Monday, October 3, 2016

Supreme Court on Dishonour of Post-Dated Cheques Issued as Security

[The following post is contributed by Sneha Bhawnani, who is an Assistant Legal Advisor at Vinod Kothari & Co. She can be contacted at sneha@vinodkothari.com.]

In the present era of commercial dealings, the issuance of post-dated cheques has become a common phenomenon and therefore the significance of such post-dated cheques cannot be under-emphasized. In this context, a predominant question arises, i.e., whether the issuance of post-dated cheques for satisfaction of a subsisting liability and those issued as security yield identical or similar consequences. The aim of this post is delve upon the nature of a post-dated cheque, the importance of the intention of the parties while executing a contract and the circumstances in which dishonour of post-dated cheques will attract the penal provisions of law with reference to landmark case law.

At the very outset, it must be understood that the nature of post-dated cheques is such that it acts as a two-fold weapon in the hands of the lenders by means of which they pressurise the borrowers as well as create a deterrent impact on all the other borrowers or debtors so that there is no room for default on repayment of outstanding debt to the creditors. The major penal consequences of dishonour of cheques have been codified in section 138 of the Negotiable Instruments Act, 1881 (hereinafter referred as the “Act, 1881”) which has created a sense of fear and anxiety in the minds of the borrowers.

The impact of Section 138 of the Act, 1882 operates differently on the borrowers on one hand and the lenders on the other. In other words, this provision of law is hailed by the lenders whereas the borrowers dread it the most as the dishonour of cheques may lead to months of imprisonment. The text of the said section is reproduced below-

Dishonour of cheque for insufficiency, etc., of funds in the account
138. Dishonour of cheque for insufficiency, etc., of funds in the account. Where any cheque drawn by a person on an account maintained by him with a banker for payment of any amount of money to another person from out of that account for the discharge, in whole or in part, of any debt or other liability, is returned by the bank unpaid either because of the amount of money standing to the credit of that account is insufficient to honour the cheque or that it exceeds the amount arranged to be paid from that account by an agreement made with that bank, such person shall be deemed to have committed an offence and shall, without prejudice to any other provision of this Act, be punished with imprisonment for a term which may extend to one year, or with fine which may extend to twice the amount of the cheque, or with both:

Provided that nothing contained in this section shall apply unless-

(138.a) the cheque has been, presented to the bank within a period of six months from the date on which it is drawn or within the period of its validity, whichever is earlier;

(138.b) the payee or the holder in due course of the cheque as the case may be, makes a demand for the payment of the said amount of money by giving a notice, in writing, to the drawer of the cheque, within fifteen days of the receipt of information by him from the bank regarding the return of the cheque as unpaid; and

(138.c) the drawer of such cheque fails to make the payment of the said amount of money to the payee or, as the case may be, to the holder in due course of the cheque, within fifteen days of the receipt of the said notice.

Explanation.-For the purposes of this section, “debt or other liability” means a legally enforceable debt or other liability.”

Essential Components of Post-Dated Cheques

At the very outset, it is imperative to highlight the essential components of a post-dated cheque in order to analyse whether the dishonour of such post-dated cheque given as security would attract Section 138 of the Act, 1882. In this context, reference must be made to a landmark judgement of the Supreme Court in the case of Anil Kumar Sawhney vs Gulshan Rai (1993 Supp 3 SCR 204) in which the following was held-

A "Bill of Exchange" is a negotiable instrument in writing containing an instruction to a third party to pay a stated sum of money at a designated future date or on demand. A "cheque" on the other hand is a bill of exchange drawn on a bank by the holder of an account payable on demand. Thus a "cheque" under Section 6 of the Act is also a bill of exchange but it is drawn on a banker and is payable on demand. It is thus obvious that a bill of exchange even through drawn on a banker, if it is not payable on demand, it is not a cheque. A "post- dated cheque" is only a bill of exchange when it is written or drawn, it becomes a "cheque" when it is payable on demand. The post-dated cheque is not payable till the date which is shown on the face of the said document. It will only become cheque on the date shown on it and prior to that it remains a bill of exchange under Section 5 of the Act. As a bill of exchange a post-dated cheque remains negotiable but it will not become a "cheque" till the date when it becomes "payable on demand”.

Thus, the Apex Court has elucidated that at the time when a post-dated cheque is drawn then it is nature of a negotiable instrument (“bill of exchange”) whereas it attains the nature of a cheque from the date appearing on the face of such cheque.


Application of Section 138 to Post-Dated Cheques

In simple terminology, section 138 of the Act, 1881 shall have application when the cheque issued by the borrower to the lender is dishonoured in relation to a subsisting debt or liability. Therefore, keeping in mind the essential elements of post-dated cheques, as elucidated above, it can be concluded that section 138 of the Act, 1881 shall be attracted only when such post-dated cheque attains the nature of a cheque, i.e.,  with effect from such date as is mentioned on it. However, when the post-dated cheque retains the nature of a negotiable instrument (bills of exchange) then such post-dated cheque cannot be presented to the bank and subsequently the question of return or dishonour of cheque does not arise.

