Cooperative Banks Under SARFAESI Act : Analysis Of Constitution Bench Judgment

Recently a Constitution Bench of the Hon'ble Supreme Court comprising Hon'ble Mr. Justice Arun Mishra, Hon'ble Justice Indira Banerjee, Hon'ble Mr. Justice Vineet Saran, Hon'ble Mr. Justice M.R. Shah and Hon'ble Mr. Justice Aniruddha Bose dealt with a batch of matters in Pandurang Ganpati Chaugule v. Vishwasrao PatilMurgud Sahakari Bank Limited (Civil Appeal No. 5674 of 2009, decided on05.05.2020) decided the following issues:

Whether 'co­operative banks', which are co­operative societies also, are governed by Entry 45 of List I or by Entry 32 of List II of the Seventh Schedule of the Constitution of India, and to what extent?

Whether 'banking company' as defined in Section 5(c) of the Banking Regulation Act, 1949 (BR Act, 1949) covers co­operative banks registered under the State Co­operative Laws and also multi­-state co­operative societies

Whether co­operative banks both at the State level and multi-state level are 'banks' for applicability of the SARFAESI Act?

Whether provisions of Section 2(c) (iva) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) on account of inclusion of multi­- state co­operative banks and notification dated 28.1.2003 notifying cooperative banks in the State are ultra vires?

The aforesaid questions of law emanate from the various writ petitions that were filed questioning the vires of the notification dated 28.1.2003 (Notification No. 105(E)) issued under Section 2(1)(c)(v) of the SARFAESI Act and the insertion of Section 2(1)(c)(iva) to the SARFAESI Act in 2013. By the said notification issued in 2003, the co­operative banks were brought within the class of banks entitled to seek recourse to the provisions of the SARFAESI Act. Section 2(1) (c)(iva) was inserted into the SARFAESI Act, w.e.f. 15.1.2013 thereby expressing including a " multi-state co-operative bank" within the definition of "bank" under SARFAESI. Before that, the co­operative bank and the multi­-State co­operative bank took recourse to the SARFAESI Act under the notification issued in 2003.

The matter was referred to the Constitution Bench in view of conflicting decisions in Greater Bombay Coop. Bank Ltd. v. United Yarn Tex (P) Ltd^[2], Delhi Cloth & General Mills Co. Ltd. v. Union of India and Ors^[3], T. Velayudhan Achari and Anr. v. Union of India^[4] and Ors., and Union of India and Anr. v. Delhi High Court Bar Association and Ors^[5].

The Constitution Bench has answered the question in reference as under:-

The co­operative banks registered under the State legislation and multi­ State level co­operative societies registered under the Multi State Co-operative Societies Act, 2002 (MSCS Act) w.r.t. 'banking' are governed by the legislation relatable to Entry 45 of List I of the VII Schedule of the Constitution of India (Union List).

The co­operative banks run by the co­operative societies registered under the State legislation w.r.t. the aspects of 'incorporation, regulation and winding up', in particular, with respect to the matters which are outside the purview of Entry 45 of List I, are governed by the said legislation relatable to Entry 32 of List II (State List)

1. The co­operative banks involved in the activities related to banking are covered within the meaning of 'Banking Company' defined under Section 5(c) read with Section 56(a) of the Banking Regulation Act, 1949, which is a legislation relatable to Entry 45 of List I. The co­operative banks cannot carry on any activity without compliance of the provisions of the Banking Regulation Act, 1949 and any other legislation applicable to such banks relatable to 'Banking' in Entry 45 of List I and the RBI Act relatable to Entry 38 of List I.

2. The co­operative banks under the State legislation and multi-state co­operative banks are 'banks' under section 2(1)(c) of Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. The recovery is an essential part of banking; as such, the recovery procedure prescribed under Section 13 of the SARFAESI Act, a legislation relatable to Entry 45 List I, is applicable.
3. The Parliament has legislative competence under Entry 45 of List I to provide additional procedures for recovery under section 13 of the SARFAESI Act with respect to co­-operative banks. The insertion of multi­-state co­operative bank in the definition of bank in Section 2(1)(c) of the SARFAESI Act by Act 1 of 2013 is "ex abundanti cautela". The notification dated 28.01.2003 and the amendment are not ultra vires the Constitution.

The arguments advanced by the parties, the discussion on each reference question and the conclusion arrived at by the Constitution Bench are summarised in the paragraphs below.

