K.K. Baskaran vs State Rep. by its Secretary, Tamil Nadu & Ors.

REPORTABLE

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NO. 2341 of 2011

[ Arising out of S.L.P.(Civil) No. 7285/2011 ]

[ CC No. 18900/2010 ]

K.K. Baskaran .. Appellant

-versus-

State rep. by its Secretary, Tamil Nadu & Ors. .. Respondents

J U D G M E N T

1. Delay condoned. Leave granted.

2. Heard learned counsel for the appellant.

3. Financial swindling and duping of gullible investors/depositors is not

unique to India. It has been referred to in Charles Dicken's novel `Little

Dorrit', in which Mr. Merdle sets up a Ponzi scheme resulting in loss of the

savings of thousands of depositors including the Dorrits and Arthur

Clennam. In recent times there have been many such scandals e.g. the get-

rich-quick scheme of the scamster Bernard Madoff in which the estimated

losses of investors were estimated to be 21 billion dollars.

2 4. The present case illustrates what has been going on in India for quite

some time. Non-banking financial companies have duped thousands of

innocent and gullible depositors of their hard earned money by promising

high rates of interest on these deposits, and then done the moonlight flit,

often disappearing into another State or even foreign countries leaving the

depositors as well as the State police high and dry.

5. This appeal has been filed against the impugned judgment and order

of the Full Bench of the Madras dated 02.03.2007 in writ petition No.

26108/2005.

6. By means of the aforesaid writ petition, the petitioner and others

challenged the constitutional validity of the Tamil Nadu Protection of

Interests of Depositors (in Financial Establishments) Act, 1997 (for short the

Tamil Nadu Act). By the impugned judgment the Full Bench of the Madras

High Court has held the aforesaid Act to be constitutional. Hence, this

appeal.

7. Learned counsel for the appellant has relied on the Full Bench

decision of the Bombay High Court in Vijay C. Punjal vs. State of

Maharashtra (2005) 4 CTC 705 by which a similar Act of Maharashtra ,

being the Maharashtra Protection of Interests of Depositors (in Financial

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Establishments) Act, 1999 was held to be unconstitutional. We are of the

opinion that the impugned judgment of the Full Bench of the Madras High

Court is correct, while the judgment of the Full Bench of the Bombay High

Court in Vijay's case (supra) is not correct.

8. The main submission of the learned counsel for the appellant in

challenging the Tamil Nadu Act, which was also the main submission in

challenging the Maharashtra Act, 1999, was that the said Act is beyond the

legislative competence of the State Legislature as it falls within entries 43,

44 and 45 of List I of the Seventh Schedule to the Constitution. It was also

submitted that the impugned Act is liable to be struck down as the field of

legislation is already occupied by legislation of Parliament being the

Reserve Bank of India Act, 1934, Banking Regulation Act, 1949, the Indian

Companies Act, 1956 and the Criminal Law Amendment Ordinance, 1944

as made applicable by Criminal Law (Tamil Nadu Amendment) Act, 1977.

It was also contended that the Tamil Nadu Act was arbitrary, unreasonable

and violative of Articles 14, 19(1)(g) and 21 of the Constitution.

9. We are of the opinion that none of these submissions have any merit.

4 10. A perusal of the Statement of Objects as well as the relevant

provisions of the Tamil Nadu Act shows that its object was to ameliorate the

situation of thousands of depositors from the clutches of financial

establishments who had duped the investor public by offering high rates of

interest on deposits and committed deliberate fraud in repayment of the

principal and interest after maturity of such deposits. The Act provides for

measures for attachment of the properties of the financial establishments as

well as mala fide transferees and to bring these properties for sale for

realization of the dues payable to the depositors speedily.

11. As per the statistics of July 2002, about Rs. 1945 crores were

collected from over 19 lakhs of depositors. These depositors were either

poor or middle class persons, retired government servants and pensioners

and their dependants, senior citizens or economically backward sections of

society etc. The deposits were either siphoned off or diverted mala fide by

these fraudulent financial establishments. The commission and omission of

these financial establishments was well-organized, and constitute an

organized systematic white color crime which jeopardizes the safety and

interest of the public.

5 12. As noted in the impugned judgment, the Tamil Nadu Act was not

focused on the transaction of banking or acceptance of deposits, but it is

designed to protect the public from fraudulent financial establishments who

defraud the public by offering lucrative returns on deposits and then

disappear with the depositors' money or refuse to return the same with

interst. In our opinion, the impugned Tamil Nadu Act is in pith and

substance relatable to Entries 1, 30 and 32 of the State List (List II) of The

Seventh Schedule.

