Legal and Regulatory Aspects

ContentsBanking Law & Practice

Banking Regulation Act

Banking Laws (Amendment) Act, 2012

Types of charges over securities ( Transfer of Property Act,

Indian Contract Act, SARFAESI)

Credit Information Companies (Regulation) Act, 2005

Negotiable Instruments Act

Anti Money Laundering & Know Your Customer

- Key Aspects and elements of AML KYC

Banking Law and Practice Several enactments

- Banking Regulation Act, 1949

- Reserve Bank of India Act, 1934

- Banking Companies (Acquisition and Transfer of Undertakings) Act,1970 & 1980

- SBI Act, 1955 & SBI (Subsidiary Banks) Act, 1959

- RRB Act, 1976

- Companies Act, 1956

- Negotiable Instruments Act, 1881

- Prevention of Money Laundering Act, 2002

- Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002

- Credit Information Companies Act

- Recovery of Debts due to Banks

- Transfer of Property Act

Regulations

Widely accepted practices

Banking Regulation Act, 1949

Banking Regulation Act, 1949 Definition of banking & banking company

Licensing

Permitted business

Prohibited business

RBI’s powers

Control over management

Definitions Banking means

“ accepting, for the purpose of lending or investment, of deposits of money from the

public, repayable on demand or otherwise, and withdrawal by cheque, draft,

order or otherwise”

{Section 5(b)}

Banking company

“means any company which transacts the business of banking in India”

- Explanation excludes manufacturing and trading company

{Section 5 (c)}

Use of the word “bank”, ”banker”, “banking” or “banking company” - Section 7

Permitted business Can carry on business permitted u/s 6

- Borrowing, lending, bill discounting, etc.

• Buying, selling and dealing in bullion

• Buying and selling of foreign exchange

• Traveller’s cheques

• Letters of credit

• Underwriting and dealing in shares, debentures, etc.

• Safe deposit

• Collecting and transmitting of money and securities

• Undertaking/ executing trusts

- Activities that are incidental/ conducive to the promotion/ advancement of its business

- Central Govt. empowered to notify permitted business

Act overrides memorandum, articles, etc.

Prohibited business Trading prohibited vide Sec 6

Non-banking assets – Sec 9

- Immoveable property can only be held for own use

- Other – disposed within 7 years

• RBI can give additional 5 year extension

Restriction on nature of subsidiary companies – Sec 19

- Permitted business u/s 6

- Carrying on banking outside India

- Credit information business

- Other business with RBI and CG approval

Licensing RBI empowered to issue & cancel licences

- Section 22 criteria

• Solvency

• Affairs/ management not detrimental to depositor and public interest

• Adequate capital structure and capital prospects

• Public interest will be served

• Grant of licence not prejudicial to operation and consolidation of banking system

• Foreign banks – home country does not discriminate against Indian banks

• Other conditions specified by RBI

- New bank licencing requirements

Branch licencing u/s 23

Returns Section 24

- Monthly return of assets in India

- DTL on reporting Friday

Section 25

- Quarterly return of assets and liabilities at the close of business on the last Friday of every

quarter

Section 27

- Monthly return on Asset & Liability position as on last Friday

- RBI empowered to direct banks to furnish information within a specified time frame

- RRBs also need to submit a copy to NABARD

Section 26

- Return of unclaimed deposits

Section 31

- Three copies of annual returns to be submitted to RBI

InspectionSection 35

- Inspect books

• Also on direction of CG

• Copy of report to be given to bank

• Empowers RBI Inspecting officer to examine bank officials under

oath

- Also empowers RBI to carry out a scrutiny

Powers of RBISec 35A – Power to give directions

Sec 35B – Prior RBI approval required for

appointment of Chairman, MD, CEO or director

Sec 36 – Further powers and functions of RBI

- Caution/ give advice regarding certain transaction/ class

of transactions

- Call for meeting of directors, depute its officer to board

meeting, appoint observer, etc

- Report on Trend and Progress in Banking in the country

Powers of RBI – Control over management

Sec 36AA – Power to remove managerial and

other persons from office

- Appeal lies with Central Government

Sec 35B – Power to appoint additional directors

Other important provisionsSec 14 – Prohibition of charge on unpaid capital

Sec 15 – Prohibition on payment of dividend

unless intangible assets written off

Sec 17 – Creation of reserve fund

Sec 18 – Maintenance of cash reserve ratio

Sec 20 – Restrictions on loans and advances

Sec 24 – SLR

Applicability of BR Act Nationalised Banks

- Banking Companies (Acquisition and Transfer of Undertakings) Act,1970/1980;

