail.

D It is not possible to accept the contention of Mr. Setalvad that severing the agreements into two parts would amount to re-writing or re-arranging the contract. We are here dealing with a case where there was one ai;:-;:ement, but which envisaged two sale transactions. Execution of each transaction envisaged the transfer of title in the securities. The valid part (the ready leg) of the transaction has been completed while the invalid E part (forward leg) has to be ignored.

What the notification issued under Section 16 did was to prohibit the entering into of a forward contract, i.e., sale at a future date for a fixed price. It expressly permitted sale of securities by spot delivery which, in the F present case, is represented by the ready leg. It is only the future sale or the re-sale of the securities at a later date which the notification did not permit. This latter part of the agreement could not have been entered into and is clearly severable and cannot affect the transfer of the title which had already taken place at the time of the execution of the ready leg. This being G so the securities which had been purchased by the appellants from the notified persons could not be attached.

POSITION IN LAW IF THE TRANSACTIONS ARE NOT SEVERABLE:

Even if it be assumed that the agreements were not severable, and H they were composite agreements even then the ready leg having been

B.O.I. FINANCE LTD. v. CUSTODIAN [KIRP AL, J. J 77

performed, the position in law is that the illegality of the agreements cannot A affect the transfers which had already taken place.

Reference may fust be made to the decision of the Privy Council in Sajan Singh v. Sardara Al~ (1960) A.C. 167. In that case the regnlations which had been framed provided that no person could use or sell a motor B vehicle for the carriage of goods without a haulage permit. Six motor vehicles were purhased 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 subsequently C purchased. Although the lorry was owned and operated by the respondent 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 D war. The respondent did not fall within that category, whereas the appellant did and that is why the permit was in the name of appellant but the lorry was paid for and operated by the respondent. In 1955, the appellant removed the lorry from the respondent's possession without his consent and refused to return it. A suit was filed by the respondent/plaintiff against the appellant/defendant for the return of the lorry or its value. While E upholding the decision in favour of the respondent, the Privy Council observed as follows :

n Although the transaction between the plaintiff and the defendant was illegal, nevertheless it was fully executed and carried out: p and on that account it was effective to pass the property in the lorry to the plaintiff. There are many cases which show that when two persons agree together in a conspiracy to effect a fraudulent or illegal purpose-and one of them transfers property to the other in pursuance to the conspiracy-then, so soon as the contract is executed and the fraudulent or illegal purpose is achieved, the G property (be it absolute or special) which has been transferred by the one to the other remains vested in the transferee, notwithstanding its illegal origin: see Scarfe V. Morgan per Parke B. The reason is because the transferor, having fully achieved his unworthy end, cannot be allowed to turn round and repudiate the means by which H

he did it-he cannot throw over the transfer. And the transferee, having obtained the property, can assert his title to it against all the world, not because he has any merit of his own, but because there is no one who can assert a better title to it. The court does not confiscate the property because of the illegality-it has no po_wer to do so-so it says, in the words of Lord Eldon : "Let the "estate lie where it falls", see Muckleston v. Brown. This principle was applied by the Court of Appeal recently in Bowmakers Ltd. v.

Bamet Instrnments Ltd. The parties to the fraud are, of course, liable to be punished for the part they played in the illegal transaction, but nevertheless the property passes to the transferee."

In conclusion it was observed that if the law were not to allow the plaintiff to recover in this case, then it would leave the defendant in possession of both the lorry and the money he had received for it. This, it was observed, was not the law.

It was submitted by Mr. Shanti Bhushan that even though the contract may have been illegal, the transaction of sale was independent of that and did not, in any way, affect the transfer of title in the securities. In support of this submission, reliance was placed on the following observations in Alexander v. Rayso11, (1936) 1 KB 169 where at page 185 it was E observed as follows :

"The distii~Ction 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 their by the plaintiff and divers prostitutes in a debauch there, to incite them to ritous, 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

B.O.I.FINANCELTD. v. CUSTODIAN[KIRPAL, J.] 79

which it had passed, the defendant was entitled to keep it. As was A said by the KB in Sca1fe v. Morgan, (5) in a passage quoted by Hannen J. in the course of the argument: "if the (illegal) contract is executed, and a property either special or general has passed thereby, the property must remain." The plaintiff, on the other hand, could not maintain his action without asserting and relying B upon the unlawful agreement. He could not, to use the language of Mellor J. in delivering the judgment of the Court, recover without showing the true character of the deposit; and that being upon an illegal consideration, to which he himself was a party, he was precluded from obtaining "the assistance of the law" to recover it back." C

(Emphasis added)

It would follow that if pursuant to an agreement to do an illegal act a transaction, in part, takes place which would otherwise be valid if there D was no such prior agreement, then notwithstanding the illegality of the contract the said completed transaction itself cannot be regarded as invalid.

