Holding

The ready‑forward contract is severable; the completed ready leg is valid and the illegal forward leg is ignored, and violation of RBI circulars does not invalidate the contract with third parties.

Summary

The appellant banks entered into ready‑forward (buy‑back) contracts with brokers before June 1992, consisting of a completed ready leg (purchase of securities) and a future forward leg. The Custodian, under the Special Court Act, claimed the contracts were void for violating RBI circulars issued under the Banking Regulation Act and the Securities Contracts (Regulation) Act, and sought the return of the securities. The Supreme Court held that the RBI circulars bind only the banks, not third parties, and that a breach of the circulars does not invalidate contracts with customers. The contract is severable: the performed ready leg is valid, while the illegal forward leg is ignored. Consequently, the transfer of title in the securities under the ready leg remains effective and cannot be set aside. The appeal was allowed, setting aside the Special Court’s order to return the securities.

Issues considered

The effect of RBI circulars issued under the Banking Regulation Act on contracts between banks and third parties.
Whether ready‑forward contracts are severable into a valid ready leg and an illegal forward leg.
The impact of the illegality of the forward leg on the transfer of title effected in the ready leg.
The applicability of the Special Court Act and its provisions to the attachment of securities.

Legislation cited

Banking Regulation Act, 1949s. 21, s. 35A, s. 36(1)(a), s. 36(1)(b)
Indian Contract Act, 1872s. 23, s. 57, s. 58
Sale of Goods Act, 1930s. 19, s. 20, s. 4
Securities Contracts (Regulation) Act, 1956s. 16
Special Court (Trial of Offences Relating to Transactions in Securities) Act, 1992s. 11, s. 13, s. 2, s. 3, s. 4, s. 5
Transfer of Property Act, 1882s. 5, s. 6(1)(h)

Subjects

ready‑forward contractseverabilityillegal contractBanking Regulation ActRBI circularsSpecial Court Actcustodiantransfer of titleex turpi causacontract law

Judgment

B.0.1. FINANCE LIMITED ETC. A
v.
THE CUSTODIAN AND ORS. ETC.

MARCH 19, 1997

[AM. AHMADI, CJ., S.P. BHARUCHA AND B.N. KIRPAL, JJ.] B

Banking Regulation Act 1949, ss. 21, 35-A, 36(1) (a) and (b) r/w
Secwities Contracts (Regulation) Act 1956, s. 16 and Special Court (Trial of
Offences relating to Transactions in Securities) Act 1992, s. ]()--Circulars is-
sued by Reserve Bank of India under Banking Act prohibiting ready-f01ward C
transactions-Special Court holding ready forward contracts entered into by
appellant banks in violation of circulars to be illegal (/Jld ordering retum of
securities to Custodian-Held, non-compliance of circulars did not result in
invalidation of contract by banks with third parties.

Contract Act 1872, ss.23 and 57-Ready-fonvard contracts entered into D
by appellant banks with third parties in violation of Rese1ve Bank of India
circulars-Whether ready leg of transaction severable from the forward
leg-Held, yes; the ready leg having been pe1fonned, the f 01ward leg which
alone was illegal, had to be ignored.
E
Trai1sfer of Property Act 1882, s.5, 6(11) r/w Sale of Goods Act 1930,
ss.4, 19 and 20-Ready-forward contracts entered into by appellant banks with
third parties in violation of Rese1ve Bank of India circular:.-Wliether illegality
of agreement preceding transfer of title in securities could invalidate the
transfe1-Held, no; illegality offonvard leg could not affect transfers that had
already taken place. F

The appellant banks had prior to June 6, 1992, entered into ready-
fonvard contracts with different brokers for the purchase and sale of
certain securities which were not listed on any stock exchange. These
transactions consisted of two inter-connected legs, viz., the first or the G
ready leg, consisting of purchase or sale of certain securities at a specified
price, and the second or fonvard leg, consisting of the sale or purchase of
the same or similar securities at a later date at a price determined on the
first date.

The ready leg of the transactions were completed with the appellants H
51
52 SUPREME COURT REPORTS [1997] 3 S.C.R.

A paying the agreed price and receiving the delivery of securities agreed to
be purchased. Before the forward leg could be completed, a Special Court
(Trial of Offences relating to Transactions in Securities) Ordinance, 1992
was issued on June 6, 1992 which was subsequently replaced by the Act
('Special Court Act'). The Custodian, under the Special Court Act filed
applications before the Special Court to the effect that the ready forward
B
contracts entered into between the banks and the notified persons were in
violation of the Banking Regulation Act, 1949 ('Banking Act') and the
Securities Contracts Regulation Act, 1956 and therefore void. Consequent-
ly those securities which had been sold to the appellants in the ready leg
continued to be, in law, the properties of the notified persons and stood ·
C attached under s. 3 (3) of the Special Courts Act. The Custodian required
the Special Court to direct the appellant banks to return the said
securities.

Allowing the applications of the respondents, the Special Court held

D
that the circulars issued under the Banking Act were binding and the ready
forward contracts being contrary thereto were illegal and void in respect
.~
'

of the third parties. The appellants were directed to return the securities
to the Custodian. ·

In this Court the appellants contended that the violation of the
E circulars issued under the Banking Act did not invalidate the contracts
entered by them with their customers. Further, the forward· leg of the
transaction, which was alone illegal, was severable from the ready leg and
had to be ignored. Even assuming that the transaction was not severable,
the ready leg having been performed, the illegality of the agreements could
not invalidate the transfers that had already taken place.
F
Allowing the appeals, this Court

Held : 1.1. Infringements of the instructions issued by the Reserve
Bank of India under the Banking Regulation Act, 1956 prohibiting the
G banks from entering into buy-back arrangements did not invalidate such
contracts entered into between the banks and it's customers. The instruc-
tions which were issued by the circulars were meant to be complied with
by the banking companies only and did not purport to, nor could they, be
binding on third parties. [87-A-B, 70-A-B]

H 1.2. It would be unjust and inequitable if such transactions entered
"'Y
I

B.O.I. FINANCE LTD. v. CUSTODIAN 53

into by the bank with a customer were to be regarded as void because the A
bank did not follow the directions or instructions of the Reserve Bank of
India. [69-G- HJ

Seth Banarsi Das v. The Cane Commissioner, [1963) SCR Supp. 760,
referred to.
B
Yango Pastoral Company Pvt. Limited v. First Chicago Australia
Limited, (1978) 139 C.L.R. 411, referred to.

2.1. The ready forward contract was severable into two parts, name-
ly, the ready leg and the forward leg. The ready leg of the transaction
having been completed, the forward leg, which alone was illegal, had to C
be ignored. [87-B]

2.2. In the case of a ready-forward contract the stipulation to re-
transfer the securities, on a later date, could only be regarded as condition
precedent and it was only this part or condition which would fail. Thus, the
securities purchased by the appellants from the notified persons could not D
be attached. [76-C-D, 76-G]

Asaram v. Ludheshwar, AIR (1938) Nag 335 and Ram Santp v.
Mussumat Bela, XI Indian Appeals 44 and Sec. v. Drysdale Secwities, 785
F2d 38, referred to.
E
3.1. With the ready leg having been performed the illegality of the
forward leg contained in the agreements could not affect the transfers
which had already taken place. [87 -CJ

3.2. The validity of the transfer of the securities had to depend on the F
provisions of the Transfer of Property Act and the Sale of Goods Act
relating to transfer and not to the validity of the agreement preceding the
transfer. [86-E]

SajanSingh v.SardaraAli, (1960) A.C.167 andSmt. Surasaibalii1iDebi
v. Phanindra Mohan Majmudar, [1965] 1 SCR 860, relied on. G
Alexander v. Rayson, (1936) 1KB169 and Tinsley v. Millingan, (1993)
3 All ER 65, referred to

CIVIL APPELLATE JURISDICTION : Civil Appeal No. 1753 of
1994 Etc. Etc.
H
54 SUPREME COURT REPORTS [1997] 3 S.C.R.