- Section 51 of BR Act makes specific sections applicable

Regional Rural Banks

- Regional Rural Banks Act, 1976

- Section 51 of the BR Act

Cooperative Banks

- Cooperative Societies Act. 1912 or the respective Co-operative Socieities Act of

the state concerned

- Part V of the B R Act – BR (AACS) Act

Some important RBI instructions in context of BR ActMaster Circular

- Loans & Advances – Statutory and other restrictions

- Branch authorisation

- Cash Reserve Ratio and Statutory Reserve Ratio

Others

- Restriction on drawdown of reserves

- Guidelines on declaration of dividend

Banking Laws (Amendment) Act Passed by Parliament in Dec 2012

Some highlights

- Voting rights

• 26% from existing 10% in private sector banks

• 10% from existing 1% in public sector banks

- Prior approval for voting rights/ shareholding more than 5%

- Power to RBI to supersede entire board of banks

- Power to call for information from associate and group companies

- Depositor Education and Awareness Fund

- Primary cooperative societies to be licenced by RBI

- Preference shares

- Naionalised banks can issue bonus shares

- Joint inspections of associates with sectoral regulator

Laws relating to securities and modes of chargingTransfer of Property Act, 1882Indian Contract Act, 1872SARFAESI

Overview of chargesCreation of a right in favour of the creditors

Nature of security

Types of security Kind of Charge

Defined in Act

Immoveable property

Land and building Mortgaage Sec 58, Transfer of Property Act

Actionable claims (i.e. unsecured debts)

Book debts, term deposit receipts, etc.

Assignment Sec 130, Transfer of Property Act

Moveable property/ goods

Plant & machinery, stocks, vehicles, etc.

Pledge/ hypothecation/ lien

Pledge-Sec 172 Indian Contract ActHypothecation – Sec 2(n) SARFAESI

Paper securities Shares, debentures, MF, bonds

Lien Sec 170 and 171Indian Contract Act

Personal guarantee

Promoters & 3rd party guarantees

Personal liability

Sec 126 Indian Contract Act

Kinds of charges – Fixed v/s Floating Fixed charge

- created on properties such as land and buildings, plant and machinery

- Identity does not change

- Credit consent required for disposal

- Debtor retains ownership and possession

Floating charge

- Created on assets that undergo change

- Security allowed to be used in ordinary course of business unless charge

crystallises

Kinds of charges Pari Passu charge

- Several creditors- typically in consortium accounts

- Equal priority

Exclusive charge

- To one creditor

- No intervention of other creditors

First charge

- First right over the proceeds from the security charged

Second charge

- Rights subject to those of first charge holder

Mortgage Dealt with in Transfer of Property Act, 1882

- “A mortgage is the transfer of interest in specific immoveable property, for the

purpose of securing the payment of money advanced or to be advanced by

way of loan, on existing or future debt or the performance of an engagement

which may give rise to pecuniary liability”

Types

- Simple

- Conditional sale

- Unsufructuary mortgage

- English mortgage

- Equitable Mortgage

- Anomoalous morgage

Simple Mortgage“Without delivering possession of the mortgaged property, the mortgager binds himself

personally to pay the mortgage money and agrees, expressly or impliedly, that in the

event of his failing to pay according to his contract, the mortgagee shall have a right to

cause the mortgaged property to be sold by a decree of the court in a suit and the

proceeds of the sale to be applied so far as may be necessary in payment of the

mortgage money” [Sec 58(b)]

Intervention of court required

Mortgagee has no right to get any payments out of the

rents and produce of the mortgaged property

Mortgagee not put in possession of the property

Registration is mandatory

Conditional Sale“The mortgager ostensibly sells the mortgaged property on the condition that:

(a) on default of payment of the mortgage money on a certain date, the sale

shall become absolute, or

(b) on such payment being made the sale shall become void, or

(c) On such payment being made, the buyer shall transfer the property to the

seller” [Sec 58(c)]

