The legislature and the Reserve bank of India have tried many permutations of legal restrictions to maintain a balance between restrictions over acceptance of deposits and allowing businesses to continue with minimal interference. It was however found that unincorporated bodies, which were widespread and in very large numbers, often either violated the law blatantly or circumvented it.

Thus, in 1997, an ordinance was promulgated amending the RBI Act whereby unincorporated bodies engaged in the business of finance were simply prohibited from accepting deposits at all. Note that all unincorporated bodies, including even entities not engaged in the business of finance were also initially prohibited from accepting deposits.

It was this total and common prohibition that resulted in severe protests and many writ petitions were filed all over the country. Realising that the prohibition was too broad, an amendment was introduced whereby only entities engaged in the business of finance and certain other entities were prohibited from accepting deposits. Nevertheless, the cases filed and other cases were pursued and several high courts stayed the operation of section 45S being the revised provision in the Reserve Bank of India Act that provided for such prohibition.

The matter reached the Supreme Court recently and the Hon'ble Court rendered its decision on the matter (Bhavesh D Parikh v UOI (2000) 24 SCL 454 (SC)).

The Supreme Court upheld the constitutionality of the new provision. In fact, effectively, it has also removed the stays granted by several high courts.

In other words, throughout India, the restrictions over finance entities on acceptance of deposits are now fully operational. It is interesting, however, to review the reasoning of the Supreme Court.

In particular, the Supreme Court laid down some guidelines over the manner in which courts will look at economic laws while determining their constitutionality and has stated that courts would be hesitant in holding such laws to be unconstitutional except in extreme cases. It has also laid down guidelines over how the constitutionality of such economic laws will be determined. The applicability of such remarks would extend not only to the present law but also to laws relating generally to credit, finance, capital markets, etc. Hence, the far-reaching effect of this decision cannot be overstated.

It was argued before the Supreme Court particularly by persons engaged in the business of finance, such as Shroffs, that such restriction simply prohibited their business and hence amounted to a violation of their fundamental right to do business.

It was stated that such entities provided a very convenient service to the members of the public and just because some entities have defaulted on their deposits should not mean that all should be prohibited from accepting deposits.

The Supreme Court noted the background in which such a law was introduced. It was noted that over a period, several attempts of the legislature in this direction had failed to control the indiscriminate deposit acceptance by such entities and many of such entities soon defaulted.

The Court noted that particularly in the States of Kerala and Tamil Nadu, numerous entities raised finance by promising high returns and marketed their deposit schemes aggressively through flashy advertisements. Many of such entities soon closed down and the monies of the depositors were simply lost.

The earlier attempts of the law to limit the number of depositors per entity or partners were circumvented since unscrupulous entities simply multiplied the number of entities.

It was also noted that there was no haste in passing the new law in the sense that several studies were made by committees and only after carefully reflecting on the suggestions made that the amendments were introduced.The Hon'ble Court noted the fact that there was not a total prohibition on acceptance of deposits by unincorporated entities. Only those entities that were carrying on the business of finance or other specified businesses were so prohibited. Even these could accept deposits from their relatives.

Further, such entities were not prohibited from carrying on such business altogether in the sense that they could carry on such business out of their own resources. They were only prohibited from accepting monies from the public. Further, such entities also had the option of incorporating themselves and then raise deposits. Thus, if such entities were willing to submit themselves to the restrictions and regulation placed on corporate bodies, they could raise deposits from the public.

The petitioner entities then argued that depositors were well aware of what they are going into and if depositors were still willing to give deposits, there should not be any prohibition on entities on accepting them.

Here, the court made an interesting analogy. It relied on the remarks on an earlier decision and held that sometimes it is necessary to have a total prohibition since one cannot be sure that depositors would use their mind rationally.

The Court quoted the remarks in the earlier decision that "how can you save moth from the fire except by putting out the fatal fire?" Thus, it was stated that the circumstances warranted an absolute prohibition. Interesting also are the remarks of the Court on interpreting and examining the constitutional validity of certain economic legislations. The Court said, "when considering an application for staying the operation of a piece of legislation, and that too pertaining to economic reform or change the courts must bear in mind that unless the provision is manifestly unjust or glaringly unconstitutional, the courts must show judicial restraint in staying the applicability of the same." The Court also stated that, "Another rule of equal importance is that laws relating to economic activity should be viewed with greater latitude than laws touching civil rights such as freedom of speech, religion, etc. It has been said by no less a person than Holmes J that the legislature should be allowed some play in thejoints, because it has to deal with complex problems which do not admit of solution through any doctrinaire or straight jacket formula and this is particularly true in case of legislation dealing with economic laws, where having regard to the nature of the problems required to deal with, greater play in the joints has to be allowed to the legislature."

The Court also stated that, "In such economic matters, this Hon'ble Court does not interfere with a decision of the expert bodies which have examined the matter."

The Court repeatedly observed that these entities were prohibited only from acceptance of public deposits and not totally from carrying out the business of finance. It repeatedly stressed that the whole scope and intent of the legislation was on those entities that accepted deposits from the public.

One may recall, as has been discussed in this column earlier, that finance companies have been totally prohibited from carrying on the business of finance without registration even if they carry on the business with their own funds without accepting deposits from the public. It is submitted that the remarks of the Supreme Court support the contention of such companies that such total prohibition over carrying on of the business by such companies is unconstitutional. Nevertheless, to conclude, now the uncertainty over whether or not the law prohibiting unincorporated bodies engaged in the business of finance is constitutional or not has been ended.

Since all the stays granted by high courts have effectively been removed and the constitutionality of this provision has been upheld, unincorporated finance entities will now not be able to accept deposits from the public(The author is a Mumbai-based chartered accountant and can be contacted at jmt@bom4.vsnl.net.in)