A From the Judgment and Order dated 14.12.93 of the Bombay High
Court in Misc. Application No. 11/93 and 23/93.

T.R. Andhyarujina, Solicitor General of India, Shanti Bhushan, K.
Parasaran, Soli J. Sorabjee, S.K. Cooper, I.M. Chhagla, D.A. Dave, S.K.
Dholakia, A.M. Setalwad, Arnn Jaitley, Ram Jethmalani, P.K. Mullick, V.
B Tulzapurkar, (Anand Bhatt, Sandeep Mittal, R.N. Karanjawala, Ms. Ruby
Ahuja, N. Gore) for Mrs. M. Karanjawala, E.C. Agrawala, Mahesh Ag-
grawala, Atul Sharma, M. Himayatullah, S. Ganesh, S. Sukumaran, T K.
Cooper, U.A. Rana, S. Tripathi, T. Cooper, Neeraj Sharma, Ms. Kiran,
Neena Gupta for Vineet Kumar, D. Khambatta, J.D. Das, Ms. Anjali Seth,
C Ms. Mona Bhide, Dr. A.F. Julian, Arputham Aruna & Co., G .R. Joshi, A.
Subba Rao, P. Parmeshwaran, Sunil Dogra, Monica Sharma, S.S. Shroff,
Mahesh Jethmalani, S.B. Jaisingham, Anand Desai, Ms. Lata Krishnamurti,
Jay Salva, J.K. Das, H.S. Parihar, Subrat Birla, K.S. Parihar, S.K. Mehta,
Dhruv Mehta, Fazlin Anam, Ms. Monica Mehta, K.J. John, P.H. Parekh

D
and Ms. Sunita Sharma for the appearing parties.
'
A
'
'

The Judgment of the Court was delivered by

KIRPAL, J. These appeals, under Section 10 of the Special Court
(Trial of Offences relating to Transactions in Securities) Act, 1992
E (hereinafter referred to as 'The Special Court Act') arises from the judg-
ment of the Special Court at Bombay which decided common questions of
law relating to certain transactions of purchase of securities by the appel-
lant banks from some of the brokers to whom the Special Court's Act, 1992
had been made applicable.

F The appellant banks had prior to 6th June, 1992, entered into con-
tracts with different brokers for the purpose and sale of certain
securities which were not listed on any stock exchange. For the purpose
of this case these contracts have been regarded as ready-forward trans-
actions or buy-back transactions. The parties are agreed, and it is on
G this basis that the High Court also 'proceeded, that the nature of such
a transaction is that it consists of two inter-connected legs, namely, the
first or the ready leg, consisting of purchase or sale of certain securities
at a specified price, and the second or forward leg, consisting of the
sale or purchase of the same or similar securities at a latter date at a
price determined on the first date. Such ready-forward transactions
H have, in most cases, been entered into either by execution of a single
-
,.
B.0.1.FINANCELTD. v. CUSTODIAN[KIRPAL,J.]

document or by execution of two documents contemporaneously, one A
55

representing the first or ready leg and the other the forward or second leg.
On such contracts being entered into the ready leg of the transactions were
completed with the appellants paying the agreed price and receiving the
delivery of the securities which were agreed to be purchased.

Before the forward leg of the transactions could be completed, a B
Special Court (Trial of Offences relating to transactions in securities)
Ordinance 1992 was issued on 6.6.1992 which was subsequently replaced
by the Act.

Special Courts Act, 1992 :
c
. The necessity for issuance of the said Ordinance is contained in the
Statement of objects and reasons which reads as follow :

"In the course of the investigations by the Reserve Bank of
India, large scale irregularities and malpractices were noticed in
transactions in both the Government and other securities, indulged D
in by some brokers in collusion with the employees of various banks
and Financial institutions. The said irregularities and malpractices
led to the diversion of funds from banks and financial institutions
to the individual accounts of certain brokers.

2. To deal with the situation and in particular to ensure the E
speedy recovery of the huge amount involved to punish the guilty
and restore confidence in and maintain the basic integrity and
credibility of the banks and fmancial institutions the Special Court
(Trial of Offences Relating to Transactions in Securities) Or-
dinance, 1992 was promulgated on the 6th June 1992. The Or- F
dinance provides for the establishment of a Special Court with a
sitting Judge of a High Court for speedy trial of offences relating
to transactions in securities and disposal of properties attached.
It also provides for appointment of cine or more Custodians for
attaching the property of the offenders with a view to prevent
diversion of such properties by the offenders." .G

We will now refer to some of the provisions of the said Act which
are relevant for the purpose of this matter.

Section 2 contains defmitions. The term "securities" is defined in
Section 2( c) and is as follows : H
56 SUPREME COURT REPORTS [1997] 3 S.C.R.
-
-
·l>
A "securities includes -

(i) shares, scrips, stocks, bonds, debentures, debenture stock, units
of the Unit Trust of Indin or any other mutual fund or other
marketable securities of a like nature in or of any incorporated

B
company or other body corporate;

(ii) Government Securities; and
JI
(iii) rights or interests in securities."

Section 3 of the said Act relates to appointment and functions of
C Custodian and reads as follows :

"3(1) The Central Government may appoint one or more Cus-
todians as it may deem fit for the purposes of this Act.

(2) The Custodian may, on being satisfied on information
D received that any person has been involved in any offence relating
to transaction in securities after the 1st day of April, 1991 and on
and before the 6th June, 1992 notify the name of such person in
the Official Gazette.

E (3) Notwithstanding anything contained in the Code and any
other law for the time being in force, on and from the date of
notification under sub-section (2), any property, movable or im-
movable, or both belonging to any person notified under that
sub-section shall stand attached simultaneously with the issue of
the notification.
F
(4) the property attached under sub-section (3) shall be dealt
with by the Custodian in such manner as the Special Court may
direct.

. (5) The Custodian, may take assistance of any person which
G
exercising his powers or for discharging his duties under this
section and Section 4."

The Custodian has been given power under Section 4 to order the
cancellation of any contract or agreement entered into between 1.4.1991
H and 6.6.1992 which, in his opinion, has been entered into fraudulently or
B.O.I.FINANCELTD. v. CUSTODIAN(KIRPAL,J.] 57

to defeat the provisions of the Act. On such cancellation being ordered, A
the property stands attached under the Act.

Special Court is established under Section 5 by the Central Govern-
ment issuing the notification to that effect. Section 11 deals with the
discharge of liabilities and reads as follows :
B
"11(1) Notwithstanding anything contained in the Code and any
other law for the time being in force, the Special Court may make
such order as it may deem fit directing the Custodian for the
disposal of the property under attachment.

(2) The following liabilities shall be paid or discharged in full, C
as far as may be, in the order as under :

(a) all revenues, taxes, cesses and rates due from the persons
notified by the Custodian under sub-section (2) of Section 3 to
the Central Government or any State Government or any local D
authority;

(b) all amounts due from the person so notified by the Cus-
todian to any bank or financial institution or mutual fund;

(c) any other liability as may be specified by the Special Court E
from time to time."

Section 13 provides that the provisions of the Act will have an overriding
effect notwithstanding anything inconsistent therewith contained in any
other law for the time being in force or in any instrument having effect by
virtue of any law, other than this Act, or in any decree or order of any F
Court, Tribunal or other authority.

As is evident from the above the intention of framing the aforesaid
Act was to protect the interest of the banks and financial institutions from
irregularities and mal-practices which had been committed by some
brokers in collusion with employees of various banks and financial institu- G
tions. The important feature of the Act was the attachment of the proper-
ties of the offenders with a view to prevent its diversion. The Special Court
is required to pass orders directing the disposal of the properties under
attachment. Sub-section (2) of Section 11 provides for the priorities in
which the liabilities of the notified person are to be discharged from out H
58 SUPREME COURT REPORTS (1997] 3 S.C.R.

