Dishonour of any post dated cheque issued as an advance payment by any purchaser cannot be considered in discharge of legally enforceable debt or any other liability and thus would not amount to an offence, the Supreme Court has ruled
In the world of lending, banks/ financial institutions insisting on taking post-dated cheques (PDCs) from borrowers as a security has been a common norm. These PDCs have been astras (weapons) in the hands of the financial institution used for arm-twisting the borrowers and also acting as a deterrent to ensure that borrowers do not default. Wherever the borrower would explicitly or implicitly give indications of not having the ability to pay, the lender would present these PDCs to the bank; and once these PDCs bounce, the legal team of the lender would jump to action to initiate a case against the borrower under section 138 of the Negotiable Instruments Act, 1881 (NI Act).
It is one of the most common legal actions being undertaken by lenders against borrowers and as we are all aware section 138 of the NI Act is the most dreaded section with regard to dishonour of cheque, which could lead you to some months of imprisonment to the drawer of the cheque. The text of the section is mentioned below for your ready reference:
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. (emphasis ours at relevant places)
So there are two things. which are most critical to fall under the section apart from the basic conditions as stated in the section above. One, that the PDC needs to be a cheque at the time of presentation and second the cheque should be for discharging debt or liability, which is a legally enforceable debt or liability. That is to say, to institute a suit under Section 138 of the Act, there should be a legally enforceable debt or other liability subsisting on the date of drawal of the cheque.
The matter whether PDCs are cheque at the time of presentation to the bank has been a contentious issue for long now. In a Supreme Court ruling of Anil Sawhney vs Gulshan Rai, the Court held that a post dated cheque is composed of two elements. At the time the post- dated cheque is drawn, it is in the nature of a bill of exchange and they assume the character of a cheque from the date appearing on the cheque. The extract of the ruling explains the fact:
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".
The Apex Court further stated that
“An offence to be made out under the substantive provisions of Section 138 of the Act it is mandatory that the cheque is 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.... When a post-dated cheque is written or drawn it is only a bill of exchange and as such the provisions of Section 138(a) are not applicable to the said instrument.
One of the main ingredients of the offence under Section 138 of the Act is the return of the cheque by the bank unpaid….A post-dated cheque cannot be presented before the bank and as such the question of its return would not arise. It is only when the post-dated cheque becomes a "cheque", with effect from the date shown on the face of the said cheque, the provisions of Section 138 come into play.”
The ruling above made the fact clear that if a PDC was withdrawn or cancelled before the date on which it was to be presented to the bank then such cancellation of PDC would tantamount to cancellation of a Bill of exchange and not of a cheque per se.
The recent ruling of the Supreme Court in the matter of Indus Airways Pvt Ltd & Ors. vs Magnum Aviation Pvt Ltd & Anr. brought out clarity on conditions for attracting 138 action clearly stating that dishonour of any post dated cheque issued as an advance payment by any purchaser cannot be considered in discharge of legally enforceable debt or any other liability and thus would not amount to an offence under Section 138 of the Negotiable Instruments Act, 1881.
A brief insight into the relevant facts and the judgement of the above stated case would make one clear on the captioned perspective.
Facts of the Case:
Indus Airways Pvt Ltd & Ors. (hereinafter referred to as the ‘purchaser’) placed two purchase orders on 19 February 2007 and 26 February 2007 with Magnum Aviation Pvt Ltd (hereinafter referred to as the ‘supplier’) for supply of certain aircraft parts. Two post dated cheques were issued by the purchaser in this regard. The date on the face of such two post dated cheques been 15 March 2007 and 20 March 2007. It is important to note that such post dated cheques were issued as an advance payment to the supplier as the terms of the contract stated to facilitate the supplier procure the parts from abroad. Subsequently on presentation of these cheques to the bank, they were dishonoured on the ground that the purchaser had stopped payment for the same. A cancellation letter was received by the supplier on 22 March 2007 cancelling the order and requesting the return of the cheques.
The Supreme Court quashed several conflicting views of the subordinate courts on the captioned subject. The important crux in this case as highlighted in the judgement was that one of the conditions of the contract entered into between the parties contended that the purchaser needed to make an advance payment to the supplier to enable him to purchase the aircraft parts from abroad. The fact that purchaser cancelled the purchase order and that the purchase order was not carried to its logical conclusion clearly meant that the cheque did not represent a debt or liability. The Apex Court placed reliance on the ruling in the matter of Swastik Coaters Pvt Ltd vs Deepak Brothers and others (1997 Cri LJ 1942 (AP)), whereby the Andhra Pradesh High Court held that
“……..Explanation to Section 138 of the Negotiable Instruments Act clearly makes it clear that the cheque shall be relateable to an enforceable liability or debt and as on the date of the issuing of the cheque there was no existing liability in the sense that the title in the property had not passed on to the accused since the goods were not delivered. ……..”
The ruling will have a far reaching consequence as there are thousands of cheque bouncing cases pending in the country.