6. Arguments on behalf of the Appellants

The Appellants argued that the Notification No. 105(E) dated 28.01.2003 and the amendment brought to the definition of Bank contained in Section 2(1)(c) of the SARFAESI Act are ultravires the Constitution as the Parliament lacks legislative competence to regulate financial assets related to co-operative society. The broad arguments of the Appellants are summarised hereunder:-

Meaning of the Expression Banking in Entry 45 of List- I

The meaning of the term "Banking" in Entry 45 of List I must be confined to the definition of banking contained in Section 5(b) of the Banking Companies Act, 1949^[6] (renamed BR Act). That although BR Act, in addition to core banking activity recognises other business that can be carried by a bank, the expression "banking" in Entry 45 of List- I is restricted to "core- banking". It was submitted that a distinction must be drawn between an "entity" and "activity". Mere performance of additional business does not confer any status of banking company upon such an entity. Loan advanced to members by a co-operative society is another form of business that is not a banking business.

Business of securitisation is not a banking business

The object of SARFAESI Act is to regulate securitisation and reconstruction of financial assets and enforcement of security interests. The business of securitisation is not a banking business.

Lack of Legislative Competence

Parliament lacks the legislative competence to regulate financial assets related to the non­banking activity of a co­operative society. The power of Parliament to regulate co-operative banks is confined to specific provisions of the BR Act (legislation referable to Entry 45 of List- I) and RBI Act(Entry 38 of List I). That co-operative societies are expressly excluded from Entry 43 of List I which confers power upon the Parliament to legislate with respect to "incorporation, regulation and winding up" of a trading corporation. The power to enact legislations with respect to "incorporation, regulation and winding up" of a multi-state co-operative society is traceable to Entry 44 of List- I and of a state co-operative society to Entry 32 of List- II. That the banking business carried on by co-operative societies are merely an incidental/ancillary activity and that the doctrine of pith and substance must be applied to hold that regulation of such activities is not a subject matter on which Parliament can legislate.

Definition of bank under SARFEASI

The term bank is defined under Section 2(1)(c) of the SARFAESI ACT. 2(1)(c)(v) empowers the Central Government to add any other bank in the definition, by a notification. It was argued by the Appellant that the bank which the Central Government may add by the notification has to be confined to the entity of the kind referred under Clauses (i) to (iv) and not beyond that, i.e., a banking company or a banking corporation only and not co­operative societies/banks.

Arguments on behalf of the Respondent

The Respondents argued that the Notification and amendment to the SARFAESI Act are well within the legislative competence of the Parliament and that the SARFAESI Act is traceable to Entry 45 of List I. The arguments advanced are summarised hereinbelow:-

Definition of Bank under SARFAESI Act

Reliance was placed on the doctrine of 'incorporation by reference' to submit that Section 2(1)(c) of the SARFAESI Act which defines bank includes within its ambit co-operative banks. It was argued that Section 2(1)(c) and (d) of the SARFAESI Act defines 'bank' to mean 'banking company' as defined in Section 5(c) of the BR Act to read cooperative bank as banking company. Thus, the definition of 'bank' contained in Section 5(c) of the BR Act, 1949 stands incorporated in Section 2(1)(c) of the SARFAESI Act. Section 5(c) of the BR Act defines bank. The BR Act was amended by the Act 23 of 1965 w.e.f. 01.03.1966. By the said amendment, Section 56 was inserted in the BR Act. As per Section 56(a) of the BR Act, the reference to a 'banking company' or a 'company' shall be construed as a reference to a co¬-operative bank. The impact of this is that the definition of bank contained in Section 5(c) includes co-operative bank (both State level and multi-state). A combined reading of all the sections makes it clear that the reference to 'a banking company' and 'bank' under SARFAESI Act shall include a reference to a co-operative banks.

As a consequence of the aforementioned argument, it was submitted that even the unamended term "bank" in Section 2(1)(c) of the SARFAESI Act included co-operative bank. Thus, the insertion of a 'multi¬- State co-operative bank' in Section 2(1) (c)(iva) is ex majori cautela.

1. Terms such as corporation and company will take within its compass a registered co-operative society^[7]
2. The Parliament has legislative competence to enact legislations regulating banking business.

A distinction was drawn between regulating the non­-banking affairs of a co-operative society and regulating the banking business of society. It was submitted that any legislation dealing with different aspects of banking, including ancillary or subsidiary matter relating to it, will be traceable to Entry 45 of List I and the Parliament alone will be competent to legislate on those aspects.