A of the attached properties. Considering that the Act has been passed
because of the diversion of funds from the banks and financial institutions
to the individual accounts of certain brokers, the implication of Section
11(2)(b) clearly is that after the discharge of the liabilities under Section
11(2)(a), the amounts which are paid to. the banks would probably be those
funds which were diverted from the banks by reason of mal-practices in
B the security transactions. In other words, the losses caused to the banks
and the financial institutions were to be made from out of the assets of the
notified persons.

At this stage, it will be relevant to see as to what is the position of
C the Custodian.

Section 4 of the Act gives the custodian the power to cancel such
contracts or agreements which have been entered into fraudulently. That
apart, he is merely a custodian of the properties of the notified persons
D which stand attached under the Act and such properties are to be dealt
with by him in such manr ':r as the Special Court may direct.

The Act shows that the Custodian has three main functions to
perform. Firstly; he has the authority to notify a person under Section 3(2)
who has been involved in any offence relating to transactions in securities
E during the period 1.4.1991 to 6.6.1992. Secondly; he has been given the
authority by Section 4 to cancel contracts or agreements relating to the
properties of the notified persons which, in his opinion, have been entered
into fraudulently or for the purpose of defeating the provisions of the Act.
Lastly; he is required to deal with properties in the manner as directed by
F the Special Court. To put it simply the Custodian is required to assist in
the attachment of the notified person property and to manage the same
thereafter. The properties of the notified persons, whether attached or not,
do not at any point of time, vest in him. He is merely a Custodian and his
position is not like that of a Receiver under Civil Procedure Code (Section
94 Order 44) or an official receiver under Provincial Insolvency Act or
G official assignee under the Presidency Insolvency Act. There is no vesting
of the attached properties of the notified persons in the custodian. This is
in contrast with Section 28(2) of the Provincial Insolvency Act and Section
17 of the Presidency Insolvency Act. There is the vesting in the official
receiver or official assignee. He is also not in a position of an official
H liquidator under the Companies Act in whom not only the property vests
B.0.I. FINANCE LTD. v. CUSTODIAN [KIRPAL, J.] 59

but who is also in control thereof. This being so there is considerable force A
in the contention of the counsel for the appellants that, except for power
exercisable under Section 4, the position of the Custodian is the same as
that of the notified person himself.

Pursuant to the promulgation of the Ordinance in 1992, Mr. Justice
Variava of the Bombay High Court has been constituted as a Special Court B
at Bombay. This Court has been hearing several matters brought before it
.. by the Custodian as well as other parties.

INITIATION OF PROCEEDINGS AND DECISION OF THE SPECIAL
COURT
c
The custodian filed applications before the Special Court to the
effect that the above mentioned contracts entered into between the banks
and the notified persons were void. It was contended that such ready-for-
ward transactions were illegal under the provisions of the Banking Regula-
tion Act 1949 and the Securities Regulation Act 1956. It was therefore, D
;
contended that as the contracts were void those securities which had been
sold to the appellants in the ready leg continued to be, in law, the proper-
ties of the notified persons on the date they were so notified and the same
stood attached under Section 3(3) of the Act. The applications required
the Special Court to direct the appellant banks to return the said securities. E
Similar applications were also filed, subsequently, by Sh. Harshad Mehta,
one of the notified parties, with whom such transactions had been entered
into by some other appellant banks.

Resisting the applications the appellant banks had, inter alia, con-
tended that the transactions in question were not illegal and did not F
contravene the provisions of Banking Regulation Act, 1949 and the cir-
culars issued by the Reserve Bank of India thereunder and nor were they
1

contrary to the provisions of the Securities Contract Regulation Act, 1956
and the notification issued under Section 16 thereof. lt was further con-
tended that in any case the contracts in question were severable and the
illegality, if any, was attached only to the second leg and not to the first G
leg. The transfer for title had taken place in favour of the appellant banks
and the securities did not belong to the notified persons and as such they
could not be regarded as being attached under Section 3(3) of the Act. It
was also submitted that, assuming that the entire contract was illegal and
void, neither the Custodian nor the notified parties could ask for the relief H
60 SUPREME COURT REPORTS (1997) 3 S.C.R.

A sought for as both the parties to the contract were in pari delicto. It was
also contended that in the event the court was to order the return of the
securities then the notified parties should be directed to return the con-
sideration received by them.

B The Special Court heard the applications only on that points of law
without going into the facts of any case. The case proceeded on the
assumption that the appellants .had entered into ready-forward transac-
tions. It was accepted by the parties before the Special Court that the
ready-forward transaction (or as sometimes described as a buy-back trans-
action) had four ingredients; (i) there must be a present sale or purchase
C with the commitment to repurchase or resale in future; (ii) the contract
must be between the same parties; (iii) it must be in respect of some kind
of securities and for the same quantum of securities and; (iv) the transac-
tion must be entered into on the same day or contemporaneously and the
price of resale and repurchase would be fixed at the stage of first leg itself.
D
The Special court by a common judgment proceeded to decide the
general questions of law which arose by regarding the transactions in
question to be ready-forward transactions. It took note of the concession
on behalf of the counsel for the Custodian that if a transfer had already
E taken place prior to the date of the notification then the concerned
property could not be properly regarded as belonging to the notified
persons and would not stand attached. It allowed the applications of the
respondents holding that the circulars issued under the Banking Act were
binding and, since the transactions were contrary thereto, the same were
p illegal and void "in respect of the third parties. It rejected the contention
that the contract was severable and that the first leg was not hit by the
illegality. It forth.er came to the conclusion that the contracts were also
illegal under the provisions of the Securities Regulation Act, 1956 and the
notification issued under Section 16 thereof. It also came to the conclusion
that the principles of in 'pari delicto' did not come into play in the present
G case as the Custodian was not making any claim in the applications but was
merely bringing to the attention to the court the fact that third parties were
in possession of properties which stood attached under the provisions of
Act of 1992. The fact that the Custodian had not exercised any power
under Section 4 of the Special Courts Act, in respect of these transactions,
H was also taken note of.
B.0.1.FINANCELTD. v. CUSTODIAN[KIRPAL,J.] 61

Having come to the conclusion that the contracts were void, the A
Court held that the claim of the banks for restitution will have to be dealt
with as an ordinary claim against the property of a notified person at the
stage of distribution under Section 11. It accordingly directed the banks to
return the securities to the Custodian. While giving this direction it further
observed that if these securities had been transferred by the banks to third B
parties then no right could be created in their favour as the banks had no
right to transfer them and, therefore, the banks should purchase the
securities of the same value from the market and deliver the same to the
custodian.

The appellant banks have challenged, in these appeals, the correct- C
ness of the aforesaid decision of the Special Court. The contentions raised
before the Special Court were reiterated by the learned counsels for the
appellant banks while Mr. Atul Setalvad, on behalf of the Custodian and
Mr. Jethmalani on behalf of Harshad Mehta supported the decision of the
Special Court. The Solicitor General, appearing on behalf of Reserve Bank
of India addressed arguments with regard to the effect of the circulars D
issued by the Reserve Bank of India on the contracts in issue.

Having heard very lucid arguments of the learned counsels for the
parties, we now propose to deal with these contentions which are necessary
for deciding these appeals. E
RE : ALLEGED VIOLATION OF THE CIRCULARS ISSUED BY THE
RESERVED BANK OF INDIA

With regard to the finding of the Special Court that the transactions
in question were illegal, as they were in contravention of the circulars which p
were issued by the Reserve Bank of India under the provision of the Act,
it was contended by Mr. Cooper, learned counsel, that the circulars issued
were no more than guidelines which were required to be followed by the
Bank and they were not mandaiory in nature. Elaborating this contention,
Mr. Cooper submitted that the Banking Companies Act contains provisions
which enable the Reserve Bank of India to issue directions which were G
mandatory and also give advice to the banks. Our attention was drawn to
Sections 21 and 35A of the said Act and it was contended that the
directions which are issued by the Reserve Bank of India under these two
provisions are clearly mandatory. On the other hand, Section 36(1)(a) &
(l)(b) gives power to the Reserve Bank of India to give advice or lend H
62 SUPREME COURT REPORTS [1997) 3 S.C.R.

