A Division Bench of the Supreme Court of India (“SC”) in the case of Nedumpilli Finance Company Limited v. State of Kerala , [Civil Appeal No. 5233 of 2012, on May 10, 2022], inter-alia held that, Non-Banking Financial Companies (“NBFC”) regulated by the Reserve Bank of India (“RBI”), in terms of provisions of Chapter III-B of the Reserve Bank of India Act, 1934(“RBI Act”) cannot be regulated by State enactments.
Facts in Brief:
- The State of Kerala enacted the Kerala Money-Lenders Act, of 1958 (“Kerala Act”) with a professed object of providing for the regulation and control of the business of money lending in the State of Kerala, inter alia with an object “to regulate the interest charged by the money lenders and to provide protection to the borrowers”
- At that given period, as the concept of NBFCs was not familiar in India, the RBI and Parliament had not stepped in to regulate such financial companies which were not banks or banking companies.
- After the mushroom growth of NBFCs, Government of Kerala started insisting upon NBFCs to take a license under the Kerala Act, failing which penal consequences were threatened.
- A batch of Writ Petitions were filed before the Hon’ble High Court of Kerala (“Kerala HC”) impugning aforesaid the action of the Government of Kerala and inter alia seeking a declaration that NBFCs registered under the RBI Act will not come within the preview of the Kerala Act.
- A Single Bench of Kerala HC dismissed these Petitions. Further the Division Bench confirmed the said order.
- Thereafter, appeals were preferred before the Supreme Court by the NBFCs operating in the State of Kerala.
- In the year 2009, the Bombay Money Lenders Act, 1946 (“Bombay Act”), which was applicable in the State of Gujarat was sought to be invoked against NBFCs operating in Gujarat.
- Challenging the action so initiated, NBFCs filed a batch of special civil applications before the High Court of Gujarat (“Gujarat HC”).
- When these applications were pending before Gujarat HC, the decision of Kerala HC came.
- By the judgment dated January 01, 2010, the Gujarat HC quashed the notices issued to NBFCs under the Bombay Act. The Gujarat HC disregarded the view taken by the Kerala HC.
- Thereafter, the legislature of the State of Gujarat passed the Gujarat Money-Lenders Act, 2011 (“Gujarat Act”), which received the assent of the Governor on April 01, 2011, and was published in Gujarat Government Gazette on April 08, 2011.
- Therefore, a fresh batch of special civil applications were filed seeking a declaration that the provisions of the Gujarat Act are not applicable to the NBFCs registered under the RBI Act.
- The Division Bench of Gujarat HC allowed the special civil applications and held that the Gujarat Act is ultra-virus of the Constitution of India (“the Constitution”) for legislative incompetence, to the extent that it seeks to have control over NBFCs registered under the RBI Act.
- Therefore, the State of Gujarat had filed a Civil Appeals before the SC.
Whether after the enactment of a law by the Parliament for the incorporation and regulation of financial corporations, such financial corporations would continue to be regulated also by the State enactments?
Discussion by the Court:
A. On Competence of State Legislatures to enact laws:
- The Court observed that List -I of the Seventh Schedule to the Constitution contains three entries viz.
i) Entry No. 38: Reserve Bank of India
ii) Entry No. 43: incorporation, regulation and winding up of trading corporations including banking, insurance and financial corporations but not including cooperative societies.
iii) Entry No.45: Banking
- Further, List-II (State List) of the Seventh Schedule contains an entry in Entry No.30, which reads: “money lending and money-lenders; relief of agricultural indebtedness”.
- The Court observed that the competence of the legislature of the States of Kerala and Gujarat to enact a law for the regulation of the business of money lending cannot be questioned as their power is traceable to Entry-30 of List II.
- At the same time any parliamentary enactment dealing with incorporation, regulation and winding up of financial corporations would fall under Entry No.43 in List-I.
B. Kerala Act:
- The Court observed that the only object of the Kerala Act was to afford protection to borrowers from unscrupulous money lenders who advanced usurious loans.
- The Court examined the definitions of “money lender”, and “bank" as provided in the Kerala Act and observed that there are 7 different types of business entities excluded from the definition of “money lender” under the Kerala Act. However, a financial corporation which is not a bank, and which is otherwise known as NBFC, is not listed as one of such excluded entities.
- The exclusion list provided in the definition of “money lender” inter alia excludes “any institution established by or under an Act of Parliament or the Legislature of a State, which grants any loan or advance in pursuance of the provisions of that Act” [Clause (f) of Section 2(7)]. The NBFCs claimed exclusion from the definition of “money lender” under this clause, contending that NBFCs are established under a Parliamentary enactment. The Court observed that NBFCs are not established by or under an Act of the Parliament or the legislature of a State. Incorporation/registration of a business entity under an Act of Parliament or the Legislature of a State is completely different from being established by or under an Act.
