Legal Reforms: Backbone Of Economic Progress

Over the past decade and a half, several legal reforms have been introduced in the financial sectors which have added tremendous value to financial and economic development

Any discussion on legal reforms is generally very critical. We deplore the Government and our legislators perhaps, most of the time, if not, all the time. India is a large country with a vast population; well spread boundaries, a great history of eco-socio-political issues and challenges. Still the euphoria on a positive note exists and has not died down. In spite of several obstacles, including but not limited to the lack of political will, corruption, policy paralysis etc., there is always a silver lining which keeps India moving and in some situations "Shining".

The plethora of laws in India is mostly a legacy of the British era. Many of the Acts, still applicable, are archaic, enacted in 19th and 20th century which are amended from time to time to bring them on par with the current economic, social & political eco-system and expectations. Let us not forget that India being a democratic country, with multi-party democracy, where everyone has a right to voice his/her views; it is not easy to get an act or law completely substituted with a new one. What we sometimes forget is that, the way a glimmer of light and hope can show us the path on a dark night, similarly, amendments to old laws could be one of the ways to keep pace with the ever changing and ever evolving socio-political and economic scenario of India. The story of India’s economic liberalisation actually started in 1991 with the present Prime Minister, then at the helm of financial affairs. In the last two decades, there have been consistent amendments made to financial and economic laws regardless of the political party in power. This article is focussed on certain macro changes which have been made in the last two decades to promote the economic liberalisation & growth of India.

The first and foremost point for the growth of any economy is a robust banking and financial system as it steers the growth of corporates and business houses and moves the wheels of economy. A robust banking system, sound financial laws with defined rules and regulations are the backbone for the economic progress of the country. So far as financial laws impacting financial industry are concerned, in our opinion, our Government has taken several initiatives, from time to time, which have been extremely useful and instrumental in the overall economic progress of the country.

One of the most important aspects for the growth of financial sector is protection accorded to banking and financial industry with regard to realization of investments made by them. With the advent of liberalisation in India and to some extent it is true even today, growth of business of any Indian corporate largely depends on receipt of debt finance from banks and financial institutions. Indian banking & financial industry has been plagued with non-performing assets and defaults made by business houses in repaying their dues on time. Delay in enforcement of rights of lenders has always been a big challenge for the growth of the Indian Economy. Several reforms have been introduced in this area which have enabled the banking industry as a whole to be seen as a robust industry in the eyes of not only the people of India but also people outside India. Let us review briefly the legislative and judicial reforms which enabled India to create a robust banking and financial system.

1. Debt Recovery Tribunal

The Debt Recovery Tribunals were constituted under Section 3 of The Recovery of Debts due to Banks and Financial Institutions Act, 1993. Wherever banks and financial institutions are to recover any amount exceeding INR One Million from defaulting borrowers, banks and financial institutions can file an application for recovery before the relevant specially constituted Debt Recovery Tribunal (DRT). This implies that banks and financial institutions are not required to approach either the lower courts or the concerned high court in connection with recovery of outstanding dues from the defaulting borrower. The Debt Recovery Tribunal overall has done a commendable job:

1. Reducing the pressure on the existing infrastructure of courts in India (lower courts as well as high courts);
2. Providing a specially constituted forum to take action for recovery;
3. Reducing the overall time period taken in such litigation in comparison to regular Courts, prior to establishment of DRTs;
4. Procedure and approach has been established, which further helps in speedy disposal of cases.

As of the moment, there are thirty-three Debt Recovery Tribunals and five Debt Recovery Appellate Tribunals in India and in the last two decades, they have done a commendable job in reducing the burden on the courts in the form of banking disputes.

2. The Negotiable Instruments Act, 1881

The Negotiable Instruments Act, 1881 defines the laws relating to promissory notes, bills of exchange, cheques and other negotiable instruments. This Act is one of the most important pieces of legislation connected with banking, trade and commerce and has been amended from time to time to keep pace with the changes in laws and practice of international trade and commerce. One of the important provisions made in 1988 is to introduce the provisions relating to dishonour of cheques and making it a criminal offence in certain circumstances. Chapter XVII of the Act relates to penalties in case of dishonouring of certain cheques for insufficiency of funds in the account.

Although the Courts are flooded with litigation under Section 138 of the Act, still this amendment has checked the menace of bouncing of cheque to a great extent and has proved to be a deterrent for any person issuing a cheque as the bouncing thereof can make the issuer liable for a criminal prosecution. In any country, all such laws, which compel the person residing in the country to honour their commercial commitment is always a welcome piece of legislation as it promotes the creation and establishment of sound economic system. With the advent of electronic banking in the Indian banking regime, a default on the part of person / borrower in meeting its obligation on account of breach in Electronic Service System (ECS) has also been made punishable under an action under Chapter XVII of this Act.

3. The Arbitration and Conciliation Act, 1996

The Arbitration and Conciliation Act, 1996 was passed to consolidate and amend the laws relating to domestic arbitration, international commercial arbitration and enforcement of foreign arbitral awards and also to define the law relating to conciliation and for matters connected therewith or incidental to the adoption of UNCITRAL Model Law on International Commercial Arbitration in 1985.