A assistance and any action taken thereunder cannot be regarded as man-
datory. It was submitted that the language of the circulars dated 14.4.1987
and 1.12.1987, which prohibit the banks from entering into buying back

B
arrangements, clearly shows that the said circulars were only in the nature
of advice and must be regarded as having been issued under Section
36(1)(a) and (l)(b) of the Act.

At this juncture, it will be appropriate to refer to the said circulars
I
dated 15.4.1987 and 1.12.1987. The Circular dated 15.4.1987 was marked
"confidential" and was issued to all scheduled commercial banks and dealt
with the question of buy-back arrangements in Government and other
C approved securities entered into by commercial banks. The relevant por-
tion of this circular reads thus :

"Buy-back arrangements in Government and other approved
Securities entered into by commercial banks.

D Please refer to paragraph lO(a) of Governor's letter No.
CPC.BC.84/279A-87 dated 31st March, 1987.

2. It has been observed that banks often enter into buy-back
arrangements in respect of Government and other approved
Securities among themselves and with their large public sector and
corporate clients. The banks are advised to follow the guidelines
given hereunder in respect of their buy-back arrangements with
banks and others. -•
A Prohibition against buy-back arrangements in respect of
Corporate Securities and Bond issued by Public Sector Undertak-
F
ings.

Bank should not enter into buy-back arrangement in respect of
their holdings of public sector bonds or corporate shares and
debentures.
G
B. Buy-back arrangements in Governmen~ and other Approved
Securities with (non-bank) clients.

(i) The buy back deals should be exclusively confined to
Government and other Approved Securities and the re-purchase
H date should be fixed after a minimum period of 30 days from the

I
B.O.I.FINANCELID. v. CUSTODIAN[KIRPAL,J.] 63

date of sale of the securities in question. A
(ii) The purchase/sale prices under the arrangement should be
in alignment with the proximate market rates prevalent on the date
of the original transaction for the relevant Government and other
Approved Securities.
B
(iii) No sales of government and other Approved Securities
under the arrangement should be effected by banks unless the same
are actually held by them on their own investment portfolio either
in the form of actual scrips or in SGL account maintained with
Reserve Bank.
c
(iv) Immediately on sale, the corresponding amount should
invariably be deducted from the investment account of the bank
and its SLR assets for entire period (minimum 30 days) of holding
by the purchaser/counter-party.

(v) Interest on the securities at COl!pon rates would be paid by D
the banks after deduction of tax on the lines indicated in our
circular No. DBOD.BP.BC 88/C.469(81-B)-86 dated 14 August,
1986.

E
4. A copy of this circular may please be placed before the Board
of Directors for their information, under advice to us.

5. Please acknowledge receipt."

(Emphasis added) F
The letter of December 1, 1987 issued by the Reserved Bank of India
was also addressed to all scheduled commercial banks and was as follows :

"Buy-back arrangements in units of Unit Trust of India (UTI).
G
We have received inquiries from banks whether they can enter
into buy-back arrangements in units of UTI under 1964 Scheme.

- We have examined the matter and have to advise that the units are
not approved security for buy-back arrangements in terms of the
instructions contained in our circular DBOD. No. DIR.BC.42/
C.347-87 dated 15th April, 1987. H
64 SUPREME COURT REPORTS [1997] 3 S.C.R.

A 2. Please acknowledge receipt."

(Emphasis added)

Referring to the language used in the said circulars dated 15.4.1987 and
1.12.1987, it was contended by Mr. Cooper that the banks were mainly
B advised to follow the guidelines contained in the said letters and that the
contents thereto were not binding on the banks.

Section 21 of the Banking Companies Act, and sub-section (2) in
particular, entitled the Reserve Bank of India to give directions to the
C banking companies with regard to the matters specified in the said section.
Sub-section (3) provides that every banking company shall be bound to
comply with any directions given to it under the said Section. Section
35A(l) also contains the power of the Reserve Bank of India to give
directions and the same reads as under :

D "35A(l) Where the Reserve Bank is satisfied that -

(a) in the (public interest) or [(aa) in the interest of banking
policy; or]

(b) to prevent the affairs of any banking company being con-
E
ducted in a manner detrimental to the interests of the depositors
or in a manner prejudicial to the interests of the banking company;
or.

(c) to secure the proper management of any banking company
-
F generally;

It is necessary to issue directions to banking companies general-
ly or to any banking company in particular it may, from time to
time, issue such directions as it deems fit, and the banking com-
panies or the banking company, as the case may be, shall be bound
G to comply with such directions."

There can obviously be no doubt, as is evident from the plain reading
of the said provisions, that the directions issued under Sections 21 and 35A
are binding on the banking companies, Section 36(1)(a) and l(b), on which
-
H reliance is placed, reads thus :
B.O.L F1NANCE LTD. v. CUSTODIAN [KIRPAL, J.) 65

"(1) The Reserve Bank may - A
(a) caution or prohibit banking companies generally or any
banking company in particular against entering into any particular
transaction or class of transactions and generally give advice to any
banking company;
B
(b) on a request by the companies concerned and subject to
the provisions of (section 44A) assist as intermediary or otherwise
in proposals for the amalgamation of such banking companies."
(Emphasis added)

Referring to Section 36(1)(a), we find that it empowers the Reserve C
Bank to "caution or prohibit" the banking companies from entering into any
particular type of transaction or generally to give advice to the said banking
companies. This provision not only enables the Reserve Bank to assume an
advisory role but it also gives it the power to prohibit a banking company
against entering into any particular transaction/s or class of transaction. D
The use of words "caution or prohibit" in Section 36(1)(a) clearly implies
that when the Reserve Bank of India prohibits the banking companies from
entering into any particular transaction then such a direction which is
issued would be binding on the banks and has to be complied with. While
the Reserve Bank of India has the power, under Section 36(1)(a) of the E
Act, to give advice or to caution the banking companies which may not be
binding on the banking companies, but when the Reserve Bank prohibits
the banking companies against their entering into any particular transaction
or class of transactions, the said prohibition has to be regarded as being
binding. The power to prohibit, given by Section 36, will be meaningless if
it was not meant to be binding on the banking companies. F

It is no doubt true that the circular dated 15.4.1987 states that the
banks are "advised" to follow the guidelines given thereunder, but para-
graph 2A of the said Circular clearly contains the prohibition relating to
the buy-back arrangements. Similarly, under paragraph 28, which is ap-
plicable in the present case, by use of the words "should be" the circular G
clearly implies that the direction contained thereunder is meant to be
binding. The word "advised" used in paragraph 2 of the first circular
cannot be read in isolation. Reading the said circular, as a whole it can
leave no doubt in any one's mind that what was stated in the said document
was meant to be binding on the banking companies and, was not merely H
-{
66 SUPREME COURT REPORTS [1997) 3 S.C.R.

A an 'advice' or a 'caution' which could be ignored.

It was then submitted that even if it is held that the said circulars
were binding they could only bind the banks and not the third parties. The
submission was that by contravening the direction contained in the said
circulars, the contracts which were entered into between the banks and the
B third parties could not be invalidated and the only result of such contraven-
tion would be the levy of penalty under Section 46 of the said Act.