13. The Statement of Objects And Reasons of the Tamil Nadu Act states :

"There is mushroom growth of Financial Establishments

not covered by the Reserve Bank of India Act, 1934

(Central Act II of 1934) in the State in the recent past

with the sole object of grabbing money received as

deposits from the public, mostly middle class and poor,

on the promise of unprecedented high rates of interest

and without any obligation to refund the deposits to the

investors on maturity. Many of these Financial

Establishments have defaulted to return the deposits on

maturity to the public running to crores of rupees and

thereby inviting the public resentment, which created law

and order problems in the State. The Government has,

therefore, decided to undertake suitable legislation , in

the public interest, in order to regulate the activities of

such Financial Establishments, other than those covered

by the Reserve Bank of India Act, 1934 (Central Act II of

1934).

2. The Bill seeks to give effect to the above decision."

6 14. A reading of the Statement of Objects and Reasons of the Tamil Nadu

Act would go to show that it does not concentrate on incorporation,

regulation or winding up of banking corporations but, on the other hand, is

basically concerned with returning money of the gullible depositors who had

been defrauded. The words found in the Statement of Objects and Reasons,

viz., "in the public interest, in order to regulate the activities of such

Financial Establishments" would mean that the Tamil Nadu Act has been

enacted to protect the interests of depositors.

15. An amendment was brought to the Tamil Nadu Act by the Protection

of Interests of Depositors (In Financial Establishments) Amendment Act,

2003, Tamil Nadu Act 30 of 2003, the object being:

"The Tamil Nadu Protection of Interest of Depositors (in

financial establishments) Act, 1977 (Tamil Nadu Act 44

of 1997) was enacted by the Government of Tamil Nadu

to protect the interest of the depositors who have lost

their hard earned money with the financial institutions.

At present, there is no provision in the said Act for

attaching the properties of the persons who borrowed

money from the financial establishments and for the sale

of attached property in public action and for the equitable

distribution of the sale proceeds to the depositors. In

order to overcome the shortcomings and to make the said

Tamil Nadu Act 44 of 1997 more effective, the

Government have decided to amend the said Act so as to-

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(1) bring a company registered under the Companies

Act, 1956 (Central Act 1 of 1956) and non-

banking financial company within the purview of

the Act;

(2) make the non-payment of interest and failure to

render service for which deposit has been made, as

offences under the Act;

(3) attach the properties of the person who has

borrowed money from the financial establishments

and failed to return the money;

(4) appoint more than one competent authority under

the Act;

(5) constitute Special Courts for different areas and

for different cases and to appoint Special Public

Prosecutors for each of the Special Courts;

(6) specify the time limit within which the Special

Court shall pass the final order;

(7) compound the offences punishable under the Act;

and

(8) to sell the attached properties in public auction and

to distribute the sale proceeds among the

depositors.

2. The Bill seeks to give effect to the above decision."

16. By section 2 of the Tamil Nadu Act 30 of 2003, the definitions of

"deposit" and "financial establishments" were amended as follows:

8 (1).......

(2) " deposit means the deposit of money either in one

lump sum or by installments made with financial

establishments for a fixed period, for interest or for return

in any kind or for any service;

(3)"financial establishment" means an individual, an

association of individuals, a firm or a company registered

under the Companies Act, 1956 (Central Act 1 of 1956)

carrying on the business of receiving deposits under any

scheme or arrangement or in any other manner but does

not include a corporation or a co-operative society owned

or controlled by any State Government or the Central

Government or a banking company as defined in Section

5 (c) of the Banking Regulation Act, 1949 (Central Act X

of 1949)"

17. Thus, by the Amendment Act 30 of 2003, the companies registered

under the Companies Act, 1956 and the non banking financial companies,

were also brought within the purview of the Act.

18. Learned counsel for the appellant relied on the Full Bench decision of

the Bombay High Court in Vijay C. Punjal's case (supra) in support of his

contention that the Tamil Nadu Act, like the Maharasthra Act, was

unconstitutional being beyond the legislative competence of the State

Legislature. We do not agree.

9 19. We have carefully perused the judgment of the Full Bench of the

Bombay High Court in Vijay's case (supra) and we respectfully disagree

with the view taken by the Bombay High Court.

20. It may be noted that though there are some differences between the

Tamil Nadu Act and the Maharashtra Act, they are minor differences, and

hence the view we are taking herein will also apply in relation to the

Maharashtra Act.

21. The Bombay High Court has taken the view that the Maharashtra Act

transgressed into the field reserved for Parliament. We do not agree. It is

true that Section 58A of the Companies Act has been upheld by this Court in

Delhi Cloth Mills Ltd vs. Union of India (1983) 4 SCC 166 and the

provisions of Chapter IIIC of the Reserve Bank of India Act, 1934 was

upheld by this Court in T. Velayndhan Achari vs. Union of India (1993) 2

SCC 582. However, we are not in agreement with the Full Bench decision

of the Bombay High Court that the subject matter covered by the said Act

falls squarely within the subject matter of Section 58A and 58AA of the

Companies Act.