Sale is ostensible – not real

If money not paid ostensible sale shall become

absolute – Court decree required

No personal liability for repayment of the loan

Unsufructuary mortgage“mortgage transaction in which

(a)the mortgager delivers possession expressly, or by implication binds himself to deliver possession of

the mortgaged property to the mortgagee, and

(b)Authorises the mortgagee to retain such possession until payment of the mortgage money and to

receive the rents and profits accruing from the property or any part of such rents and profits and to

appropriate the same in lieu of interest, or in payment of the mortgage money, or partly in lieu of interest

and partly in payment of the mortgage money” [Sec 58(d)]

Mortgagee in actual legal possession of the property, till dues are repaid

Mortgage has the right to receive rents and profits accruing from the

property

No personal liability of the mortgager

No time limit specified

English mortgage“mortgagee binds himself to repay the mortgaged property absolutely to the

mortgagee, but subject to the provision that he will retransfer it to the

mortgagee upon payment of the mortgage money as agreed” [Sec 58(e)]

Personal covenant to pay on a specified date

notwithstanding the absolute transfer of property to the

mortgagee

Absolute transfer

- Subject to reconveyance in event of repayment

Court decree for sale

Equitable mortgage“where a person delivers to a creditor or his agent documents of title to

immoveable property, with the intent to create a security thereon, the

transaction is called a mortgage by deposit of title deeds” [Sec 58(f)]

Deposit of title deed with intention to secure debt

- Original deed not required but recommended

- Saves on stamp duty

Deposit at notified places only

- Independent of location of the property

Anomalous mortgage“a mortgage which is not a simple mortgage, a mortgage by conditional

sale and Unsufructuary mortgage and English mortgage or a mortgage by

deposit of title deeds within the meaning of this section” [Sec 58(g)]

Should satisfy the basic definition of mortgage

Should not fall in the earlier categories

Usually a combination of two mortgages

Mortgages- Other key aspects Registration requirements

- Registration required for mortgages other than equitable mortgage – Sec

59

- Indian Registration Act- Sec 23 - required within 4 months of execution

- Companies Act, 1956-Sec 125- within 30 days of execution

Priority of mortgages

- First in point of time has better title – Sec 48

- Amongst registered instruments- date of execution

- Registered has priority over unregistered

• Exception is deposit of title deeds

Mortgages-Other key aspectsEnforcement

- Code of Civil procedure

- Jurisdiction based on location of property

- Preliminary decree

- Final decree

- Sale

Which Mortgage would you prefer?

Mortgage Personal Liability Possession

Simple Mortgage

Conditional Sale

Unsufructuary Mortgage

English Mortgage

Equitable Mortgage (Court decisions)

(Deposit of title

deeds)

AssignmentTransfer of actionable claim

- Claim to debt other than debt

• secured by mortgage of immoveable property

• Hypothecation/ pledge of moveable property not in possession

Key features

- Should be in writing

- Due notice to be given to the debtor

- Assignor cannot give better title

- Eg LIC policies used as security

Pledge“Pledge is the bailment (delivery) of goods as security for payment of a debt or performance of

a promise” (u/s 172 of Indian Contracts Act)

Key aspects

- Delivery of goods

• Need not be physical delivery

• May be constructive delivery – eg handing over keys of godown

• Can only be on existing goods- not on future goods

- Pawnor – borrower who gives the goods as security

- Pawnee- lender who takes the goods as security

- Ownership retained with pawnor

- Possession with pawnee

• Possession may be parted with against Trust Receipt

• Right to retain or sell goods where pawnor makes default in payment

• Notice to sell required to be given

• Right of pledge prevails over any other dues including Government dues except workers wages

Hypothecation Defined in SARFAESI, 2002 (Sec 2(n))

- Charge upon moveable property

- Existing/ future

- Without delivery – possession with borrower

Drawbacks

- Risk of fraud- multiple charges on same property

- Erosion of security value

Precautions

- Periodic stock statements

- Registration of charge

- Notice of charge

- Insurance of property

LienGeneral Lien

- Creditor’s right to retain property of debtor

- Possession in ordinary course of business

- Limited to possession of property – not to sell

Banker’s lien

- General lien+ right to sell

- Applicable to negotiable instruments and credit balances

- Not applicable to safe deposit, for sale

Other aspects relating to ContractsProposal and acceptance

Consideration

- Exemption

Free consent

Capacity to contract

- Sound mind

- Not disqualified from entering into a contract

- Minor contract

Stamping of documents Stamp duty – tax levied on documents

- Originated in Netherlands – 1624

- France (1654), Denmark (1657), Prussia (1682)