That the expression "incorporation, regulation and winding up" in Entry 44 of List I and Entry 32 of List- II refers only to organisational aspects of the corporation. It does not have bearing on business or transaction and hence, any legislation dealing with regulation of banking business shall not be traceable to Entry 44 of List I and shall not touch upon Entry 32 of List- II. It was argued that Banking operations would inter alia include accepting of loans and deposits, the grant of loans and recovery of debts due to the bank.

The SARFAESI Act relates to the business of banking

SARFAESI Act does not deal with "incorporation, regulation and winding up" of a corporation, company and co-operative society. It provides for the recovery of dues of banks, the procedure for recovery, the authority competent to recover the loan, and the judicial forum to deal with disputes arising out of recovery and thus is traceable to Entry 45 of List I and not Entry 32 of List- II.

Discussion by the Constitution Bench

Reference Question No. 1

The Constitution Bench holds that the concept of regulating non­-banking affairs of society and regulating the banking business of society are two different aspects and are covered under different Entries, i.e., Entry 32 of List II and Entry 45 of List I, respectively.

That by enacting the SARFAESI Act, Parliament does not intend to regulate the incorporation, regulation, or winding up of a corporation, company, or co­operative bank/co­ operative society. The enactment provides for recovery of dues to banks, including co­operative banks, which is an essential part of banking activity. The Act in no way trenches upon the field reserved under Entry 32 of List II and is a piece of legislation traceable to Entry 45 of List I.

The Constitution Bench while dealing with the first issue has taken note of the following:-

Statutory Matrix

The Constitution Bench has observed that initially the provisions of the Banking Companies Act, 1949 (renamed as Banking Regulation Act, 1949) applied only to Banking Companies and it was extended to the Co-operative banks by the Act No. 23 of 1965 w.e.f. 1.3.1966 as the Parliament felt that the deposits and working funds of co-operative banks have become large and the same must be regulated.

That extensive amendments were carried out in the BR Act in order to ensure that extension of the Act to co-operative banks does not in any manner impinge upon the legislative competence of State legislature to make laws with respect to "incorporation, management and winding up" of co-operative banks, which is traceable to Entry 32 of List II. The amendments made which applied to or were about co-operative banks were specified in Section 56. Section 56(a) provides that throughout the Act, unless the context otherwise requires, references to banking company or the company or such company shall be construed as reference to co-operative bank.

The Bench notes that the very existence of the co-operative bank is dependent upon and is governed by the BR Act and the RBI Act as no business can be done by a co-operative bank without obtaining license from the RBI. The legislative competence of Parliament in enacting the RBI Act is traceable to Entry 38 of List- I and Entry 45 of list- I in case of BR Act.

The Constitution Bench also takes note of that the purpose for which the SARFAESI Act was enacted and the notification and amendment in question.

The meaning of the term Banking used in Entry 45 of List- I

The term "bank" ordinarily means a financial establishment that uses money deposited by customers for investment, pays it out when required, makes loan at interest and exchanges currency.

Business of banking not restricted to core banking

The Constitution Bench relies on the judgment in Rustom Cavasjee Cooper v. Union of India^[8] wherein the term "banking" used in Entry 45 of List- I came up for consideration by a bench comprising of 11 Hon'ble Judges. The argument that the word "banking" is confined only to core of banking as defined in Section 5(b) of the BR Act, 1949 was rejected. It was observed that wide meaning must be given to the term so as to include all legitimate businesses of a banking company referred to in Section 5(b) as well as in Section 6(1) of the 1949 Act. It was also observed that the term has never had any static meaning and the only meaning will be the common understanding of men and the established practice in relation to banking.

The decision of the Calcutta High Court in Mahaluxmi Bank Ltd. and of the Apex Court in ICICI Bank Limited were also examined. The respective Courts had drawn a distinction between the core banking activities and the activities that are ancillary to core banking. The Courts observed that Section 5(1)(b) of the BR Act deals with core banking whereas Section 6(1) deals with activities which a bank can carry out in addition to core banking. That performance of core banking business is a sine qua non for a company to be a banking company.

Restrictive meaning cannot be given to the term "banking"

The argument of the Appellants that the ambit of the term banking must be limited to the definition of "banking" in the BR Act, 1949 which prevailed when the Constitution was drafted, was rejected. The Constitution Bench relied on the decision in R.C. Cooper case to hold that the decision leaves no room for doubt that the co-operative bank is covered within the ambit of Entry 45 of List- I. In relation to the argument on distinction between entity and activity, the Court observed that there cannot be any form of activity/business of banking without there being an entity.