It is not in dispute that the said circulars which have been issued
were not made public. The said circulars were confidential documents and
C required the banking companies to transact their businesses in a particular
manner namely they should not enter into any buy-back contracts which
were not according to the terms of the circulars. The Act itself does not
provide that, where the directions issued by the confidential circulars are
violated by the bank, the contracts entered into with the third parties would
D in any way be invalidated. The said circulars also, did not say that the
consequence of the directions contained therein not being followed by the
Banking Companies will result in such transaction being regarded as void.
Indeed, no such stipulation could be made which would adversely affect
third parties to whom no directions have been or could be issued and who
were not aware of such directions issued-to .the banks.
E
It will be appropriate at this stage, to consider the decision of this
Court in the case of Seth Banarsi Das v. The Cane Commissioner & Another,
(1963) SCR (Supp.) 760. In that case an agreement was entered into
between the appellant and the cane marketing society for supply of sugar
p cane. The appellant claimed that there was short supply of sugar cane and
the society moved the Cane Commissioner for arbitration. These proceed-
ings were sought to be challenged by the appellant by contending that the
Cane Commissioner had no right to assume the office of arbitrator in this
dispute because no valid agreement had been entered into between the
parties, as contemplated by Section 18(2) of the Uttar Pradesh Sugar
G Factories Control Act, 1938 and in the form XII as prescribed under the
rules made thereunder. It was also contended that there were some blanks
which were left to be filled in the prescribed form and it also did not have
the signature of any representative of the sugar mill. On behalf of the
appellant it was contended in this Court that the provisions of Section 18(2)
H of Uttar Pradesh Sugar Factories Control Act were mandatory and had to
-
B.O.I.F1NANCEL1D. v. CUSTODIAN[KIRPAL,J.] 67

be followed to the letter. Inasmuch as the Act and the Rules prescribed a A
penalty for breach of the said Section, it could not but be regarded as
mandatory in all its parts. Therefore, assuming that the appellant may be
guilty and could be punished but, it was submitted, the mandatory provision
not having been followed no valid contract could come into existence and,
consequently the Cane Commissioner had no jurisdiction to proceed in the B
matter for appointment of an arbitrator. While repelling the contention,
this Court at page 780 observed as follows :

"This rule has been applied in many cases both in India and in
England. In State of U.P. v. Manbodhan Lal Srivastava, this Court
observed that no general rule can be laid down but the object of C
the statute must be looked at and even if the provision be worded
in a mandatory form, if its neglect would work serious general
inconvenience or injustice to persons who have no control over
those entrusted with the duty and at the ·same time would not
promote the main object of the Legislature, it is to be treated only D
as directory and the neglect of it though punishable would not
affect the validity of the acts done. These observations have been
followed in other cases and recently in Bhikraj v. Union of India,
it was observed that where a statute requires that a thing shall be
done in a particular manner or form but does not itself set out the
consequences of non-compliance the question whether the E
prescription of law shall be treated as mandatory or directory could
only be solved by regarding the object, purpose and scope of that
law. If the statute is found to be directory a penalty may be incurred
for non-compliance but the act or thing done is regarded as good.
It is unnecessary to multiply these cases which are based upon the F
statement in Maxwell which is quoted over and over again."

It will also be useful to refer to the decision of the High Court of
Australia in the case of Yango Pastoral Company Pvt. Limited and Others
v. First Chicago Australia Limited and Others, (1978), 139 C.L.R. 411 where
Mason, J. made observations in this regard. That was a case where Section G
8 of the Bdnking Act, 1959 prohibited a body corporate from carrying on
the business of banking without a license. The question arose whether a
mortgage and guarantees given to an unlicensed corporation in the course
of carrying on business were void or unenforceable. The High Court
unanimously held that nothing in the statute made them void and that the H
68 SUPREME COURT REPORTS (1997] 3 S.C.R.

A separate question of illegal performance should be determined by examin- ..
~
'
ing the terms of the statute to determine the impact of illegality on the
enforceability of the contract. At page 428, it was observed as follows :

"The weighing of considerations of public policy in this case and the
decision in favour of enforcing the contract is influenced by the form
B of the particular legislation. In this case the Act, as I have mentioned,
is to a large extent directed to aiding the Government in executing
its fiscal policy rather than regulating the relationship between banker
and customer per se, a feature which lends support for the view that
the provision of a large recurrent penalty for offences against Section
c 8 is Parliament's determination of the consequences of breach of the
section and as the only legal consequences thereof. 17zere is much to
be said for the view that once a statutory penalty has been proi>ided
. '
for an offence the rule of the common law in determining the legal
consequences of commission of the offence is thereby diminished-see
my judgment in Jackson v. Haniso1; (1978) 138 C.L.R. 438, at p.
D
452. See also the suggestions that the principle cannot apply to all
statutory offences (Beresford v. Royal 1hsurance Co. Ltd., in the
C:::ourt of Appeal (1937) 2 K.B. 197, at p. 22, per Lord Wright;
Maries v. Philip Trant & Sons Ltd., (1954) 1 Q.B. 29 at p. 37, per
Denning L.J ., and that it would be a curious thing if the offender is
E to be punished twice, civilly as well as criminally; (St. John Shipping
Corporation v. Joseph Rank Ltd., (1957) 1 Q.B. 267, at p. 292 per
Devlin J.). The main considerations from which the principle ex
turpi causa arose can be seen in the reluctance of the courts to be
instrumental in offering an .inducement to crime or removing a
restraint to crime : Beresford's Case (1938) A.C. at pp. 586, 599;
F
Amicable Society v. Bolland, (1830) 4 Bligh (N.S.) 194 at p. 211.

However, in the present case Parliament has provided a penalty
which is a measure of the deterrent which it intends to operate in
respect of non-compliance with Section 8. In this case it is not for
G the court to hold that further consequences should flow, conse-
quences which in financial terms could well far exceed the
prescribed penalty and could even conceivably lead the plaintiff to
insolvency with resultant loss to innocent lenders or investors. In
saying this I am mindful that there could be a case where the facts
H disclose that the plaintiff stands to gain by enforcement of rights
B.O.I. FINANCE LTD. v. CUSTODIAN [KIRPAL,J.] 69

gained through an illegal activity far more than the prescribed A
penalty. This circumstance might provide a sufficient foundation
for attributing a different intention to the legislature. It may be
that the true basis of the principle is that the court will refuse to
enforce a transaction with a fraudulent or immoral purpose :
Beresford v. Royal Insurance Co. Ltd., (1937) 2 K.B. 197 at p. 220. B
On this basis the common law principle of ~ turpi causa can be
given an operation consistent with, though subordinate to, the
statutory intention, dying relief in those cases where a plaintiff may
otherwise evade the real consequences of a breach of a statutory
prohibition."
c
(Emphasis added)

The aforesaid principles will clearly be applicable in the present case
as well. The non-compliance of the directions issued by the Reserve Bank
may result in prosecution/or levy of penalty under Section 46, but it cannot D
result in invalidation of any contract by the bank with the third party. If
the contention of the Custodian is accepted it will result in invalidation of
agreements by the banks, even where the third parties may not be aware
of the directions which are being violated. To give an example if the
Reserve Bank by confidential circulars fixes the limit in excess of which the
banks cannot give any Joan but, without informing the third party, the bank E
while exceeding it's limit gives a loan which is then utilised by the bank's
customer. It will be inequitable and improper to hold that as the directions
of the Reserve Bank had not been complied with by the bank, the grant of
loan cannot be regarded as valid and, as a consequence thereof, the
customer must return the amount received even though he may have F
utilised the same in his business. Yet another instance may be where the
bank advances loan by charging interest at a rate lower than the minimum
which may have been fixed by the Reserve Bank, in a direction issued under
Section 36(1)(a). As far as the customer is concerned, it may not be aware
of the direction fixing the minimum rate of interest. Can it be said, in such
a case, that the advance of loan itself was illegal or that the bank would be G
entitled to receive the higher rate of interest? In our opinion it will be
wholly unjust and inequitable to hold that such transactions entered into
by the bank with a customer, which transactions are otherwise not invalid,
can be regarded as void because the bank did not follow the directions or
instructions issued by the Reserve Bank of India. H
70 SUPREME COURT REPORTS [1997] 3 S.C.R.

A The instructions which were issued by the said circulars were meant
to be complied with by the banking companies only and did not purport "I
to, nor could they, be binding on the third parties. This being so, even if
the appellant bank has been prohibit--d from entering into the buy-back
arrangements in question, that by itself, would not invalidate the contracts
though the infringement of the said directions may lead to action being
B taken under Section 46 of the Act.

