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January 19, 2021

Are provisions prohibiting payment of interest on the amount of security deposits are violative of Article 14 of the Constitution of India?

by CA Shivam Jaiswal in Income Tax

Are provisions prohibiting payment of interest on the amount of security deposits are violative of Article 14 of the Constitution of India?

The State of Karnataka enacted the Karnataka Money Lenders Act, 1961 with a view to regulate and control the transactions of money lending in the State. Section 5 of the M.L. Act makes it obligatory for any person carrying on the business of money lending to procure licence before carrying on the business of money lending.

The State of Karnataka then enacted the Karnataka Money Lenders (Amendment) Act, 1998 and a similar amendment was also made to the Pawn Brokers (PB) Act. According to the amended Section 7A(3) and 4A(3), the amount of the security payable in a year by a licensee shall be determined on the basis of the amount invested by him in the business during the previous year and such security deposit shall not carry any interest.

Let us refer to the case of State of Karnataka vs Karnataka Pawn Brokers Association, where the main issue raised in these appeals was whether the amendments made to the Karnataka Money Lenders Act, 1961 and the Karnataka Pawn Brokers Act, 1961 providing that the security deposit furnished by the money lenders and pawn brokers in terms of Sections 7-A and 4-A of the Acts respectively shall not carry interest, is constitutional, legal and valid?

Facts of the Case:

  • The State of Karnataka enacted the Karnataka Money Lenders (Amendment) Act, 1998 and a similar amendment was also made to the Pawn Brokers (PB) Act.
  • According to the amended Section 7A(3) and 4A(3), the amount of the security payable in a year by a licensee shall be determined on the basis of the amount invested by him in the business during the previous year and such security deposit shall not carry any interest.
  • The association of pawn brokers and money lenders filed writ petitions in the High Court challenging the constitutional validity of these amendments. The Single Judge dismissed the writ petitions.
  • However, the Division Bench allowed the writ petitions and held that though all other amendments made to Sections 7-A and 7-B of the M.L. Act and Sections 4-A and 4-B of the P.B. Act were constitutionally valid and legal, the provisions providing for non-payment of interest on security deposits were held to be constitutionally bad and were accordingly set aside.
  • In the earlier judgment in Manakchand Motilals case, the Karnataka High Court had held that the money lenders and pawn brokers were entitled to interest on the amount of deposit and the said judgment had become final since the SLP against the same was dismissed.

Grounds of Appeal before the Supreme Court (SC)

  • What is the scope, ambit and effect of the judgment of the Karnataka High Court in Manakchand Motilals case (supra)?
  • Whether the provisions providing that no interest is payable are arbitrary and hence violative of Article 14 of the Constitution of India

Observations of the SC on the the scope, ambit and effect of the judgment of the HC in Manakchand Motilals case

  • The main issue raised in Manakchand Motilals case (supra) was with regard to the validity of Section 7-A and 4-A of the M.L. Act and the P.B. Act respectively, in so far as they made a provision for deposit of security as a pre-requisite to the grant of licence.
  • At that time, there was no provision with regard to the payment of interest. The Court held that the State Government was entitled to introduce a condition for payment of deposit.
  • The Court, however, felt that for the provision to be constitutionally valid, the deposit must carry interest.
  • In SC’s view, the observations that if there was a provision prohibiting payment of interest, the same would be arbitrary and hence illegal, were not necessary in the fact situation of Manakchand Motilals case (supra).
  • As observed by HC, there was no provision prohibiting the payment of interest.
  • Therefore, the observations in this behalf were not called for and were hypothetical.
  • SC also pointed out that there was no discussion on the issue as to whether a provision providing that no interest would be payable on the security deposit would be legally valid or not?
  • A passing observation was made that there would have been force in the contention of the money-lenders and pawn brokers that the provisions would be violative of Article 14 of the Constitution but this, in SC’s opinion, was not the rationale of the case.
  • Also, after making the aforesaid observation, the Division Bench again noted that in the absence of any prohibition in the provisions of the Acts, regarding payment of interest, in view of Article 14, the Government while making rules must provide for payment of interest.
  • This itself was a clear indicator that the Court decided the issue in Manakchand Motilals case (supra) mainly on the ground that there was no provision prohibiting the payment of interest.
  • SC, therefore, was of the considered view that the observation made in Manakchand Motilals case (supra) that a provision prohibiting payment of interest would be arbitrary and violative of Article 14 of the Constitution of India was a passing observation in the nature of obiter not arising for decision in the said case.

Observations of the SC on whether the provisions providing that no interest is payable are arbitrary and hence violative of Article 14

  • It was repeatedly held that interest was basically compensation for the use or retention of money. Interest in general. Interest is the return or compensation for the use or retention by one person of a sum of money belonging to or owed to another
  • SC held that the clause not providing for interest is neither arbitrary nor palpably unreasonable, nor even unconscionable. In holding so SC regarded the following:
    1. The consumer made the security deposit in consideration of the performance of his obligation for obtaining the service which is essential to him.
    2. The electricity supply is made to the consumers on credit.
    3. The billing time taken by the Board is to the advantage of the consumer.
    4. Public revenues are blocked in generation, transmission and distribution of electricity for the purpose of supply. The Board pays interest on the loans borrowed by the Board. This is in order to perform public service. On those payments made by the Board it gets no interest from the consumers.
    5. The Board needs back its blocked money to carry out public service with reasonable recompense.
    6. The Board is not essentially a commercial organisation to which the consumer has furnished the security to earn interest thereon.
  • It was apparent that the courts frowned upon the trade of money lending.
  • The profession of money lending, may be a trade, but onerous restrictions may be placed on such trade which is definitely usurious.
  • These onerous restrictions would be reasonable keeping in view the nature of the trade.
  • The Legislature in its wisdom can decide whether it should make it more difficult for people to engage in the business of money lending and pawn broking
  • A money lender or a pawn broker applies for licence to do this business knowing fully well that the security that he shall deposit shall not earn any interest. He with open eyes accepts the condition which is part of the Acts.
  • Nobody forces a person to engage in the trade of money lending or pawn broking. Therefore, the impugned provisions cannot be held to be unreasonable
  • Lastly, SC considered the submission as to whether a provision providing that no interest is payable on the security deposit is so arbitrary, as to make it unconstitutional.
  • In Independent Thought vs. Union of India and Anr, SC held that arbitrariness must be writ large to make it un-constitutional.
  • Whether the interest should be paid or not is a matter which parties decide amongst themselves.
  • Contracts providing for non-payment of interest on earnest money and security deposits have been considered in the context of the Arbitration Acts.
  • The Courts have held that in view of the agreement entered into between the parties, the arbitrator cannot award interest prior to the date of passing of the award.
  • Though these authorities did not directly deal with the issue with which SC was concerned, it was obvious that in all these cases, the Court has not construed the provision of the contract providing for non-payment of interest to be void.
  • The said provision had, in fact, been legally enforced.
  • SC, however, noted that under the Arbitration Act of 1940, this Court held that the arbitrator could award interest but under the Arbitration and Conciliation Act, 1996 the arbitrator could not award interest prior to the date of award
  • Therefore, SC was clearly of the view that the provisions prohibiting payment of interest on the amount of security deposits could not be said to be arbitrary or violative of Article 14 of the Constitution of India

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