Arbitration forum provides an alternate forum to the disputing parties and helps to reduce the overall burden on the Indian judiciary. This Act governs and takes care of domestic and international arbitration and is extremely important to the business, industry and government organisations that have trade and financial dealings and transactions. In most of the investment or trade transactions, as a matter of practice, provisions relating to arbitration and conciliation are inserted.

This Act has created a platform, to not only resolve disputes through arbitration process in India, but also accorded recognition and legal sanctity to the foreign arbitration awards, provided such awards meet the requirements prescribed under the Act. Many foreign jurisdictions, such as Singapore, Malaysia, London and Geneva have gained recognition for expeditious resolution of disputes. All said and done, arbitration in India provides an alternate forum in a dispute situation, many times it also provides for speedy and efficacious decisions inter-alia on commercial disputes and on settlements between parties.

4. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (54 of 2002)

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 popularly known as SARFAESI or Securitisation Act is another landmark which has, inter alia, empowered the banks and financial institutions in enforcing securities provided by the borrower or sureties. This Act regulates securitisation and reconstruction of financial assets and enforcement of security interest and matters connected thereto. The Act enables the banks and financial institutions to realise long-term assets, manage problems of liquidity, asset liability mismatch and improve recovery by exercising powers to take possession of securities, sell them and reduce non-performing assets by adopting measures for recovery or reconstruction.

The legislators had got a clear message from the financial industry that for the rapid development of the economy and to create a stable and sound base for banking, judicial reforms are necessary for the speedy disposal of the cases pertaining to banking industry and also to check the growing non-performing assets. This Act has proven to be a landmark enactment, providing and regulating the securitisation and reconstruction of financial assets as well as enforcing the security interest. One important development which made this Act quite effective was the passing of judgement by the Hon’ble Supreme Court of India in the matter of Mardia Chemicals and others Vs. Union of India, popularly known as Mardia Chemicals case, which has indeed put to rest several litigations initiated all over the country, challenging the vires of the Act.

The enforceability of the Act was upheld by the Supreme Court of India. Amongst other things, this Act enables the banks and financial institutions including asset reconstruction companies to take possession of the secured assets and/or control the management of the delinquent borrower without intervention of the court. Of course, the rights of the lenders / security holders are subject to reasonable compliance of the Act, still this Act empowers the lenders and security holders tremendously in recovering the dues from the delinquent borrowers on one hand; while on the other hand, it creates a great deterrence to the borrower in committing a default. Overall this Act is perceived as a very useful enactment, providing teeth to the lending industry against delinquent borrowers.

5. The Foreign Exchange Management Act, 1999

The Foreign Exchange Management Act, 1999 (popularly known as FEMA) was enacted to consolidate and amend the law relating to foreign exchange with the objective of facilitating external trade and payments and for promoting the orderly development and maintenance of foreign exchange market in India.

Many of us still remember the Foreign Exchange Regulation Act, 1973 which was directly coming in the way of the country's progress creating several hurdles in the on-going process of economic liberalisation specially relating to foreign investments and foreign trade. So far as the reforms in financial laws are concerned, FEMA has assumed great significance and generally received well in India as well as abroad. There are several progressive provisions, which have been incorporated. The Reserve Bank of India is empowered to frame regulations on most of the capital account-related transactions, which may have a direct impact on the financial growth and robustness of Indian economy.

In the last one decade, consistent modifications have been made in the regulations to ensure that the pace of growth of Indian economy should not get slowed down. Changes have been made time and again to:

1. The policy of external commercial borrowings, to ensure that more and more sectors can have access to less cost of debt in foreign currency, with the caps prescribed through all in cost ceiling;
2. The policy framework which deals with the aspect of Indian investments in joint-ventures and wholly owned subsidiaries abroad to ensure that the financial and economic needs of Indian corporate houses can be met;
3. Liberalised remittance scheme is introduced and limit prescribed therein has been consistently enhanced and restrictions are removed to ensure that the Indian resident individuals could use the foreign currency for the permitted current and capital account transactions;
4. Liberalisation and ease out the restrictions on imports and exports of goods and services; and
5. Recognition of Limited Liability Partnerships, commonly known as "LLPs", as a vehicle which could receive foreign investments in India.

The violation of the Act imposed severe penalties; however, the draconian provisions of arrest and detention have been done away with. This Act acts like Bible for the external trade and payments. This Act also assumes significance in view of substantial foreign direct investments received by India in the last few years. Although, issue on full convertibility is still lingering, India has opened up substantially in various sectors and hence FEMA 1999 is an achievement as part of the overall reforms in the financial sector.

6. Amendments to Securities Laws and Takeover Code regulations

It needs to be lauded that India has consistently reviewed and modified its securities laws to keep abreast of the latest international policies and practices. Introduction of depository norms, demutualisation of stock exchanges, institution of new takeover code, consistent amendments to regulations governing mutual funds, foreign institutional investors, new regulations to govern and regulate alternative investment funds, SEBI (ICDR) Regulations, corporate governance etc., are some of the major policy initiatives.