Key aspects

- Amount of duty

- Type of stamp used

- Cancellation of stamp

- Time of stamping and execution

- Place of stamping and execution

Consequences

- Admissibility as evidence

- Adjudication

Law of limitationPeriod within which suit can be filed

- Bars to remedies

- Original right may continue to be exercisable

Right of action revived by

- Fresh set of documents

- Acknowledgement of debt

• Writing, signed, stamped and addressed to lender

- Part payment authorised by the borrower

Power of AttorneyTypes

- General v/s special

Registration of power of attorney

Precautions

- Scope of powers

- Agent acting within the scope of powers

- Confirmation of validity

SARFAESI Act, 2002Securitisation and Reconstruction of Financial

Assets and Enforcement of Security Interest Act,

2002

- Coverage

- Securitisation and reconstruction of financial assets

- Enforcement of security interest without court

intervention

- Central Registry

SARFAESI - Coverage Effective since June 21, 2002

- Retrospective coverage

- Applicable to whole of India including J&K

- Also covers notified Housing Finance Companies

- Sec 31 - excludes

• Lien and pledge

• Aircrafts, shipping vessels

• Conditional sale, hire purchase, contract where no security interest created

• Financial asset<=Rs.1 lakh

• Agricultural land

• Amount due<20% of the Principal +Interest

- Mardia Chemicals case – Supreme Court

• Sec 17(2) – unconstitutional- arbitrary, oppressive and unreasonable

• Subsequent amendment

SARFAESI – Securitisation/ Reconstruction CompaniesRegistration with RBI

- Guidelines issued by DNBS

- Minimum owned fund of Rs100 crore/ 15% of financial assets

to be acquired – whichever is lower

Acquisition of financial assets

- Scheme wise

- Funded by investors – QIBs

- Issuance of Security Receipts

- Managed by trust

SARFAESI – Enforcement of security interest No need for court intervention

- Overriding effect over provisions of Transfer of property Act

- Notice mandatory

• 60 days notice

• Details of amount payable and secured asset intended to be enforced

• Borrower prohibited from transferring assets

- SC Guidelines in Mardia case

• Borrower can raise objections

• Bank to apply mind while answering objections

• Response to borrower within one week

• Rejection of objections cannot be appealed to DRT

- Can appeal to DRT – deposit of 50% of the amount due

Can seek help of District Magistrate/ Chief Metropolitan Magistrate

SARFAESI – Enforcement of security interest Recourse available to lender

- Possession of secured asset

- Management of secured asset

- Appoint person as manager of secured assets

- Require from any person who has acquired the secured asset from the borrower to

pay the amount due to the extent of the secured asset

Appropriation of proceeds

- Expenses->Dues->Balance to debtor

- If winding up – dues of workman have pari passu charge

Consortium accounts – multiple secured creditors

- Creditors representing ¾ of outstanding dues have to agree

Recent amendment- bank may purchase at auction [13(5A)]

SARFAESI – Enforcement of security interest Safeguards

- Inventory of property taken into possession

- Take care of property as owner of ordinary prudence – insure if necessary

- Expedite sale if subject to speedy decay

- Possession notice

• affixation at outer door/ conspicuous place

• Publication in 2 leading newspapers including one vernacular

- Auction

• 30 days notice – publication in 2 leading newspapers incl. vernacular

• Valuation to fix reserve price

- Appeal to DRT - Compensation

• Within 45 days of measures being initiated

• 50% to be deposited- DRT may reduce to 25%

SARFAESI - CERSAI Sec 25 Company promoted by Government & PSU banks

Maintains registry of

- Securitisation of financial assets

- Reconstruction of financial assets

- Creation of security interests

Registration additional – not substitute for existing requirements

Records available for search

Minimisation of frauds due to multiple borrowing on same

security

Recovery of Debts due to Banks and Financial Institutions Act, 1993 Coverage

- Applicable to whole of India except J&K

- Debt > Rs. 10.00 lakhs

Constituted Debt Recovery Tribunals for speedy recovery

- Established by Central Government

- Single member – Presiding Officer

- Appeal against DRT order lies with DRAT

• Chairperson

- Jurisdiction of civil courts (other than HC/SC) barred

Credit Information Companies (Regulation) Act, 2005

Credit Information Companies(Regulation) Act, 2005

Objective- regulation of credit information companies

Registration

- Compulsory registration with RBI

• Existing companies to apply within 6 months

- Conditions

• Minimum capital – Rs. 30 crore (authorised), Rs.20 crore(issued)