SUBMISSIONS OF THE PARTIES

On 27.6.1969 the Government issued a Notification under Section
C 16(1) of the Securities Contracts (Regulations) Act, 1959 which is as
follows :

"S.O. 2561. In exercise of the powers conferred by sub-section
(1) of Section 16 of the Securities Contracts (Regulation) Act, 1956
(42 of 1956) the Central Government being of opinion that is
D necessary to prevent undesirable speculation in securities in the
whole of India, hereby declares that no person in the territory to
which the said Act extends, shall save with the permission of the
Central Government enter into any contract for the sale or pur-
chase of securities other than such spot delivery contract or con-
tract for cash or hand delivery or special delivery in any securities
E
as is permissible under the said Act and the Rules, bye-laws and
regulations of a recognised stock exchange :

Provided that a contract other than a spot delivery contact or
contract for cash or hand delivery or special delivery in any
F securities on the Cleared Securities List of a recognised stock
exchange may be entered into between its members or through or
with any such member for the purpose of closing out or liquidating
all existing contracts entered into upto the date of this notification
and remaining to be performed after the said date, but such
contract shall be subject to the rules, bye-laws and regulations of
G
the recognised stock exchange that come into force when further
new dealings are prohibited in any securities on the Cleared
Securities List and subject also to such terms and conditions, if
any the Central Government may from time to time impose.

H As a result of the aforesaid Notification, except for sale or purchase of
_J
B.0.1.FINANCELID. v. CUSTODIAN[KIRPAL,J.] 71

securities under a spot delivery contract or contract for cash or hand A
delivery or special delivery, all other contracts were prohibited. As a
consequence thereof entering into a forward transaction became illegal.

Proceeding on the assumption that the aforesaid notification applied
to the securities in question even though they were not listed on the stock
exchange, the counsel for the appellant submitted that each contract B
between the parties, namely, the notified person and the appellant was in
two parts. According to this, the securities were sold by the notified person
to the appellant and market price in respect thereof, was paid. The contract
further stipulate that after a period of 14 days on a fixed day, at a fixed
price the transaction will be reversed i.e. to say the appellant will sell back C
the securities, which had been purchased by it, to the notified person who
would pay the price which was agreed to between the parties. Assuming
the contract as a whole to be illegal, it was submitted that before the
notified date the securities had already been sold by the notified person to
the appellant when the same were delivered to the bank against payment
of money. The bank had, thus, become the owner of the securities and on D
the date the said brokers were notified the said securities did not belong
to the notified person and, therefore, the same could not be attached.

On behalf of the Custodian it was submitted by Mr. A.M. Setalvad
that the said contracts were composite and unseverable, the illegality E
attached to the forward element of the contract rendering the contract
wholly void. While relying upon the Halsbury Law of England IVth Ed.
Vol. 19 paragraph 430 it was contended by Mr. Setalvad that in such a case
there can be no question of severing the illegal part from the legal part.
The court, it was submitted, will not re-write or re-arrange the contract.
Furthermore, even if the part of the compromise could be struck off, the F
court will not do this if to do so would alter entirely the scope and intention
of the agreements.

It is not necessary to refer to other submissions which were advanced
by the counsel for the parties as, in our opinion, the above stated submis- G
sions on behalf of the appellants merit acceptance.

ARE THE READY-FORWARD TRANSACTIONS SEVERABLE :

We will first deal with the submission that the agreements in question
were severable and the illegality attached to the forward leg cannot affect H
72 SUPREME COURT REPORTS [1997] 3 S.C.R.

A the ready leg of the transaction. '
Mr. Chagla, appearing for ANZ Grindlays Bank, while assuming that
the ready-forward transaction was one composite transaction, submitted
that the same was severable into two parts each of which had a separate
consideration and a separate object. He submitted that provisions of
B Section 57 of the Contract Act were applicable to the present case and the
first set of promises or the ready leg would constitute a binding contract
while the second leg, namely, the forward leg would be void. In support of
this contention reliance was placed on a decision of the Full Bench of the
Nagpur High Court in Asaram and Ors. v. Ludheshwar and Ors., AIR
C (1938) Nagpur 335. In that case a joint family was indebted to the defen-
dants. It had pr~paratory share in land to which the provisions of the
Central Provinces Tenancy Act applied. According to Section 49 of the
said Tenancy Act alienation of 'sir' land, that is home farm land in
cultivation, was ineffective unless the sanction of appropriate official had
D first been obtained. Section 49 of the said Tenancy Act postulated that if
a proprietor lost his right to occupy any portion of the sir land as a
proprietor he shall, as from the date of the loss, become an ocwpancy
tenant of such 'sir' land. In order to alienate the interest in the said land
a device was adopted to circumvent the provisions of Section 49 of the said
Act. On 14th April, 1923 two deeds were executed by the father of the
E appellants. By the first deed the proprietory right in the said land was sold
for a sum of about Rs. 7367. On that very date a second document, a deed
of surrender, was executed. In consideration a sum of about Rs. 7367 the
appellants, predecessor in interest relinquished their occupancy rights in
the 'sir' land. The appellants challenged the validity of the aforesaid deeds
F executed by their predecessors in interest and filed a suit for transfer of
the land in question, inter alia, on the ground that the said transactions
were contrary to the provisions of Section 49 of the Tenancy Act and was,
therefore, void. Taking note of the fact that the Act did not prohibit the
transfer of the proprietory interest, because on such transfer the proprietor
becomes an occupancy tenant of the 'sir', the Full Bench considered
G whether, in such a case, Section 24 of the Contract Act became applicable,
while dealing with the case where the contract consisted of legal and illegal
parts Mr. Justice Vivian Bose at page 343 observed as under:

'Therefore if this transaction has consisted of a single considera-
H tion for the two objects contemplated, namely, the sale of the
·Ji
B.O.I.FINANCELTD. v. CUSTODIAN[KIRPAL,J.] 73

proprietary rights (as distinguished from the occupancy rights) A
together with the occupancy right (which we usually somewhat
inaccurately call cultivating rights in these Provinces), then the
whole would have fallen to the ground under this section unless
the transferee had been content to accept the proprietary rights
alone for the entire consideration and forgo the occupancy rights. B
But since the transaction consists of two separate considerations
for two severable objects we are left with a contract consisting of
legal and illegal parts in which the lawful is separable from the
unlawful. In such a case it is always possible to give effect to the
lawful and reject the unlawful; in fact that is what the Courts are
bound to do unless the whole transaction is prohibited by statute C
or unless it involves serious moral turpitude or is otherwise against
public policy. See S. 57 and 58, Contract Act. This rule was applied
and in my opinion rightly, to this very class of cases in 27 N L R
113 at p. 115 and 22 NL R 136 at p. 141. As I have said the whole
transaction in this case is not prohibited by statute; on the contrary D
the part of it relating to the transfer of the proprietary rights is
expressly allowed. Therefore under this rule since the considera-
tions are separable that portion can, in my opinion, be enforced
and it is only the surrender which is of no effect... .. "

-- Section 57 applies to cases where two sets of promises are distinct. E
When the voici part of an agreement can be properly separated from the
rest, the letter does not become invalid. The ready-forward transaction
consists of two r :irts. In the ready leg there is a purchase or sale or
securities at a stat. d price which is executed on payment of consideration
for the spot delive;y of the security certificates together with transfer forms. F
The full and absolute ownership of the title in securities vests in the
purchaser, the entire property in the security passing immediately upon
such delivery and payment. The seller is divested of all rights, title and
interests in the said securities. The forward leg is to be performed at a later
date on the stated price being paid. The securities are to be delivered back
when the title in interest therein would pass to the original seller. It is clear G
that such a ready - forward transaction consists of a set of reciprocal
promises. The first set of promises were fully executed, but the second set
remained executory. Section 57 of the Contract Act would thus be attracted
to the present case, the effect of which would be that the first set of
promises would constitute a binding contract but the second or the forward H
\1"
74 SUPREME COURT REPORTS [1997] 3 S.C.R.

