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BANKERS TO AN ISSUE

Custodians of faith?

Banks are the lifelines of any modern economy. They play a vital role in the success/failure of aneconomy. In a market-oriented economy where the capital market plays a dominant role, banks are one

of the important financial pillars. They not only provide finance but also serve as repositories of investorsfunds. When subscribers to a public issue deposit their application money with the bankers(who are alsoacting as bankers to that particular issue), they do it with a belief that the bankers will act diligently. If allgoes well for the company and its shares get listed, then the bankers to the issue have to transfer thecollected application money to the company. However, if the company fails to get the minimumsubscription or fails to get its shares listed on a stock exchange for any reason, then the banker has torefund the application money to the public within a stipulated time period.

The Companies Act, 1956, stipulates that every company intending to offer shares to the public forsubscription by the issue of a prospectus is required to make an application to at least one recognisedstock exchange for listing. Generally, companies mention the names of two or more stock exchangeswhere they intend to get their shares listed. If a company fails to get its shares listed on any one of therecognised stock exchanges, then it has to repay without interest all monies received from applicants

within eight days after the company becomes liable to pay back the money.

There is an interesting case concerning the public issue of 36 lakh equity shares of Rs 10 each made byJaltarang Motels Ltd. The prospectus issued by the company categorically stated that the companysshares would be listed on the Ahmedabad and Bombay stock exchanges and that the necessaryapplication had been made for the purpose. However, the company could obtain permission for listingonly from the Ahmedabad Stock Exchange (ASE).

While the ASE granted approval, the Bombay Stock Exchange (BSE) rejected the application for listing.Unfortunately for the applicants, Bank of Baroda, one of the bankers to the issue, transferred a sum of Rs38,89,218 collected from the public to the companys account. Similarly, another banker to the issue,Union Bank of India, transferred a few lakh of rupees to third parties and to the company. Surprisingly,these transfers by the bankers were made without even waiting for the decision on listing from BSE.

Since BSE refused to list the companys shares, the public issue became void in terms of the CompaniesAct, 1956. It necessitated a refund of the application money to the applicants as required by the Act. Thecompany did not comply with this statutory requirement of returning the money to the applicants and, as aresult, innocent applicants (investors) had to undergo unwarranted hardship.

The matter came to the notice of Sebi. After holding an inquiry, Sebi directed Atul Shah, managingdirector and one of the promoters of the company, to refund the subscription money to the applicants. Ashas happened in many cases, instead of complying with Sebis direction, the company preferred anappeal against the order before the appellate authority under the Sebi Act. The appeal was dismissedand the company filed a revision application before the appellate authority. This was also dismissed.

Thereafter, the company filed a special civil application (SCA) in the Gujarat High Court. A single judgebench of the high court dismissed the SCA on 30 Jul.98 giving liberty to Sebi to take appropriate action inthe matter. The LPA filed against the single judges order was dismissed by the division bench on 18Sep.98.

To protect the interest of applicants, Sebi opted to pursue the matter with the aforesaid two banks, theybeing the bankers to the issue. After conducting an inquiry, Sebi issued orders invoking powers underSec. 11B of the Sebi Act. It directed the banks to refund money to the investors. Both the banks wereheld guilty of negligence. Bank of Baroda was directed to refund a sum of Rs 40.32 lakh together with an

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interest @ 15% pa from 25 Mar.96. Union Bank was directed to refund Rs 353.32 lakh together withinterest @ 15% pa from 3 Apr.96. Both these orders were issued on 19 Jan. 2000.

Bankers seem to have a thick skin, particularly, the nationalised banks. Both the banks in this casechallenged the order by way of an appeal before the Securities Appellate Tribunal, Mumbai [Bank ofBaroda vs SEBI [2000] 26 SCL 532. The authorised representative of Bank of Baroda submitted that Sebi

had no jurisdiction to pass such an order under the Sebi Act. In fact, the bank even claimed that, underthe law, there was no liability on it to refund the money to the applicants. The bank also claimed that Sebiwas fully aware of the developments from day one. It had vetted the prospectus and had also rejected thecompanys appeal against BSEs refusal for listing.

The bank tried to turn the tables on Sebi by contending that Sebi did not advise it to retain the money andthat the money should not be released to the company. The bank claimed that it had collected theapplication money as the companys agent and since the collection money was handed over to thecompany, they were not in the picture. According to the bank, i ts liability as a banker to the issue endedwhen the collection money was handed over. It said that Sebi had no power to direct the bank to refundthe money and only the company could have been asked to do so.

Bank of Baroda claimed that the refund had become time barred as the direction to refund the money was

belated as it was made after a lapse of four years from the date of issue of prospectus and after a lapseof three years from the transfer of money to the company.

An example of ingenuity of a legal brain was provided by the counsel for the bank when he claimed thatSebi had no authority as was evident from the scheme of the Sebi Act itself. The Act had not provided forany recovery mechanism in the event of an order for recovering money. It was further contended thatthere was not even an implied suggestion in the Act in that regard.

The bank stuck to its stand that in case an issue required a refund of the application money, theobligation was on the issuer company and its officers and there was not even a remote obligation on thebanker to refund money to the applicants. So far as Sebi was concerned, its representative submitted thatSebi was empowered to issue the said order. The regulator contended that the Sebi Act empowered it totake necessary measures to protect the interest of investors and the said direction was issued as an

investor protection measure. To support this contention, Sebi cited the Gujarat High Courts divisionbenchs decision in Securities and Exchange Board of India vs Alka Synthetics Ltd. [1999] 19 SCL 460.

It was submitted on behalf of Sebi that the banker to an issue was an agent of the issuer company and atrustee for the funds of subscribers.It was submitted that the bank should not have released the money tothe company ignoring the requirements of Sec. 73 of the Companies Act. The appellate tribunalconsidered all the contentions put forward by the parties and made an interesting observation. Thetribunal said that to blame Sebi for not having advised the bank to retain the money and to say that but forSebis silence the bank would not have parted with the money was too much to digest.

The tribunal agreed with Sebis contention that the said direction was in the nature of a relief measure forthe benefit of investors and that Sebi was duty bound to take such a measure. The tribunal referred to theSupreme Courts decision in Radheyshyam Khemka vs State of Bihar [1993] 77 Comp. Case 356 which

throws light on the role of dual agencies where enforcement of power is found overlapping.

The tribunal held that in the light of the decision of the various high courts, Sebis authority to issuedirections (of the type challenged by the bank) for the purpose of investor protection is well established.The tribunal also dismissed the banks claim that the bank was acting as an agent of the company andhaving passed on the collection money to the company, the bank was no longer liable to repay themoney. The tribunal held that the bank had acted negligently and had caused hardship to investors.

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According to the bankers own admission, they had acted as bankers to an issue for several public issuesin the past and as such they cannot claim to be ignorant of the statutory requirements and theirobligations.

In conclusion, I cannot do better than quote the tribunal itself: The main reason for investors misery inthis case is the negligence of the appellants (banks). The facts and circumstances do not suggest that the

appellants (banks) had acted diligently. Since they were holding the application money in trust they wereaccountable for its safe keeping and return. They cannot escape the liability for misapplication of money.The liability to refund the money is now on them.

by S D Israni