- The Court also examined the definitions of “bank” and “banking company” as provided in the Banking Regulation Act, 1949 and observed that as per the definition of the word “banking” contained in Section 5(b) of the Banking Regulation Act, 1949, an institution or business entity which does not accept deposits of money from the public, either for the purpose of lending or for the purpose of investment, will not be a banking company. While a banking company may be involved in both the business of accepting deposits and lending money, a financial institution which is engaged only in the business of lending, it may not be covered by the definition of the expression “banking company” under the Banking Regulation Act, 1949.
- The Court examined the broad scheme of the Kerala Act.
C. Gujarat Act:
- The Court examined the definitions of “money lender”, and “business of “money-lending" as provided in the Gujarat Act. The court observed that the application of the Gujarat Act to any business entity/ individual revolves around the definition of the word “loan” as provided in Section 2(9) of the act, which is as follows:
“loan” means an advance whether of money or in kind, at an interest, with or without security, and includes advance, discount, money paid for or on account of or on behalf of or at the request of any person, or the forbearance to require payment of money owing on any account whatsoever, and every agreement under any law for the time being in force (whatever its terms or form may be) which is in substance or effect a loan of money, but does not include –
(a) a deposit of money or other property in a Government post office, a bank, a company or a cooperative society;
(b) a loan to, or by, or a deposit with any society or association registered under the Societies Registration Act, 1860, or any other enactment relating to a public, religious or charitable object;
(c) a loan advanced by the State Government or by any local authority authorized by the State Government;
(d) a loan advanced to a Government employee from a fund, established for the welfare or assistance of Government employees and which is sanctioned by the State Government;
(e) a deposit of money with or a loan advanced by a cooperative society;
(f) an advance made to a subscriber to, or a depositor in, a provident fund from the amount standing to his credit in the fund in accordance with the rules of the fund;
(g) a loan to or by an insurance company as defined in the Insurance Act, 1938;
(h) a loan advanced by a Government company as defined in the Companies Act, 1956;
(i) an advance made bona fide by any trader carrying on any business, other than moneylending, if such advance is made in the regular course of such business;
(j) a loan advanced by the National Bank for Agriculture and Rural Development established under the National Bank for Agriculture and Rural Development Act, 1981;
(k) a loan advanced by the Export Import Bank of India established under the Export Import Bank of India Act, 1981;
(l) a loan advanced by the Small Industries Development Bank of India, established under the Small Industries Development Bank of India Act, 1989;
(m) a loan advanced by the National Housing Bank, constituted under the National Housing Bank Act, 1987 ;
(n) a loan advanced by State Financial Corporations established under the State Financial Corporations Act, 1951 ; and
(o) a loan advanced by any institution (1) established by or under an Act of Parliament or the legislature of a State, which grants any loan or advance in pursuance of the provisions of that Act, or (2) notified in this behalf by the State Government, in consultation with the Reserve Bank;
- The Court observed that by virtue of aforesaid definitions, the authorities under the Gujarat Act sought to apply the provisions of the Gujarat Act to the NBFCs also.
- The Court also examined the broad scheme of the Gujarat Act.
D. Role of RBI and scheme of Chapter III-B of the RBI Act
- While referring to the judgment in Internet and Mobile Association v. Reserve Bank of India, [(2020) 10 SCC 274], the Court observed that in contrast to the State enactments regulating the business of money lending, whose one-eyed focus is only the protection of borrowers, the RBI Act takes a holistic approach to the business and of banking and money lending and operation of the currency and credit system in the country.
- The Court examined the history right from 1960, when the Government found it necessary to regulate the institutions which were not banks, but which were carrying on other businesses allied to banking, up to the enactment of the Reserve Bank of India (Amendment) Act, 1997, which provides of Chapter III-B [Provisions Relating to Non-Banking Institutions Receiving Deposits and Financial Institutions] of the RBI Act as it stands today.
- The Court observed that the Chapter III-B of RBI Act has become a complete Code in so far as NBFCs are concerned. The court also examined the broad scheme of Chapter III- B of the RBI Act.
- The Court observed that the scheme of the Chapter III-B of the RBI Act shows that the power of intervention available for RBI over NBFCs, is from the cradle to the grave. In other words, no NBFC can carry on business without being registered under the Act and an NBFC which takes birth with the registration under the RBI Act is liable to be wound up at the instance of the RBI.
- The Court also examined the regulations, directions and Master Circulars issued by RBI and observed that all aspects of NBFCs are regulated by RBI and nothing is left untouched.