A leg would be void and unforceable. Neither the object nor the considera-
tion of the ready leg is illegal, unlawful or prohibited under Section 23 of
the Contract Act. The forward leg is neither the consideration nor the
object for entering into the ready leg. At best it may be that the forward
leg provided the parties with the motive for entering into the contract but
that would not affect the severability of the forward leg, which alone is
B
declared illegal under the Securities Control Regulation Act.

Mr. Chagla also relied on the decision in SEC v. Drysdale Securities,
785 F 2d 38 : FED SEC L Rep. p. 92, 487 at 92, Col. 2. The US Court of
Appeal had an occasion to deal with such a ready - forward contract. In
C that case a broker entered into sale and re-purchase agreements (more
commonly known there as "Repos"). These agreements were structured as
sales of securities by the broker subject to an agreement to re-purchase
them, from the other party, at a fixed price at a later date. The broker also
entered into reverse sale and purchase agreement ("reverse repos")
D whereby he purchased government securities subject to an agreement to
re-sell them, to the other party at a fixed price at a later date. The 'repos'
and 'reverse repos' were thus description of the same transaction viewed
from different sides. One of the questions which came up for c -,ideration
was whether such a transaction could be regarded as being a funding
agreement or was it in the nature of a loan against collateral security. It
E was held by the US Court of Appeal that there was a significant difference
between repos and standard collaterised loans. It was observed that "in the
latter transaction, the lender holds pledged collateral for security and may
-
not sell it in the absence of a default. In contrast, repo "lenders" take title
to the securities received and can trade, sell or pledge them. The repo
F merely imposes a contractual obligation to deliver identical securities on
the settlement date set by the repo contract and then proceed to hold that
the secured lender in the re po is free to deal the collateral".

In the present case also some of the banks which had purchased the
securities had sold them. There was, at no point of time, any stipulation
G between the parties that the banks could not trade in the securities which
have been purchased by them. The obligation to re-sell the securities to
the notified person, in the forward leg of the agreement, could be fulfilled
by the purchase by the appellants of the securities from the market ancl
then to sell them to the notified persons, in order to complete the forward
H leg. The trading in the securities purchased by the banks in the ready leg
B.O.I. F1NANCE LID. v. CUSTODIAN [KIRPAL, J.] 75

was not in conflict with any law. The appellants were free to deal with them. A
This would show that with the first or the forward leg of the transaction
being completed the banks had become the absolute owners of the said
securities and they could deal with them in any manner in which they liked.
There was nothing in the terms of ready-forward transaction which
prohibited the bank, if they had sold the securities, from purchasing the B
securities of the same value from the market and selling the same to the
broker in order to complete the second or the forward leg of the transac-
tion. This will itself show that the two legs of the transaction are severable.

It was contended by Mr. Setalvad that being a composite contract
there can be no severance of the same. But the question of severance will C
arise only in the case of a composite agreement consisting of reciprocal
a
promises. It is only in such case that the court has to see whether the
contract is suc;h that the illegal or void part of the transaction can be
severed. This is clearly evident from the decision in the case of Ram Samp
v. Mussumat Bela and Ors., (Vol. XI Indian Appeals 44). There the Privy D
Council dealt with a case where a person - Hearsey - had gifted certain
property owned by him to his second wife, generally c, 'l"d Vilayati Begum,
and her three children on the condition of the wift. "'heyjo~ her husband
and the children remaining faithful to their religion. There were decrees
obtained by the predecessor in interest of the appellant against the said
Hearsey. In execution thereof the transfer of the aforesaid property by E
Hearsey was inter alia challenged by suits being instituted by the decree
holder challenging the gift by Hearsey on the ground that the said trans-
action was invalidated by the immorality of the consideration. If the trans-
action was invalidated then the property would have continued to belong
to Hearsey and would have been available in order to satisfy the decree p
against him. It was contended before the Privy Council that by reason of
Hearsey's descent and religion the case was to be governed by rules of
English law and that the Begum could not be lawful wife; that the stipula-
tion as to her continuing to act as his wife was immoral; though she was
under the Mohammedan law, which allowed sexual relations forbidden to
Christians; and that the gift was so thoroughly vitiated as to leave Hearsey, G
the grantor, still the owner of the property in such a sense that the plaintiff
could treat it as his right, title and interest liable to be sold under an
attachment. While upholding the decision of the courts below in treating
the gift to the Begum as resting on the valid and moral consideration, it
was observed by the Privy Council as follows : H
76 SUPREME COURT REPORTS [1997] 3 S.C.R.

A "Their Lordships are of opinion that the gift is in fact uncon-
ditional, because, as it was complete at the time when the actual
transfer took place the parties could not afterwards import a
condition; and the petition must be treated as inefficacious for that
purpose. But even if it were otlwwise - assuming a condition, and
B an immoral condition - it would be the condition that is immoral
and not the consideration; and then the case would fall under the
general rule of law that a gift to which an immoral condition is
attached remains a good gift, while the condition is void."

(Emphasis added)
c
In the case of a ready-forward contract the stipulation to re-transfer the
securities, on a later date, can only be regarded as condition precedent and
it is only this part or condition which will fail.

D It is not possible to accept the contention of Mr. Setalvad that
severing the agreements into two parts would amount to re-writing or
re-arranging the contract. We are here dealing with a case where there was
one ai;:-;:ement, but which envisaged two sale transactions. Execution of
each transaction envisaged the transfer of title in the securities. The valid
part (the ready leg) of the transaction has been completed while the invalid
E part (forward leg) has to be ignored.

What the notification issued under Section 16 did was to prohibit the
entering into of a forward contract, i.e., sale at a future date for a fixed
price. It expressly permitted sale of securities by spot delivery which, in the
F present case, is represented by the ready leg. It is only the future sale or
the re-sale of the securities at a later date which the notification did not
permit. This latter part of the agreement could not have been entered into
and is clearly severable and cannot affect the transfer of the title which had
already taken place at the time of the execution of the ready leg. This being
G so the securities which had been purchased by the appellants from the
notified persons could not be attached.

POSITION IN LAW IF THE TRANSACTIONS ARE NOT SEVERABLE:

Even if it be assumed that the agreements were not severable, and
H they were composite agreements even then the ready leg having been
B.O.I. FINANCE LTD. v. CUSTODIAN [KIRP AL, J. J 77

performed, the position in law is that the illegality of the agreements cannot A
affect the transfers which had already taken place.

Reference may fust be made to the decision of the Privy Council in
Sajan Singh v. Sardara Al~ (1960) A.C. 167. In that case the regnlations
which had been framed provided that no person could use or sell a motor B
vehicle for the carriage of goods without a haulage permit. Six motor
vehicles were pur~hased by the appellant. The respondent paid a part of
the consideration towards the cost on the understanding that one of the
vehicles, a dodge motor lorry, would become his property. The appellant
executed a document of sale stating that he had sold the motor lorry jointly
to the respondent and his friend, whose share the respondent subsequently C
purchased. Although the lorry was owned and operated by the respondent
for the carriage of goods on his own account, the appellant registered the
lorry in his own name and obtained a haulage permit which authorised its
use by himself and his employees. The policy of the authority at that time
was to restrict the issue of permits to persons who had them before the D
war. The respondent did not fall within that category, whereas the appel-
lant did and that is why the permit was in the name of appellant but the
lorry was paid for and operated by the respondent. In 1955, the appellant
removed the lorry from the respondent's possession without his consent
and refused to return it. A suit was filed by the respondent/plaintiff against
the appellant/defendant for the return of the lorry or its value. While E
upholding the decision in favour of the respondent, the Privy Council
observed as follows :

nAlthough the transaction between the plaintiff and the defen-

dant was illegal, nevertheless it was fully executed and carried out: p
and on that account it was effective to pass the property in the
lorry to the plaintiff. There are many cases which show that when
two persons agree together in a conspiracy to effect a fraudulent
or illegal purpose-and one of them transfers property to the other
in pursuance to the conspiracy-then, so soon as the contract is
executed and the fraudulent or illegal purpose is achieved, the G
property (be it absolute or special) which has been transferred by
the one to the other remains vested in the transferee, notwithstand-
ing its illegal origin: see Scarfe V. Morgan per Parke B. The reason
is because the transferor, having fully achieved his unworthy end,
cannot be allowed to turn round and repudiate the means by which H
78 SUPREME COURT REPORTS [1997) 3 S.C.R.