1 22. We are of the opinion that the impugned Tamil Nadu Act enacted by

the State Legislature is not in pith and substance referable to the legislative

heads contained in List I of the Seventh Schedule to the Constitution though

there may be some overlapping. In our opinion, in pith and substance the

said Act comes under the entries in List II (the State List) of the Seventh

Schedule.

23. It often happens that a legislation overlaps both Lists I as well as List

II of the Seventh Schedule. In such circumstances, the doctrine of pith and

substance is applied. We are of the opinion that in pith and substance the

impugned State Act is referable to Entries 1, 30 and 31 of List II of the

Seventh Schedule and not Entries 43, 44 and 45 of List I of the Seventh

Schedule.

24. It is well-settled that incidental trenching in exercise of ancillary

powers into a forbidden legislative territory is permissible vide Constitution

Bench decision of this court in State of West Bengal etc. vs. Kesoram

Industries Ltd & Ors etc. (2004) 10 SCC 201 (vide paras 31(4), (5) and (6)

and 129 (5). Sharp and distinct lines of demarcation are not always possible

and it is often impossible to prevent a certain amount of overlapping vide

ITC Ltd. vs. State of Karnataka, 1985 (Supp) SCC 476 (para 17). We

1

have to look at the legislation as a whole and there is a presumption that the

legislature does not exceed its constitutional limits.

25. The `financial companies' in the present case had not obtained any

licence from the Reserve Bank of India. Hence they are not governed by the

Reserve Bank of India Act nor the Banking Regulation Act, 1949.

26. The doctrine of pith and substance means that an enactment which

substantially falls within the powers expressly conferred by the Constitution

upon a Legislature which enacted it cannot be held to be invalid merely

because it incidentally encroaches on matters assigned to another legislature.

The Court must consider what constitutes in pith and substance the true

subject matter of the legislation. If on such examination it is found that the

legislation is in substance one on a matter assigned to the legislature then it

must be held to be valid even though it incidentally trenches on matters

beyond its legislative competence vide Union of India vs. Shah

Goverdhan L. Kabra Teachers' College (2002) 8 SCC 228 (vide para 7).

27. For applying the doctrine of pith and substance regard is to be had to

the enactment as a whole, its main objects and the scope and effect of its

provisions vide Bharat Hydro Power Corporation vs. State of Assam

(2004) 4 SCC 489 (vide para 15).

1 28. For this purpose the language of the Entries in the Seventh Schedule

should be given the widest scope of which the meaning is fairly capable vide

State of West Bengal vs. Kesoram Industries Ltd (supra) (para 31(4),

Union of India vs. Shah Goverdhan Kabra Teachers College (supra)

(para 6), ITC Ltd. vs. State of Karnataka (supra) (para 17).

29. Learned counsel for the appellant submitted that the subject-matter of

the Tamil Nadu Act being banking, falls within the legislative competence

of Parliament under Entry 45 of List I. We do not agree. Admittedly, none

of the financial companies in question obtained any licence from the Reserve

Bank of India. Hence they are not governed by the Reserve Bank of India

Act or the Banking Regulation Act. The activities of these financial

companies do not, in our opinion, come within the meaning of the term

`banking' as defined in the Banking Regulation Act, 1949 or the Reserve

Bank of India Act, 1934.

30. The Tamil Nadu Act was enacted to find out a solution for the

problem of the depositors who were deceived on a large scale by the

fraudulent activities of certain financial establishments. There was a

disastrous consequence both in the economic as well as social life of such

depositors who were exploited by false promise of high return of interest.

1 These financial institutions/establishments did not come either under the

Reserve Bank of India Act or the Banking Regulation act, and hence they

escaped from public control.

31. By the impugned Act the State not only proposed to attach the

properties of such fraudulent establishments and the mala fide transferees,

but also provided for the sale of such properties and for distribution of the

sale proceeds amongst the innocent depositors. Hence, in our opinion, the

doctrine of occupied field or repugnancy, has no application in the present

case.

32. The object of the Tamil Nadu Act was to give a speedy remedy to the

innocent depositors who were vulnerable to the temptation of earning high

rates of interest and were victimized by the financial establishments

fraudulently.

33. As regards Section 58A of the Companies Act, this prescribes the

conditions under which the deposits may be invited or accepted by the

companies. On the other hand, the aim and object of the Tamil Nadu Act is

totally different.