 

The ambit of Section 138 to punish for dishonour of cheques

 

After analysing the significant elements of post-dated cheques and Section 138 of the Act 1881, this post shall now embark on the law in relation to dishonour of such post-dated cheques which are given as security. However, at this juncture, reference must be made to the case of I.C.D.S Ltd. v Beena Shabeer and Another ((2002) 111 Comp Cas 742) in which the Supreme Court elucidated the broad ambit and scope of Section 138 of the Act, 1881 in the following words-

The language, however, has been rather specific as regards the intent of the legislature. The commencement of the Section stands with the words "Where any cheque". The above noted three words are of extreme significance, in particular, by reason of the user of the word "any" the first three words suggest that in fact for whatever reason if a cheque is drawn on an account maintained by him with a banker in favour of another person for the discharge of any debt or other liability, the highlighted words if read with the first three words at the commencement of Section 138, leave no manner of doubt that for whatever reason it may be, the liability under this provision cannot be avoided in the event the same stands returned by the banker unpaid. The legislature has been careful enough to record not only discharge in whole or in part of any debt but the same includes other liability as well.

Therefore, the Court emphasized that the language of section 138 of the Act, 1882 being clear and specific leaves no iota of doubt that when there is default on part of one person in favour of another person and the issued cheque is for the purpose of discharging a debt or liability then Section 138 shall apply.

Dishonour of Post-Dated Cheques given as security

After the above analysis, the central issue arises whether the ambit of Section 138 to have application of dishonour of post-dated cheques given as security. The Supreme Court has extensively dealt with this question in the case Sampelly Satyanarayana Rao v Indian Renewable Energy Development Agency Limited (2016 SCC 954). A brief facts and judgement shall provide insight on whether the dishonour of post-dated cheques given as security would attract Section 138 of the Act, 1882.

Facts of the case

Sampelly Satyanarayana Rao (“appellant”) is the director of a company which is engaged in power generation activities. Indian Renewable Energy Development Agency Limited (“respondent”), a Government of India enterprise, is engaged in the field of renewable energy development. On 15 March, 2011 both the parties entered into a loan agreement by means of which the respondent consented to grant loan of Rs. 11.50 crores for the purpose of establishing 4.00 MW Biomass Power Project. Clause 3.1(iii) of the said loan agreement provided that post-dated cheques shall be issued by the appellant as a security for discharge of loan instalments (principal and interest). The post-dated cheques carried different dates based on the due loan instalments. The said post-dated cheques were dishonoured and complaint was filed by the respondent.

Issue involved in the case

The substantial question of law involved in this case was whether the dishonour of post-dated cheques issued as security by the appellant will attract Section 138 of the Act, 1881

Ratio decidendi of the case

The Supreme Court held that whether a post-dated cheque has been issued for discharge of an outstanding liability shall depend on the nature of transaction and Section 138 of the Act, 1881 shall be attracted only on the date of the cheque there is a legally recoverable outstanding debt or liability. Further, the Court held that although according to Clause 3.1(1) of the loan agreement provided that the post-dated cheques are given as security, however, the expression “security” must be understood to refer to cheques that have been issued by the appellant for payment of the loan instalments to discharge the existing outstanding debt or liability. The relevant extract of the judgement is provided below-

Once the loan was disbursed and instalments have fallen due on the date of the cheque as per the agreement, dishonour of such cheques would fall under Section 138 of the Act. The cheques undoubtedly represent the outstanding liability.”

The Indus Airways ruling has been distinguished from this case.

The Supreme Court distinguished the landmark case of Indus Airways Private Limited v Magnum Aviation Private Limited ((2014) 12 SCC 539) from this case on the grounds that in the Indus Airways case the purchase order was cancelled and therefore the dishonour of cheque, issued for advance payment for the said purchase order, did not represent any subsisting outstanding liability or debt and therefore Section 138 of the Act, 1881 was not attracted. In other words, the dishonour of post-dated cheque would not be considered an offence under Section 138 of the Act, 1881 when the said cheque cannot be considered as discharge of a legally enforceable liability or debt. However, in the present case, although the post-dated cheques were described as “security” in the loan agreement but in essence the issuance of the same was for the purpose to repay the loan instalments for satisfaction of outstanding liability.

Thus, in this judgement the Court has held that there is difference between a purchase order transaction which was cancelled and a loan transaction in which the loan has been granted to the borrower and the repayment of the loan instalments is due on the date of the cheque.

 

The Balaji Seafoods Exports ruling has been distinguished from this case

In the case Balaji Seafoods Exports v Mac Industries Ltd (1999 (1) CTC 6) the Madras High Court held that an undated cheque, issued as security, did not represent any legally enforceable debt or liability, that is to say, it was not issued with the intention to satisfy any subsisting debt. Therefore, the dishonour of such a cheque did not attract Section 138 of the Act, 1881. However, regarding the present case the Supreme Court held that since the post-dated cheques were issued for discharge of an existing liability therefore the dishonour of the same would constitute an offence under Section 138 of the Act, 1881.

 

Conclusion


The judgement of the Supreme Court in this case will have far reaching consequences as the distinction between a post-dated cheque given as security and post-dated cheque issued for satisfaction of subsisting liability has been clearly elucidated. Henceforth, there is sufficient clarity that all the expressions and terminologies used in an agreement between the parties shall be understood keeping in mind the context of the agreement and the intention of the parties. Therefore, when a post-dated cheque is described as a “security” in an agreement and then eventually is dishonoured then Section 138 of the Act, 1881 shall stand attracted because the intention or purpose for the issuance of the said post-dated cheque is discharge or satisfaction of existing outstanding liability or debt. Undoubtedly, this judgement provides enough respite to the borrowers because now there is sufficient guidance as to events and circumstances which shall lead to an offence under the most dreaded provision of law, i.e., Section 138 of the Act, 1881 and therefore by virtue of such clarity the possibility of unfairly coercing the borrowers has been drastically reduced.

- Sneha Bhawnani


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