The Constitution Bench concluded that a combined reading of Section 5(b) and 5(c) and Section 56(a)of the BR Act leads to the conclusion that co­operative bank falls within the definition of bank and its activity is of banking, and in addition to the business of banking, a co­operative bank may engage in any of the business as enumerated in Section 6.

Effect of Entries 43 and 45 of List- I and Entry 32 of List- II of the VII Schedule of the Constitution

The Constitution Bench dealt with in detail the legislative competence of Parliament and State legislature under the VII Schedule of the Constitution, the well-established principle of primacy of federal law^[9] and also dealt with cases where the subject- matter of legislation trenched upon and entered a field covered by more than one list of the VII Schedule.

Law regulating corporation is different from law regulating the business of corporation

The Constitution Bench relied upon the decision in Kerala State Electricity Board v. M/s. Midland Rubber & Produce Co. Ltd. ^[10] which inturn relies on R.C. Cooper wherein it was held that a law regulating a corporation is different from a law regulating the business of a Corporation. That Constitution Bench concluded that Entry 43 of List- I and Entry 32 of List – II deal with "incorporation, regulation and winding up" of corporation but does not extend to law regulating business of the corporation. In contrast, Entry 45 of List- I deals with the activity carried on by the society i.e. banking.

The argument raised by the Respondents that SARFAESI Act is traceable to Entry 6 of List III was rejected.

Recovery of dues is an essential function of any banking institution and Parliament can enact law regarding the same

The Appellants argument that a dispute relating to recovery of any debt due to the co-operative society doing banking business shall be deemed to be a dispute touching the constitution, management, or business of a co-operative society and that Parliament lacks legislative competence to make laws regarding the same, was rejected. Reliance was placed on the decision in Delhi High Court Bar Association case, wherein, in the context of RDB Act, it was categorically held that the Parliament can enact a law regarding the conduct of the banking business, which includes recovery of banks' dues, and for that purpose, set up the adjudicatory body.

SARFAESI Act is traceable to Entry 45 of List- I

Reliance was been placed by the Constitution Bench on the judgment in UCO Bank and Anr. v. Dipak Debbarma and Ors.^[11] and also State Bank of India v. Santosh Gupta and Anr.^[12] wherein the Apex Court has observed that SARFAESI Act is traceable to Entry 45 of the Union List.

Doctrine of Pith and Substance and Dominant Nature Test

The Bench affirmed that the doctrine of pith and substance finds its origin from the principle that it is necessary to examine the true nature and character of the legislation to know whether it falls in a forbidden sphere.^[13] It concluded that since banking in pith and substance is covered under Entry 45 of List I, incidental trenching upon the field reserved for State under Entry 32 List II cannot invalidate a legislation.

SARFAESI Act provides additional remedy to co-operative banks

Additionally it was held that although there already exists legislation covering the procedure for recovery of dues by co-operative banks, the same shall not come in the way of providing additional remedy for speedy recovery of dues by way of a separate enactment merely because such enactment would incidentally encroach upon the filed reserved for State to legislate under Entry 32 of List- II.

Reliance placed on Greater Bombay case and Virendra Pal Singh case is misplaced

The Constitution Bench in the later part of the judgment has discussed the decision in Greater Bombay case and has held that the three judge bench in the said case had wrongly relied upon judgments^[14] where the scope of adjudication were confined to the management aspect of the co-operative bank, which indisputably is traceable to Entry 32 of List- II. Similarly, reliance placed on Virendra Pal Singh and Ors. v. District Assistant Registrar, Cooperative Societies, Etah, and Anr.^[15] was also misplaced as the Court was concerned with the management and regulation of co-operative societies (service regulations) and not the aspect of banking business of the co-operative society.

Effect of Constitutional Provision

The Constitution Bench has relied on Article 43B- Promotion of co-operative societies, Article 243ZI- incorporation, regulation and winding up of co-operative societies, 243ZL- suspension and suspension of board and interim management to hold that the constitutional provisions itself make a distinction between a co-operative bank and other co-operative societies. The third proviso to 243ZL(1) clarifies that in case of co-operative society carrying on baking, the provisions of the BR Act shall also apply besides the State Act.

The Constitution Bench concludes by holding that the concept of regulating non­-banking affairs of society and regulating the banking business of society are two different aspects and are covered under different Entries, i.e., Entry 32 of List II and Entry 45 of List I, respectively.