Tinsley v. Millingan, (1993) 3 All ER 65 was a case where the parties, who were living together, jointly purchased a house which was registered E in the name of the appellant as the sole legal owner. Both the parties accepted that the house was jointly owned but it was registered in sole name of Tinsley so as to enable Millingan, with a knowledge and assent of Tinsley, to make false claims to the Department of Social Security for, some benefits. The money so obtained from the Department was shared between F them. Subsequently, the parties quarreled and Tinsley moved out of the house which continued to be in occupation of Millingan. Tinsley brought an action claiming possession of the house and asserting ownership of it.

Millingan counter-claimed for an order for sale and a declaration that the house was held by Tinsley on trust for the parties , in equal shares. Tinsley contended, in regard to the counter claim that applying the common law G maxim ex turpi ca.usa non oritur actio, Millingan was barred from denying ......._ Tinsley's ownership because the purpose of the arrangement, whereby the house had been registered in the sole name of Tinsley was, to facilitate the fraud on the Department of Social. Security and therefore, Millingan's claim to joint ownership was tainted by illegality. It was also contended that H

A 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 B 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 at page 82 that : c

"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 right 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 of executory provisions of an unlawful contract whether the illegality is apparent ex f acie the document or whether the illegality of purpose of what would otherwise be a lawful contract emerges during the course of the trial (See Holman v.

Johnson, (1775) 1Cowp341 at 343, (1775-1802) All ER Rep 98 at . 99 per Lord Mansfield CJ., Pearce v. Brooks, {1866) LR 1 Exch 213 at 217-218 (1861-73) Allo ER Rep 102 at 103 per Pollock CB, Alexander v. Rayson, (1936) 1 KB 169 at 182 (1935) All ER Rep 185 at 191 and Bownkmakers Ltd. v. Bamet Instruments Ltd., (1944) 2 All ER 579 at 582 (1945) KB 65 at 70.

Second : it is well established that a party is not entitled to rely on his own fraud or illegality in order to assist a claim or rebut a presumption. Thus when money or property has been transferred by a man to his wife or children for the purpose of defrauding creditors and the transferee resists his claim for recovery he cannot be heard to rely on his illegal purpose in order to rebut the presumption of advancement (see Gascoigne v. Gascoine, ( 1981) 1 KB 223 at 226. Chettiar v. Chettiar, (1962) 1 All ER 494 at 498

...

B.0.I. FINANCE LTD. v. CUSTODIAN [KIRPAL, J.] 81

(1962) AC 294 at 302 and Tinker v. Tinker; (1970) 1 All ER 540 at A 543, (1970) p. 136 at 143 per Salmon Ll).

Third : it has, however, for some years been recognised that a completely executed transfer of property or of an interest in property made in pursuance of an unlawful agreement is valid and the court will assist the transferee in the protection of his interest B provided that he does not require to found on the unlawful agreement (seeAyerst v. Jenkins, (1873) LR 16 Eq 275 at 283, Alexander

v. Rayson, (1936) 1 KB 169 at 184-185, (1935) All ER Rep 185 at 191, Bowmakers Ltd. v. Barnet Instruments Ltd., (1944) 2 All ER 579 : (1945) KB 65, Sajan Singh v. Sardara Ali, (1960) 1 All ER C 269 at 272-273, (1960) AC 167 at 176. To the extent, at least, of his third proposition it would appear that there has been some modification over the years of Lord Eldon LC's principles".

By posing the question whether the respondent in claiming the existence of a resultant trust in her favour was seeking to enforce unper- D formed provisions of an unlawful transaction or whether she was simply relying on an equitable proprietary interest that she had already acquired under such transaction, Lord Janney at page 83 observed as follows :

"I find this a very narrow question but I have come to the E 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 defrauding the Department of Social Security. So long as that agreement remained F 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 G no need to rely on the illegal transaction which led to its creation."

Speaking for the majority, Lord Browne Wilkinson first observed at page 85 as follows :

"Neither at law nor in equity will the court enforce an illegal H

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 pa11icular it is now clearly established that at law (as opposed to in equity) property in goods or land can pass under, or pursuant to, such a contract. If so, the rights of the owner of the legal title thereby acquired will be enforced, provided that the plaintiff can establish such title without pleading or leading evidence of the illegality. It is said that the property lies where it falls, even though legal title to the property was acquired as a result of the property passing under the illegal contract itself."