Decision by the Court:
- After examining and analyzing all the three enactments viz. Kerala Act, Gujarat Act and the RBI Act, the Court held that once it is found that Chapter III-B of the RBI Act provides a supervisory role for the RBI to oversee the functioning of NBFCs, from the time of their birth (by way of registration) till the time of their commercial death (by way of winding up), all activities of NBFCs automatically come under the scanner of RBI. As a consequence, the single aspect of taking care of the interest of the borrowers which is sought to be achieved by the State enactments gets subsumed in the provisions of Chapter III-B.
- The Court referred to Integrated Finance Company Limited v. Reserve Bank of India ,(2015) 13 SCC 772, and held that the Chapter III-B of the RBI Act is a complete code in itself. While holding that the Court considered the followings aspects:
a. No NBFC can commence or carry-on business without obtaining the certificate of registration under the RBI Act.
b. Their continuation of business would depend upon compliance with certain prescriptions found in the RBI Act as well as the circulars/directions issued by RBI.
c. The RBI has the power to supersede the Board of Directors of an NBFC and has the power to wind up the NBFC.
- Qua the Kerala Act, an argument was advanced that the RBI does not control the rate of interest charged by NBFCs on the loans advances by them and that, as the State enactment, which seeks to control this aspect of ‘the rate of interest’ cannot be said to be repugnant. It was further argued on that since RBI Act does not deal with such an important issue of rate of interest chargeable on loans cannot be said to be a complete code in itself. The Court disagreed with this argument and held that it may be true that RBI may not be controlling the rate of interest charged by NBFCs on loans advanced by them, however, it does not mean that it has no power to step in. The Court referred to Section 45-JA of the RBI Act which confers power on RBI to determine policy and issue directions- relating to income recognition, accounting standards, making of proper provisions for bad and doubtful debts, capital adequacy based on risk weights for assets and credit conversion factors for off-balance-sheet items and also on the aspects relating to the deployment of funds. The court also noted the fact that Section 45L(1)(b) confers power upon the RBI to give directions to NBFCs “relating to the conduct of the business by them.”
- The Court observed that repugnancy or inconsistency between the provisions of Central and State enactments can occur in two situations. The first is in the case of a Central Act and a State Act on any field of entry mentioned in List III of the Seventh Schedule (Concurrent List). To such a situation of repugnancy or inconsistency, the provisions of Article 254 of the Constitution would apply. If there is such an inconsistency, Article 254(1) makes it very clear that the Central law will prevail subject, however, to the provisions of Article 254(2) and further subject to proviso to Article 254(2).
- The second situation of repugnancy or inconsistency as in the present case is between the RBI Act which is traceable only to the Entries in List -I and the State enactments which are traceable only to an Entry in List II. The Court held that in cases of this nature, Article 246(1) would squarely apply.
- The Court relied on UCO Bank and Another v. Deepak Debbama and Other (2017)2 SCC 585, and State of West Bengal and Others v. Committee for Protection of Democratic Rights and Others, (2010) 3 SCC 571, wherein the question before the SC was of repugnancy or inconsistency between subsequent Central Act (covered by List -I) and earlier State Enactment (covered by List -II).
- For ready reference, Article 246 is reproduced hereunder:
“246. Subject-matter of laws made by Parliament and by the Legislatures of States:-
i) Notwithstanding anything in clauses (2) and (3), Parliament has exclusive power to make laws with respect to any of the matters enumerated in List I in the Seventh Schedule (in this Constitution referred to as the ‘Union List’
ii) Notwithstanding anything in clause (3), Parliament and, subject to clause (1), the Legislature of any State also, have power to make laws with respect to any of the matters enumerated in List III in the Seventh Schedule (in this Constitution referred to as the ‘Concurrent List’)
iii) Subject to clauses (1) and (2), the Legislature of any State has exclusive power to make laws for such State or any part thereof with respect to any of the matters enumerated in List II in the Seventh Schedule (in this Constitution referred to as the ‘State List’)
iv) Parliament has power to make laws with respect to any matter for any part of the territory of India not included (in a State) notwithstanding that such matter is a matter enumerated in the State List.”
- The Court also held that the Kerala Act and Gujarat Act, cannot be said to be in addition to the Chapter -IIIB of the RBI Act, as Section 45 -Q of the RBI Act confers overriding effect upon said Chapter-III-B.
- In view of the above, the SC concluded that the Kerala Act and the Gujarat Act will have no application to NBFCs registered under the RBI Act and regulated by RBI.
- The Court allowed all the appeals filed by NBFCs against the judgment of the Kerala HC. Likewise, the appeals filed by the State of Gujarat against the judgment of the Gujarat HC were dismissed.
- The Court also held that the principles of law laid down in this judgment would also apply equally to other State enactments such as Tamil Nadu Pawn Brokers Act and the Tamil Nadu Money Lenders Act.
Please find attached a copy of the judgment.
This update has been contributed by Tejas Gokhale (Senior Associate).
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