Reference Question No. 2

The Constitution Bench has held that 'banking company' as defined in Section 5(c) of the BR Act, 1949 covers co-operative banks registered under the State Co-operative Laws and also multi-state co-operative societies.

Incorporation by Reference

The Constitution Bench has considered the definition of 'banking company' under Section 2(d) of the SARFAESI Act according to which, the term shall have the meaning assigned to it in Section 5(c) of the BR Act, 1949. That Section 5 (c) of the BR Act defines 'banking company' to mean any company which transacts the business of banking. That the BR Act was amended by Act No.23 of 1965, w.e.f. 1.3.1966. By the said amendment, Section 56 (a) was introduced, which provides that a reference to a 'banking company' or 'the company' or 'such company' in the BR Act shall be construed as references to a co­ operative bank. Thus, co-operative bank has to be read as part and parcel of the definition of banking company under Section 5(c) of the BR Act and the same stands incorporated in the definition of banking company under Section 2(d) of the SARFAESI Act.

The Constitution Bench observes that not amending Section 5(c) of the BR Act and introducing co-operative bank within BR Act by adding Section 56 does not alter the position as regards the definition of banking company is concerned.

The rationale behind introduction of a separate Part in the BR Act instead of amending the definition of banking company

The Constitution Bench has also examined why the legislature chose to introduce Part V in the BR Act instead of amending the definition of banking company contained in Section 5(c) of the BR Act. The Court observed that the BR Act dealt with 'incorporation, regulation and winding up' of other entities relatable to List I, as such the provisions were required to be retained. However, all such provisions could not have been extended to co-operative banks as the "incorporation, regulation and winding up" of co-operative societies is a subject matter under Entry 32 of List II and thus beyond the legislative competence of the Parliament. The Court notes that the Parliament was conscious of its limitation and therefore various provisions of the BR Act were modified or omitted in their application to co-operative banks.

Judgment in Greater Bombay does not consider the provisions of the BR Act particularly those contained in Section 56

The Constitution Bench came to the conclusion that the Court in Greater Bombay has simply noted the provisions of the BR Act, 1949 and that there was no in-depth consideration of these provisions particularly of those contained in Section 56 of the BR Act. The Constitution Bench disagreed with the view taken in Greater Bombay and held that it is wrong to hold that banking is only an incidental business of co-operative banks.

Co-operative Banks cannot be kept outside the purview of legislations traceable to Entry 45 of List- I

It was observed that the extensive amendments made in Part V of the BR Act, 1949, must be given full effect. A co­operative bank cannot be kept outside the purview of the BR Act, 1949, and other legislation under Entry 45 of List- I and RBI Act as co-operative societies cannot engage in the business of banking without complying with the provisions of these legislations.

Reference Question No. 3(a) and 3(b)

The Constitution Bench holds that since the activity of a co­operative bank being banking activity is regulated by the legislation enacted under Entry 45 of List- I, there is no reason why Parliament lacked the competence to enact the SARFAESI Act and to provide a procedure for the speedy recovery of dues. That the exclusion of the co­operative societies from Entry 43 of List I, does not have any bearing regarding the interpretation of Entry 45 of List I.

Even unamended definition of bank in the SARFAESI Act included "co-operative bank"

The Constitution Bench held that even assuming that definition of 'bank' in Section 5(c) of the BR Act, 1949 did not cover the co­operative banks; the expression 'bank' as defined in Section 2(1)(c) of SARFAESI Act authorises the Central Government to specify 'such other bank' for that Act. Thus, the notification issued on 28.1.2003 notifying 'co­ operative bank' as the 'bank' is covered by Entry 45 of List I and within the legislative competence of Parliament.

Banking activity carried out by Co-operative societies cannot be said to be over-inclusion

The Constitution Bench holds that 'banking' relating to co­operatives can be included within the purview of Entry 45 of List I, and it cannot be said to be over inclusion^[16] to cover provisions of recovery by co­operative banks in the SARFAESI Act.

Notification was issued ex abundanti cautela

The Court concluded that the notification was issued ex abundanti cautela and that by virtue of Section 56(a), co­operative banks stand included in the definition contained in 5(1)(c) of the BR Act and also Section 2(1)(c) of the SARFAESI Act.

Conclusion

The Constitution Bench concludes that the notification and the amendments do not amount to colourable exercise of power and are not beyond the legislative competence of the Parliament. That Section 2(c)(iv)(a) of the SARFAESI Act and the notification dated 28.2.2003 are not ultra vires and that they are within the ken of Entry 45 List I of the Seventh Schedule to the Constitution of India.

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