Typically in non-recourse factoring transactions since the factors have exposure on the obligors, factors commonly use section 138 route as a recovery tactic. Particularly so, the ruling may come as a respite to several borrowers/ obligors in factoring cases these days, where the factors use PDCs as a means to arm-twist the obligors and initiate section 138 action against them disregarding the fact that the debt may not be a valid and enforceable debt at all.
(Nidhi Bothra is executive vice president, while Debolina Banerjee is an associate at Vinod Kothari & Company)
To avoid costs of compliance, financial institutions in India may decide to filter the US client that they want to be on board. However, the actual impact be realised once RBI, SEBI and other regulators come out with guidelines to ensure compliance with FATCA in their respective domains
The Foreign Account Tax Compliance Act (FATCA), a US legislation meant to target tax non-compliance by US citizens with offshore accounts, has reached the Indian boundary. Regarded as one of the most controversial extra-territorial tax legislations, the Act is likely to impact various types of financial institutions in India such as deposit taking institutions, mutual funds, insurance companies and brokering firms. Regulators in India are bracing up to ensure that financial institutions in India adhere to the FATCA guidelines once it comes into force with effect from 1 July 2014.
Why it is that FATCA has suddenly become so important for India? The reason for growing significance of FATCA comes from the fact that India has entered into in-substance agreement with the US to implement FATCA guidelines. Under FATCA guidelines, there are two types of inter-governmental agreements (IGA), which countries are expected to enter into with the US to avoid non-compliance of FATCA. These are called as Model-1 and Model-2 of the inter-governmental agreements. India has consented to MODEL-1 of IGA.
So what does Model-1 agreement mean? Under Model-1, foreign financial institutions (FFIs) for the US perspective, say an insurance company or bank operating in case of India, would be required to report all FATCA-related information to Indian governmental agencies, which would then report these information to Internal Revenue Service (IRS). Some Model-1 IGAs have also provision for reciprocity, requiring the US to provide certain information about residents of the Model-1 country to the Model-1 country in exchange for the information that country provides to the US. Since India has entered into an agreement under Model-1, Indian financial institutions need not sign an FFI agreement, but they will need to register on the IRS’s FATCA Registration Portal or file form 8957.
So how does FATCA impact financial institutions in India, particularly mutual funds? While the details of the impact are yet to be known, it is very obvious that this act is going to throw various challenges with respect to compliance for mutual funds. Here, are a series of steps that mutual funds will require to take to ensure so that they are FATCA complied and avoid any withholding tax as per the act.
Step-1: Identify US persons who have invested in mutual funds in India: The first step would be to identify persons from the US, who have invested in mutual funds in India. US person for tax purposes are generally considered as:
• A citizen of the US (including an individual born in the US but resident in another country, who has not renounced US citizenship);
• A lawful resident of the US (including a US green card holder);
• A person residing in the US.
• Somebody who has spent considerable period of time in US on a yearly basis.
• American corporations, estates and trusts may also be considered US persons
The need for identifying US person arises from the fact that money invested by these entities in India, need to be reported to IRS in the US.
Step-2: Identify what needs to be reported: Foreign financial institutions or FFIs need to report to the IRS under FATCA. While the threshold limit for reporting will be specified by the regulators in India based on FATCA regulation, mutual funds will need to understand the reporting requirements under FATCA, in terms of threshold limits. As per FATCA, US persons need to report to IRS in the following scenarios:
• If the total value is at or below $50,000 at the end of the tax year, there is no reporting requirement for the year, unless the total value was more than $75,000 at any time during the tax year.
• The threshold is higher for individuals who live outside the United States.
• Thresholds are different for married and single taxpayers.
The threshold of $50,000 may become applicable in case of mutual funds in India as well. This would require tracing all accounts, which have investments beyond this limit. There is a provision for third party reporting under FATCA for FFIs which says, “Foreign financial institutions may provide to the IRS, third-party information reporting about financial accounts, including the identity and certain financial information associated with the account, which they maintain offshore on behalf of US individual account holders”.
Step-3: Understand registration process, responsibilities and penalties: Since India has signed Model-1 agreement, mutual funds in India will have to register with IRS and obtain Global Intermediary Identification Number (GIIN). The basic requirement under FATCA for mutual funds is to identify reportable accounts and provide details of these accounts to IRS.
FATCA imposes certain obligations on foreign financial institutions, which will become applicable for mutual funds in India as well. Under FATCA, FFIs that enter into an agreement with the IRS to report on their account holders may be required to withhold 30% on certain payments to foreign payees if such payees do not comply with FATCA.
Unless otherwise exempt, FFIs that do not both register and agree to report face a 30% withholding tax on certain US-source payments made to them. Since mutual funds do not fall under exempt category, these funds will to face issue of withholding tax and hence it becomes important to ensure compliance.
