Supreme Court Affirms Applicability of SARFAESI Act to Co-operative Banks, Upholds Parliamentary Competence Over Banking Activities

Constitution Bench clarifies legislative domain under Entry 45 of List I, rules that co-operative banks engaged in banking activities fall under the ambit of the SARFAESI Act and Banking Regulation Act, 1949

In a landmark judgment delivered on May 5, 2020, by a Constitution Bench of the Supreme Court of India comprising Justices Arun Mishra, Indira Banerjee, Vineet Saran, M.R. Shah, and Aniruddha Bose, the Court addressed a long-standing controversy over the applicability of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) to co-operative banks, including those registered under State cooperative laws and Multi-State Co-operative Societies Act, 2002.

The case, arising from multiple civil appeals including Pandurang Ganpati Chaugule v. Vishwasrao Patil Murgud Sahakari Bank Ltd., centered on whether co-operative banks, which are societies registered under State or Multi-State cooperative legislation, are ‘banks’ within the meaning of the SARFAESI Act, and whether the Parliament has legislative competence under the Constitution to enact laws affecting such banks, particularly recovery procedures under Section 13 of the SARFAESI Act.

Key issues revolved around the interpretation of constitutional legislative entries—Entry 45 of List I (Banking) and Entry 32 of List II (Co-operative societies)—and the definition of 'banking company' under Section 5(c) of the Banking Regulation Act, 1949 (BR Act). The appellants challenged the inclusion of co-operative banks within the ambit of the SARFAESI Act, arguing that cooperative societies are primarily governed by State laws under Entry 32 List II and that Parliament lacks competence to regulate their banking activities, including recovery procedures. They contended that co-operative banks are not ‘banking companies’ as defined in the BR Act, 1949, and that notifications and amendments extending SARFAESI Act provisions to co-operative banks were ultra vires and colorable legislation.

The Court comprehensively analyzed the constitutional scheme, statutory provisions, and judicial precedents, including earlier conflicting decisions such as Greater Bombay Coop. Bank Ltd. v. United Yarn Tex (P) Ltd. and Delhi High Court Bar Association v. Union of India. It emphasized the following key findings:

1. Definition and Meaning of Banking and Banks:

 Banking under Entry 45 of List I is broadly construed to include all activities incidental or subsidiary to the business of banking as defined in Section 5(b) of the BR Act, 1949. The Court relied on authoritative judgments (Rustom Cavasjee Cooper, ICICI Bank Ltd. v. Official Liquidator) to affirm that the ‘core banking business’ includes accepting deposits repayable on demand or otherwise and lending or investment activities, which co-operative banks perform.

2. Legislative Competence of Parliament:

 The Court held that while ‘incorporation, regulation, and winding up’ of co-operative societies fall under Entry 32 of List II (State List), the business of banking carried on by co-operative banks is within Entry 45 of List I (Union List). Thus, the Parliament has exclusive competence to legislate on banking activities, including recovery of debts, even when carried out by co-operative banks. Incidental encroachment on State subjects is permissible under the doctrine of pith and substance.

3. Applicability of the BR Act, 1949 and RBI Act to Co-operative Banks:

 Through the 1965 amendment (Banking Laws (Application to Co-operative Societies) Act), co-operative banks were brought under the regulatory framework of the BR Act and the Reserve Bank of India Act, subject to modifications. Section 56(a) of the BR Act incorporates co-operative banks within the definition of ‘banking company’ for the purpose of regulation. The Court rejected arguments that the definition of 'banking company' was not amended to include co-operative banks, clarifying that incorporation by reference in Section 56(a) effectively includes them.

4. Validity of SARFAESI Act’s Applicability and Notifications:

 The Court upheld the constitutional validity of the SARFAESI Act’s provisions as applicable to co-operative banks and multi-State co-operative banks, including the amendment inserting multi-State co-operative banks as ‘banks’ under Section 2(1)(c)(iva) of the Act. It found the notification dated January 28, 2003, specifying co-operative banks as ‘banks’ under the SARFAESI Act, to be within the Central Government’s powers and not ultra vires.

5. Recovery Procedures as Part of Banking Activity:

 Recovery of dues is an essential function of banking. The Court reasoned that the SARFAESI Act’s provisions for recovery without court intervention are an integral part of banking regulation and fall squarely within the legislative competence of Parliament under Entry 45 of List I. The existence of state recovery mechanisms under cooperative laws does not exclude Parliament’s power to provide additional recovery remedies.

6. Doctrine of Pith and Substance and Harmonious Construction of Entries:

 The Court applied the doctrine of pith and substance to reconcile Entries 32 and 45, holding that while co-operative societies are primarily governed by State laws for their incorporation and management, their banking functions are regulated by Central laws. Incidental overlap or trenching into State subjects by Central legislation is permissible.

7. Overruling Conflicting Precedents:

 The Court distinguished and effectively overruled parts of the Greater Bombay Coop. Bank Ltd. decision which had held otherwise, clarifying that co-operative banks engaged in banking activities are covered by the BR Act and SARFAESI Act.

The Court’s conclusion decisively affirms that co-operative banks registered under State or Multi-State cooperative laws are ‘banks’ engaged in banking within the constitutional meaning under Entry 45 of List I. Consequently, Parliament has the legislative competence to enact laws like the SARFAESI Act for their regulation, including recovery procedures under Section 13. The recovery procedure prescribed under the SARFAESI Act is applicable to co-operative banks, and the notifications and amendments extending the Act to co-operative banks are constitutionally valid and not colorable legislation.

This judgment resolves decades of legal uncertainty and conflicting interpretations, providing clarity on the regulatory framework governing co-operative banks and reinforcing the legislative supremacy of Parliament in matters of banking and financial sector reforms. The decision also acknowledges the constitutional amendments introducing Articles 43B and 243ZI emphasizing the autonomous and professional functioning of co-operative societies while affirming applicable banking regulation.

The appeals, writ petitions, and other pending proceedings related to this issue have been accordingly disposed of with no order as to costs.

Statutory provisions

Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 Section 2(1)(c), 2(1)(d), 13; Banking Regulation Act, 1949 Sections 5(b), 5(c), 6(1), 7, 11, 18, 19, 22, 23, 29, 30, 35, 35A, 56; Reserve Bank of India Act, 1934 Sections 2; Multi-State Co-operative Societies Act, 2002; Constitution of India Articles 246, 254, 117, 243ZL, 243ZI, 43B

Pandurang Ganpati Chaugule v. Vishwasrao Patil Murgud Sahakari Bank Ltd. (SC)(Constitution Bench) : Law Finder Doc Id # 1713868