(Emphasis added)

Lord Browne Wilkinson then considered the decisions in the cases of Bowmakers Ltd. v. Bamet Instnunents Ltd., (1944) 2 All ER 579. Feret

v. Hill, (1854) 15 CB 207 (1843-60) All ER Rep 924; Taylor v. Chester, D (1869) LR 4 QB 309 (1861-73) All ER Rep 154; Alexander v. Rayson,

(1936) 1 KB 169 and observed at page 86 that : .

"From these authorities the following propositions emerge.

(1) Property in chattels and land can pass under a contract which is illegal and therefore would have been unenforceable as a contract.

(2) A plaintiff can at law enforce property rights so acquired provided that he does not need to rely dn the illegal contract for any purpose other than providing the basis of his claim to a property rights.

(3) It is irrelevant that the illegality of the underlying agreement was either pleaded or emerged in evidence : if the plaintiff has acquired legal title under the illegal contract that is enough."

Even in the minority judgment of lord Goff the passage from the speech of Lord Denning in Sajan Singh case (supra), quoted earlier, was noted with approval and at page 72, it was observed :

"Even so, the mere fact that a transaction is illegal does not have the effect of preventing property, whether general or special,

B.O.I.FINANCELTD. v. CUSTODIAN[KIRPAL, J.] 83

from passing under it. In Scmfe v. Morgan, (1838) 4 M & W 270 A at 281, 150 ER 1430 at 1434 Parke B said that 'if the (illegal) contract is executed, and a property either special or general has passed thereby, the property must remain .. .' This principle has been applied on numerous occasions. Notable examples are to be found in Taylor v. Cheste1; (1869) LR 4 QB 309 - ((1861-73) All B ER Rep 154; Alexander v. Rayson, (1936) KB 169 - (1935) All ER Rep 185 and Sajan Singh v. Sardara Ali, (1960) 1 ALL ER 269 -

(1960) AC 167."

It was submitted by Mr. Setalvad that the principle of law enunciated in the aforesaid decisions in England is restficted in its application to cases C where the illegal contract has been performed and does not apply to an illegal contract which has been P.erformed 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 D 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 E contract, which has been partially but not fully performed. However, it does not follow that all acts done under a partially pe1fo1med 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 added)

It was contended by the learned counsel for the respondent, and Mr.

J ethmalani in particular, that the decisions of the courts in England should

not be applied in India. Where the validity of the contract has to be judged according to the statutory law applicable in this country. It was submitted that under the Indian Contract Act the entire contract was void. The G original contract could not be legally entered into and the title in the securities did not, in law, pass to the appellants.

While there can be no dispute that the transactions in question have to be viewed in the context of the law in this country but the decisions of the courts in England, based on common law principles, have been applied H

A and followed by the courts in India. This will be evident from fact that the decision in Sajan Singh case, which was approved by the House of Lords in Millingan case, has been followed by this Court in Smt. Surasaibalini Debi v. Phanindra Mohan Majmudar, [1965) 1 SCR 860.

B In Surasaibalini case the respondent (hereinafter referred to as the plaintiff) was employed at Calcutta in the Court of Wards an the service rules did not permit him to start or carry on any trade or business of his own. It was, therefore, arranged with one Rabinder Mohan Gupta (hereinafter referred to as the defendant), who was the predecessor in interest of the appellant, that the defendant should be held out to be the C owner of the suit property, which was a Boarding House, of which the plaintiff was a true owner and the plaintiff was put in its possession as Manager. The plaintiff had to leave Calcutta on medical advice and he put the defendant in possession on the understanding that when the plaintiff returns the defendant would hand over the possession. When the plaintiff D returned to Calcutta and asked the defendant to hand over possession, he refused to do so. Thereupon, the plaintiff filed a suit in the Calcutta High Court for a declaration that he was the sole proprietor of the Boarding House, and also for the delivery of possession of the same.