• Management not prejudicial to interests of users, clients or borrowers, credit information companies

• Additional conditions at discretion of RBI

- RBI may determine cap on maximum number of credit information companies

- RBI may cancel registration

- Appeal lies with Central Government

RBI PowersRegistration and cancellation

Frame policy and regulations

Give directions

Inspection

Appoint observers

Supersede board – appoint administrator

Specify maximum fee

Recommend exemption and rules

Management of Credit Information Companies

Management

- Chairman (whole time)/ Managing Director

- 50% of board with specialised knowledge

• Public administration, law, banking, management, finance,

accountancy and information technology

- RBI empowered to supersede board – appoint

Administrator

Functions Permitted businesses

- Collect information on trade, credit and standing of borrowers of member credit institutions

- Provide

• Information to specific users, credit institutions

• Credit scoring

- Research projects

- Other business specified by RBI

Membership

- Credit institutions to become members

- Compulsory to be member of at least one

- Bound to give information

Disclosure of credit information restricted

Information Privacy PrinciplesAccuracy and secrecy of credit information

Alteration of credit information

- Credit information to be supplied by credit institutions

- Borrower may request updation

Fine for unauthorised access

Credit Information Companies Regulations, 2006 Specified users

- Member credit institutions (specified in Act itself)

• Banks, Financial Institutions, NBFCs, credit card companies, housing finance company, state financial corporation

- Insurance companies

- Cellular phone service providers

- Rating agency

- Broker

- Trading member of recognised commodity exchange

- SEBI

- IRDA

Forms of business

Privacy principles

Maximum fee and charges

- Membership - Rs.15.00 lakh

- Providing credit information report- Rs.500 for individuals, Rs. 5,000 for other borrowers/ specified users

Principles

1. Care in collection of credit information

2. Data security and secrecy

3. Access and modification

4. Data collection limitation

5. Data use limitation

6. Data accuracy

7. Archiving and length of preservation

Credit Information CompaniesCredit Information Bureau (India) Ltd,

Equifax Credit Information Services Pvt. Ltd

Experian Credit Information Co. of India Pvt. Ltd,

Highmark Credit Information Services Pvt. Ltd.

Reporting of wilful defaulters Wilful default

- Default in meeting obligations

• Despite capacity to repay

• Diversion of funds

• Siphoning of funds

• Sale of assets

Diversion

- Short term loans used for long term purposes

- Purchasing assets other than those for which the loan was sanctioned

- Transferring to subsidiaries group companies

- Investments of funds in equity/ debti without lender’s permission

- Shortfall in deployment vis-à-vis disbursal

Reporting of wilful defaulters Penalties

- No additional facilities

- Legal process

- Proactive towards change of management

- Covenant- prohibiting directors from wilful defaulters

Quarterly reporting

- Suit filed

- Rs. 25 lakh and above

Monitoring end use

Negotiable Instruments Act, 1881

Negotiable Instruments Act, 1881 Brought in to

- Encourage use of negotiable instruments

- Improve credibility of negotiable instruments

Important aspects

- Definitions

- Negotiation v/s transfer by assignment

- Presumption of consideration

- Endorsement

- Payment in due course

- Holder in due course

Definitions – Negotiable Instrument

Definitions - HolderHolder (Sec 8)

- Person entitled in his own name to possession

- Entitled to receive/ recover amount due

Holder in due course (Sec 9)

- On consideration becomes

• Possessor – bearer instruments

• Endorsee/Payee – order instruments

- No cause to believe that title defective

ChequesCheques

- Crossing – Special vs general

- Order v/s Bearer

- Protection to

• Paying banker for payment in due course – Sec 128

• Collecting banker for receiving payment for customer in

good faith & without negligence – Sec 131

• Cheques payable to order subsequently endorsed - Sec 85

So what is the difference?