Basically, FATCA will result into higher compliance cost for mutual funds in India. There is a possibility of penalty as well if the compliance requirements are not met. Many mutual funds may weigh cost-benefit options arising from this new legislation as well. In order to avoid costs of compliance, financial institutions in India may decide to filter the client that they want to be on board. However, the actual impact be realized once Reserve Bank of India (RBI) and Securities and Exchange Board of India (SEBI) and other regulators come out with guidelines to ensure compliance with FATCA in their respective domains.
(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)
If you look at the earnings growth, in 2010, the first year of the recovery, it had a sharp rise of above 100%. But since then it has been a downward trend. Corporate profits may soon be contracting
It’s earnings season. Like the calendar seasons there may be a change in the air. Since the middle of 2009, corporate earnings have consistently grown, but that might be about to stop. Before earnings are reported, it is traditional for companies to give gloomy forecasts to talk down the estimates, and then exceed them. This usually gives a pop to the stock when the company ‘beats’.
Not this time. With half the US S&P companies reporting, the percentage of companies reporting, EPS above estimates is in-line with recent historical averages, but the percentage of companies reporting revenues above estimates is below recent historical averages. The problem is that the ‘beats’ did not get the reaction that the companies would have wanted. The average stock has declined by 0.35% on the first day following the report of its earnings. It has been a particularly disastrous earning season for Tech stocks.
The average Tech stock has fallen by 1.6% on the day following its report. In the past year a ‘beat’ would usually mean a large rise in the stock on the following trading day. This season it results in a gain of 0.45%. While a beat does not lead to a celebration, a miss can be dire. If a Tech stock misses, its average decline is 6.71%. Twitter dropped 14%. Others have fallen 20% or more.
Are these numbers trying to tell us something? Perhaps. Certainly corporate profits have risen dramatically. If you look at a chart of earnings growth, in 2010, the first year of the recovery, it had a sharp rise of above 100%. But since then it has been a downward trend. Corporate profits may soon be contracting.
This should hardly be surprising. Corporate profits usually revert to mean. Presently they are close to an all time high as a proportion of gross domestic product (GDP). Exactly what the mean is, has been a matter of debate. The fact that they revert is not. The question between the bulls and the bears is, whether corporate profits are just a bit higher than historical averages and nothing to worry about or a bubble that is about to burst.
The bears will point out that the 2008 fall, followed by the recovery of 2010, was one of the largest spikes in history. The acceleration of profits has been much sharper compared to other business cycles. This appears to be surprising, given that economic growth has been tepid at best.
The explanation is not hard to find. Easy money policies provided by the US central bank have allowed companies to profit from extremely low borrowing. Low labor costs and a favorable tax codes have also helped grow profits even though demand has been weak.
For example Apple, the world’s most valuable private company, has boosted its earnings by buying back shares and keeping its profits off shore and away from American tax collectors. Although Apple has a huge $150 billion cash pile, $130 billion of that is outside of the US. To boost its shares and profits, Apple wants to buy back from $60 billion to $90 billion of its own shares. It doesn’t have the money in the US, so it has to borrow it. It has already floated a $17 billion bond 12 months ago and wants to do another $17 billion.
What is wrong with this scenario is that Apple is not using the money to invest in things that will actually make more money. It has simply utilised the conjunction of a generous tax policy and free money to engineer a rise in its stock which no doubt helps management. In the short run it has helped shareholders, but there may be problems down the line. Buying expensive stock with massive debt is not a lasting strategy for growth. Tax codes can change. Cheap money can disappear.
Like financial engineering, using cost cutting to boost corporate profits also has limits. Companies have tried to get as much out of their employees as possible without hiring additional workers. As a result, productivity has increased. Eventually, growth will demand more hiring as this week’s US job report may have indicated. But more workers will eat into corporate profits.
The result is that estimates for profit growth have been revised down substantially from the beginning of the year. Earnings estimates for the S&P 500 companies were revised down 4.4%. Of course this is quite common. In 20 of the past 25 years, analysts have revised down earnings growth by an average of 8% over the year.
It is not just the US market that is having second thoughts. European earnings estimates have also been wildly optimistic. Like the last three years, 2014 started out with 8% to 15% earnings growth forecast. In the past, these expectations have fallen over the year to -6% to 1% growth. Forecasts for European growth have moved from 13% at the start of the year to just 8% now and falling. Of the 374 Stoxx600 European companies that have reported their first quarter results so far this year, 101 have disappointed consensus earnings expectations.
Forecasts for global growth have also been cut. They started the year at 11%, but have since been cut to 2%. No doubt they will continue to fall as the year progresses.
The result of strong earning growths has been exceptionally strong stock markets that are trading at or near all time records in several countries. They grew by 13% in 2012 and managed a remarkable 24% last year. Market valuations always look to the future and over the past three years the future for corporate profits has seemed rather bright. With a change in expectations, no doubt there will also be a change in valuations. So corporate profits will not be the only thing to fall.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and speaks four languages.)