The suit was decreed by the trial court, which decision was upheld E in appeal. Before this Court it was contended by the defendant's successor in interest, namely, the appellant, that the suit should have been dismissed because the plaintiff admitted in his evidence that he had escaped payment of income tax by submitting a separate return for the salary earned by him in service, and by showing that the business income from the suit property F belonged to the defendant and, therefore, the court should not coun-'- _

tenance 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. The plaintiff, while denying that the transaction was illegal, in the alternative, placed reliance on the aforesaid decision of the Privy Council in Sajan Singh case and contended G that he had equitable interest in the property and that the possession of the property should be restored to him. Gajendragadkar, C.J. and Shah, J. referred to the decision in Sajan Singh case but, while dismissing the appeal, held that the transaction of running the Boarding House was not entered into with a view to circumvent or defeat the provisions of the H Income Tax and was, therefore, not illegal. Rajagopala Ayyangar, J. by a

B.0.1. FINANCE LTD. v. CUSTODIAN [KIRPAL, J.] 85

separate judgment, agreement that the appeal should be dismissed but he A held that from the evidence on record it was clear that the object of the agreement, entered into by the plaintiff, was to defeat the provisions of the Income Tax Act and was not lawful. The learned judge, however, applied the ratio of the decision in Sajan Singh case and held that the plaintiffs claim to possession was independent and wholly disassociated from the B illegal transaction and, for this reason, the appeal should be dismissed.

While coming to this conclusion Iyyangar, J. extracted the above quoted passage from the speech of Lord Denning in Sajan Singh case and then observed as follows :

"It would thus be seen that besides the claim based on his title to C the lorry, the plaintiff had also established that while the chattel was in his possession, the defendant had unlawfully taken it away, with his consent. Insofar as his claim was based on this deprivation of possession, it was really an independent cause of action wholly separated from the original purchase of the lorry which was to D circumvent the law, and as to this claim in detinue there was no question of its being tainted with any illegality.

Besides this, Lord Denning himself pointed out that there were many cases which showed that where a transfer of property was effected in order to achieve an illegal purpose and that purpose E was achieved, the plaintiff was disabled from recovering the property for the reason that the Court will not assist him in that endeavour.

It was rightly submitted by Mr. Shanti Bhushan that the aforesaid F principles, now well settled with the decisions of the House of Lords in Tinsley's case (supra), would be applicable in India as \veil. This is not a case where the appellant is seeking to enforce an illegal contract. On the other hand, it is the Custodian who referring to the illegality of the contract with a view to recover posses:; ion of the securities, the title of which already stands transferred in favour of the appellant.

In the present case the appellants are basing their claim by relying not on the terms of the ready, forward contract, but on the payment of market price against delivery of the securities. The claim to title is independent of the ready-forward agreement.

A There can be little doubt that the appellants, when they paid the market price and took delivery of the securities, had become owners of the same. According to Section 5 of the Transfer of Property Act, 1882, 'transfer of property' inter alia means as 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 B transfer can be made; (1) insofar is it is opposed to the nature of the interest affected thereby, or (2) for an unlawful object, or consideration within the meaning or Section 23 of the Indian Contract Act or (3) to a person legally disqualified to be transferee. According to Section 23 of the Contract Act the consideration or object of an agreement will be unlawful C if it is forbidden by law; or is for 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 in between the banks are the notified parties was for the transfer and, subsequently, re-transfer of the securities. The transfer took D place on delivery of securities on payment of market price as consideration.

The consideration for the transfer of the securities, in the ready leg, was the payment of market price.

The validity of the transfer of the securities has to depend on the provisions of the Transfer of Property Act and the Sale of Goods Act E relating to transfer and not to the validity of the agreement preceding the_

transfer. Like any other movable goods the securities could validly be purchased on delivery against payment of price as per Sections 4, 19 and 20 of the Sale of Good Act. The price paid, while taking delivery, was the consideration for the transfer of the securities. When the transfer of title

has taken place the agreement between the parties preceding this cannot invalidate the transfer. The ratio of the decisions in Sajan Singh v. Sardara Ali and Tinsley v. Millingan and the observations of Rajgopal Ayyanger, J. in Surasaibalini Debi v. P.M. Majmudar (supra) are clearly applicable in the present case.

Inasmuch as, the aforesaid reasons are sufficient for the appeals to be allowed, we do not propose to deal with the other contentions which had been raised on behalf of the appellants.

CONCLUSIONS :

H The following conclusions flow from the aforesaid discussion :

( -

B.O.I. FINANCE LTD. v. CUSTODIAN [KIRPAL, J.] 87

(A) Infringements of the instructions issued by the Reserve Bank of A India 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 it's customer's.

(B) The ready forward contract is severable into two parts, namely, the ready leg and the forward leg. The ready leg of the transaction having B been completed, the forward leg, which alone is illegal, has tci be ignored.

( C) 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.

The appeals are accordingly allowed. Judgment dated 14th December, 1993 of the Special Court is set aside, the effect of which would be that the applications filed by the Custodian and the notified persons for the return of the securities stand dismissed. There will be no order as to costs.

S.M Appeals allowed.