7. Factoring Regulation Act, 2011

Introduction of the Factoring Regulation Act, 2011 is another welcome step to boost the financial and economic activities in India. Many of the small and medium enterprise entrepreneurs face difficulties to meet their short term working capital requirements due to liquidity issues and time gap in receipt of realisation of sale proceeds. This Act has actually given a strong boost towards meeting the liquidity crisis and helped the SME players to increase their business.

The foregoing records some of the key changes in some of the major financial and economic laws of India. As reform is a work in progress, though one could argue from both sides about the pace and the manner, such reforms shall require continued updating of laws and policies to support them. Following are some of the major steps which, hopefully, should become further stepping stones in the liberalisation of Indian Economy:

8. The Banking laws Act 2012

This bill is another important step in streamlining the banking policies and activities in India. The Reserve Bank of India had issued a discussion paper to lay down the path for the conversion of banking business of foreign banks operating in India through branch model to wholly owned subsidiary model. The discussion paper laid down the concerns of the Reserve Bank of India and emphasised for conversion of business model based on wholly owned subsidiary model. Some of the major issues, including the following, made it imperative and emphasised the compelling need from RBI’s perspective to get foreign banks to start/continue operations in India under the wholly owned subsidiary model:

i. Bankruptcy remoteness;

ii. Ring-fencing the Indian banking business from risks, which parent company may be subjected to;

iii. Capital adequacy norms; and

iv. Commitment of India to honour its commitments made at the World Trade Organization.

While the discussion paper was a welcome step, however, it did not provide any clarity on certain crucial and compelling operating issues which create obstacles and may deter foreign banks from walking the talk. Following are some of the major issues before foreign banks operating in India:

i. Continuity of contracts entered into by the branches of foreign banks operating in India;

ii. Transfer of business and incidence of stamp duty thereon;

iii. Continuation of existing business and banking products which are offered to clients and impact on their validity and continuity, pursuant to change in structure, for instance, validity of bank guarantee or standby letters of credit;

iv. Issues relating to voting power; and

v. Raising of capital for Indian operations.

The Act is an important step which addresses most of the concerns of foreign banks in India to opt for the wholly owned subsidiary route. Consequent to this Act, relevant modifications are made in the Indian Contract Act, 1872, Indian Stamp Act, 1899, The Reserve Bank of India Act, 1934 and other relevant Acts incorporating necessary modifications.

9. The Companies Bill, 2012

This is another important step to modify the law governing companies in India. This bill has been passed in the last winter session of the Parliament. It proposes significant number of provisions sought to enhance corporate governance practices by companies including provisions pertaining to auditors, independent directors, mandatory valuations, class action suits and corporate social responsibilities.

Other Important Enactments

In addition to some of the important acts and enactments referred to above, there have been many other reforms and initiatives taken by the Government which have proven quite beneficial to the economy as well.

i. The Government of India has also introduced Banking Ombudsman Scheme which, inter alia, supports the checks and balances theory as the aggrieved consumer can approach this forum for redressal of grievances, if any. The Government of India’s initiatives on Corporate Debt Restructuring are also seen as an important reform in the financial sector as this forum provides the means to the stressed companies to restructure their financial liabilities with active participation of the lenders.

ii. All of us are aware about the Satyam Case, where the Government of India played a crucial and significant role by taking pro-active measures in the private sector. The attempts of the Government not only saved Satyam from closing shop but also have proven to be a case history as to how a large company undergoing an acute financial stress owing to default by promoters could be rescued and thereafter well managed by the new set of investors and management.

iii. The Information and Technology Act, 2000 is also playing an important role as it is being applied in various categories of industries which, inter alia is checking financial frauds on one hand while helping financial progress on the other. This Act is heavily supporting the banking financial institutions and related industries.

iv. The recent trend of the judiciary getting involved to check corruption as well as the involvement of Economic Offences Wing of the Police, is assuming importance to check financial frauds by the wrong doers.

To conclude, we may state that, in the last over a decade and a half, several legal reforms have been introduced in the financial sectors which have added tremendous value to financial and economic development. The reforms have also provided a backbone to the progress of overall economy. The reforms have made it possible for India to meet the global challenges. The strong policies of the Reserve Bank of India have assisted the banking industry to stay calm and robust even during the global meltdown and global crises.

We, therefore, can’t ignore the legal reforms in the financial sector. It is critical that the speed of the reforms is not slowed. There should be relentless targeted effort by Government of India to speed up all possible reforms, enact progressive laws and frame regulations to enable India:

1. develop a sound economy;
2. meet the global challenges;
3. develop and maintain an excellent banking system - domestic as well as international;
4. continue to maintain and further develop international trade and payment system; and
5. check frauds and corruptions.

Disclaimer–The views expressed in this article are the personal views of the author and are purely informative in nature.