1 34. The Tamil Nadu Act was enacted to ameliorate the conditions of

thousands of depositors who had fallen into the clutches of fraudulent

financial establishments who had raised hopes of high rate of interest and

thus duped the depositors. Thus the Tamil Nadu Act is not focused on the

transaction of banking or the acceptance of deposit, but is focused on

remedying the situation of the depositors who were deceived by the

fraudulent financial establishments. The impugned Tamil Nadu Act was

intended to deal with neither the banks which do the business or banking and

are governed by the Reserve Bank of India Act and Banking Regulation Act,

nor the non-banking financial companies enacted under the Companies Act,

1956.

35. The Reserve Bank of India Act, the Banking Regulation Act and the

Companies Act do not occupy the field which the impugned Tamil Nadu Act

occupies, though the latter may incidentally trench upon the former. The

main object of the Tamil Nadu Act is to provide a solution to wipe out the

tears of several lakhs of depositors to realize their dues effectively and

speedily from the fraudulent financial establishments which duped them or

their vendees, without dragging them in a legal battle from pillar to post.

Hence, the decision of this Court in Delhi Cloth Mills (supra) has no

bearing on the constitutional validity of the Tamil Nadu Act.

1 36. In the case of the Tamil Nadu Act, the attachment of properties is

intended to provide an effective and speedy remedy to the aggrieved

depositors for the realization of their dues. The offences dealt with in the

impugned Act are unique and have been enacted to deal with the economic

and social disorder in society, caused by the fraudulent activities of such

financial establishments.

37. Under Section 3 & 4 of the Tamil Nadu Act, certain properties can be

attached, and there is also provision for interim orders for attachment after

which a post decisional hearing is provided for. In our opinion this is valid

in view of the prevailing realities.

38. The Court should interpret the constitutional provisions against the

social setting of the country and not in the abstract. The Court must take

into consideration the economic realities and aspirations of the people and

must further the social interest which is the purpose of legislation, as held by

Justices Holmes, Brandeis and Frankfurter of the U.S. Supreme Court in a

series of decisions. Hence the Courts cannot function in a vacuum. It is for

this reason that Courts presume in favour of constitutionality of the statute

because there is always a presumption that the legislature understands and

1

correctly appreciates the needs of its own people, vide Govt. of Andhra

Pradesh vs. P. Laxmi Devi (2008) 4 SCC 720.

39. We fail to see how there is any violation of Article 14, 19(1)(g) or 21

of the Constitution. The Act is a salutary measure to remedy a great social

evil. A systematic conspiracy was effected by certain fraudulent financial

establishments which not only committed fraud on the depositor, but also

siphoned off or diverted the depositor's funds mala fide. We are of the

opinion that the act of the financers in exploiting the depositors is a

notorious abuse of faith of the depositors who innocently deposited their

money with the former for higher rate of interest. These depositors were

often given a small pass book as a token of acknowledgment of their deposit,

which they considered as a passport of their children for higher education or

wedding of their daughters or as a policy of medical insurance in the case of

most of the aged depositors, but in reality in all cases it was an unsecured

promise executed on a waste paper. The senior citizens above 80 years,

senior citizens between 60 and 80 years, widows, handicapped, driven out

by wards, retired government servants and pensioners, and persons living

below the poverty line constituted the bulk of the depositors. Without the

1

aid of the impugned Act, it would have been impossible to recover their

deposits and interest thereon.

40. The conventional legal proceedings incurring huge expenses of court

fees, advocates' fees, apart from other inconveniences involved and the long

delay in disposal of cases due to docket explosion in Courts, would not have

made it possible for the depositors to recover their money, leave alone the

interest thereon. Hence, in our opinion the impugned Act has rightly been

enacted to enable the depositors to recover their money speedily by taking

strong steps in this connection.

41. The State being the custodian of the welfare of the citizens as parens

patriae cannot be a silent spectator without finding a solution for this

malady. The financial swindlers, who are nothing but cheats and charlatans

having no social responsibility, but only a lust for easy money by making

false promise of attractive returns for the gullible investors, had to be dealt

with strongly.

42. The small amounts collected from a substantial number of individual

depositors culminated into huge amounts of money. These collections were

diverted in the name of third parties and finally one day the fraudulent

1

financers closed their financial establishments leaving the innocent

depositors in the lurch.

43. Learned counsel for the appellant submitted that the appellant was

only a bona fide purchaser of some plots of land from one Arun Kumar and

Smt. Sulochana, and not from any financial establishment. We are not going

into this question as it can be raised in appropriate proceedings. In this case

we are only concerned with the constitutional validity of the Tamil Nadu

Act.

44. We are of the opinion that there is no merit in this petition. The

impugned Tamil Nadu Act is constitutionally valid. In fact, it is a salutary

measure which was long overdue to deal with these scamsters who have

been thriving like locusts in the country.

45. The Appeal is, therefore, dismissed. No costs.

......................................J.

(Markandey Katju)

.....................................J.

(Gyan Sudha Misra)

New Delhi;

4th March, 2011