State

Bank o

f India

Account P

ayee

Crossing of Cheques General Crossing (Sec 123)

- Two parallel transverse lines

- Payment only through banker (Sec 126)

Special Crossing (Sec 124)

- Name of the banker also mentioned

- Payment only through banker whose name is mentioned (Sec 126)

Liability to true owner continues if not paid through a bank (Sec 129)

Protection to paying and collecting bankersProtection to paying banker

- Sec 128 – protection for payment in due course

• Same rights and same position if the cheque had been paid to

and received by the true owner thereof

Protection to collecting banker

• Sec 131

• Good faith and without negligence

• No liability if title proves defective

Payment in due coursePayment in accordance with

- Apparent tenor of the instrument

- Good faith

- Without negligence

- No reasonable ground for believing that possessor

of NI not entitled for to receive payment

Order and Bearer Cheques Order

- Drawn payable to order

- If endorsed by/behalf of payee, drawee discharged by payment in due

course

Bearer

- Expressed payable to bearer

- Discharge by payment to bearer

• Irrespective of subsequent endorsements

- Endorsement in blank –

• payable to bearer even if originally payable to order

Account PayeeNot provided in the NI Act

Developed as practice

RBI instructions

- January 23, 2006

- Limited exemptions to cooperative societies

- Demand drafts over Rs.20,000 (AML aspect)

Anti Money Laundering Know Your Customer

AML & KYCBackground

- June 1998 – UN call on member states to adopt

national money laundering legislation

- Prevention of Money Laundering Act, 2002

Objective

• Prevent banks from being used by criminals for money

laundering and terrorist activities

Key aspects Customer

- Account holder/ business relationship

- Beneficial owner

- Any person connected to the transaction which can cause significant reputational/

other risks to the bank/FI

General guidelines

- Confidentiality of customer information

- Remittances over Rs.50,000 – only by debit to customer’s account/ cheque

- Tenor of instrument reduced to 3 months

- Adherence to provisions of Foreign Contribution (Regulation) Act, 2010

Elements of KYC PolicyCustomer Acceptance Policy

Customer Identification Procedures

Monitoring of Transactions

Risk Management

Customer Acceptance Policy No accounts in fictitious/ benami names

Parameters for categorising customers based on risk perception

Documentation to be collected

Not to open/ close accounts where due diligence not possible

Circumstances where agency/ fiduciary capacity allowed

Background checks

Product wise/ geography wise controls

Profile of each customer

Examples of customers requiring higher due diligenceNon Resident customers

High Net Worth individuals

Politically exposed persons & their relatives

Companies having close family shareholding/firms

with sleeping partners

Non face to face customers

Trusts, charities, NGOs, etc receiving donations

- Exemption for NGOs promoted by UN

Customer Identification Procedure Policy should be specified for various stages

- Initiating the relationship

- Carrying out a financial transaction

- Doubts about veracity of data

Natural persons

- Identity of customer

- Address

- Photograph

Legal persons/ entities

- Legal status

- Authorised persons

- Ownership and control structure

Unique Customer Identification Code (UCIC)

Avoid undue hardship to customers

Customer identification requirements – Indicative GuidelinesWalk in customers

Salaried employees

Trustee accounts

Companies and firms

Accounts managed by professional intermediaries

Politically exposed persons

Non face-to-face customers

Proprietary concerns

Simplified KYCTargeted at low income groups - urban and rural poor

Limits

- Balance not to exceed Rs.50,000

- Total credits not to exceed Rs.1,00,000

Simplified KYC procedure

- Introduction from another account holder with full KYC

- Other documents that satisfy the bank about the identity

Money MulesThird parties act on behalf of criminals

Recruited through

- Spam emails

- Advertisements on genuine websites/ newspapers

- Social networking sites

Banks advised to strictly adhere to guidelines on KYC/AML

Monitoring of transactionsUnderstanding of normal and reasonable pattern of

activity

Monitoring dependent upon the risk classification of

the account

Special attention to large and complex transactions

Threshold limits

Cash transactions

Risk ManagementBoard to ensure effective KYC,AML system in

place

Role of audit and compliance mechanisms

Quarterly review before Board

Cash Transaction Report

Suspicious Transaction Report

Screening & training of employees

Thank you