A he did it-he cannot throw over the transfer. And the transferee,
having obtained the property, can assert his title to it against all
the world, not because he has any merit of his own, but because
there is no one who can assert a better title to it. The court does
not confiscate the property because of the illegality-it has no po_wer
to do so-so it says, in the words of Lord Eldon : "Let the "estate
B
lie where it falls", see Muckleston v. Brown. This principle was
applied by the Court of Appeal recently in Bowmakers Ltd. v.
Bamet Instrnments Ltd. The parties to the fraud are, of course,
liable to be punished for the part they played in the illegal trans-
action, but nevertheless the property passes to the transferee."
c
In conclusion it was observed that if the law were not to allow the
plaintiff to recover in this case, then it would leave the defendant in
possession of both the lorry and the money he had received for it. This, it
was observed, was not the law.

D
It was submitted by Mr. Shanti Bhushan that even though the con-
tract may have been illegal, the transaction of sale was independent of that
and did not, in any way, affect the transfer of title in the securities. In
support of this submission, reliance was placed on the following observa-
tions in Alexander v. Rayso11, (1936) 1 KB 169 where at page 185 it was
E observed as follows :

"The distii~Ction between an action brought to enforce an unlawful
agreement and one brought to assert a right of property already
acquired under such an agreement is further illustrated by Taylor
F v. Chester, (4). The defendant in that case was the keeper of a
brothel and as such had supplied wine and supper to the plaintiff
"for the purpose of being consumed their by the plaintiff and divers
prostitutes in a debauch there, to incite them to ritous, disorderly,
and immoral conduct." When the debauch was over there followed
in due course the reckoning. Being unable or unwilling to pay it
G at once, the plaintiff deposited with the defendant the half of a
501, note as security. He subsequently repented of this action, and
instituted proceedings against the defendant for the purpose of
obtaining the return of the half bank note. It was held that he was
not entitled to recover. The property of the half note had passed to
H the defendant, and in spite of the illegality of the agreement under
B.O.I.FINANCELTD. v. CUSTODIAN[KIRPAL,J.] 79

which it had passed, the defendant was entitled to keep it. As was A
said by the KB in Sca1fe v. Morgan, (5) in a passage quoted by
Hannen J. in the course of the argument: "if the (illegal) contract
is executed, and a property either special or general has passed
thereby, the property must remain." The plaintiff, on the other
hand, could not maintain his action without asserting and relying B
upon the unlawful agreement. He could not, to use the language
of Mellor J. in delivering the judgment of the Court, recover
without showing the true character of the deposit; and that being
upon an illegal consideration, to which he himself was a party, he
was precluded from obtaining "the assistance of the law" to recover
it back." C

(Emphasis added)

It would follow that if pursuant to an agreement to do an illegal act
a transaction, in part, takes place which would otherwise be valid if there D
was no such prior agreement, then notwithstanding the illegality of the
contract the said completed transaction itself cannot be regarded as in-
valid.

Tinsley v. Millingan, (1993) 3 All ER 65 was a case where the parties,
who were living together, jointly purchased a house which was registered E ·
in the name of the appellant as the sole legal owner. Both the parties
accepted that the house was jointly owned but it was registered in sole
name of Tinsley so as to enable Millingan, with a knowledge and assent of
Tinsley, to make false claims to the Department of Social Security for, some
benefits. The money so obtained from the Department was shared between F
them. Subsequently, the parties quarreled and Tinsley moved out of the
house which continued to be in occupation of Millingan. Tinsley brought
an action claiming possession of the house and asserting ownership of it.
Millingan counter-claimed for an order for sale and a declaration that the
house was held by Tinsley on trust for the parties ,in equal shares. Tinsley
contended, in regard to the counter claim that applying the common law G
maxim ex turpi ca.usa non oritur actio, Millingan was barred from denying
......._ Tinsley's ownership because the purpose of the arrangement, whereby the
house had been registered in the sole name of Tinsley was, to facilitate the
fraud on the Department of Social. Security and therefore, Millingan's
claim to joint ownership was tainted by illegality. It was also contended that H
80 SUPREME COURT REPORTS [1997] 3 S.C.R.

A applying the equitable principle that he who came to equity had to come
with clean hands, the court ought to leave the estate to lie where it fell
since the property been conveyed into the name of one party for a
fraudulent purpose which had then been carried out and in those cir-
cumstances the court ought not to enforce a trust in favour of the other
B party. Tinsley's claim was dismissed by the trial judge, who upheld the
counter-claim of Millingan. The appeal filed by the appellant was dismissed
by the Court of Appeal. The House of Lords (Lord Keith and Lord Goff
dissenting) upheld the decision of the Court of Appeal. Lord Jauncey in
his speech, observed at page 82 that :

c "At the outset it seems to me to be important to distinguish
between the enforcement of executory provisions arising under an
illegal contract or other transaction and the enforcement of right
already acquired under the completed provisions of such a contract
or transaction. Your Lordships were referred to a very consider-
able number of authorities, both ancient and modern, from which
D certain propositions may be derived.

First : it is trite law that the court will not give its assistance to the
enforcement of executory provisions of an unlawful contract
whether the illegality is apparent ex f acie the document or whether
E the illegality of purpose of what would otherwise be a lawful
contract emerges during the course of the trial (See Holman v.
Johnson, (1775) 1Cowp341 at 343, (1775-1802) All ER Rep 98 at
. 99 per Lord Mansfield CJ., Pearce v. Brooks, {1866) LR 1 Exch 213
at 217-218 (1861-73) Allo ER Rep 102 at 103 per Pollock CB,
F Alexander v. Rayson, (1936) 1 KB 169 at 182 (1935) All ER Rep
185 at 191 and Bownkmakers Ltd. v. Bamet Instruments Ltd., (1944)
2 All ER 579 at 582 (1945) KB 65 at 70.

Second : it is well established that a party is not entitled to rely on
his own fraud or illegality in order to assist a claim or rebut a
...
G presumption. Thus when money or property has been transferred
by a man to his wife or children for the purpose of defrauding
creditors and the transferee resists his claim for recovery he cannot
be heard to rely on his illegal purpose in order to rebut the
presumption of advancement (see Gascoigne v. Gascoine, ( 1981)
H 1 KB 223 at 226. Chettiar v. Chettiar, (1962) 1 All ER 494 at 498
B.0.I. FINANCE LTD. v. CUSTODIAN [KIRPAL, J.] 81

(1962) AC 294 at 302 and Tinker v. Tinker; (1970) 1 All ER 540 at A
543, (1970) p. 136 at 143 per Salmon Ll).

Third : it has, however, for some years been recognised that a
completely executed transfer of property or of an interest in
property made in pursuance of an unlawful agreement is valid and
the court will assist the transferee in the protection of his interest B
provided that he does not require to found on the unlawful agree-
ment (seeAyerst v. Jenkins, (1873) LR 16 Eq 275 at 283,Alexander
v. Rayson, (1936) 1 KB 169 at 184-185, (1935) All ER Rep 185 at
191, Bowmakers Ltd. v. Barnet Instruments Ltd., (1944) 2 All ER
579 : (1945) KB 65, Sajan Singh v. Sardara Ali, (1960) 1 All ER C
269 at 272-273, (1960) AC 167 at 176. To the extent, at least, of
his third proposition it would appear that there has been some
modification over the years of Lord Eldon LC's principles".

By posing the question whether the respondent in claiming the
existence of a resultant trust in her favour was seeking to enforce unper- D
formed provisions of an unlawful transaction or whether she was simply
relying on an equitable proprietary interest that she had already acquired
under such transaction, Lord Janney at page 83 observed as follows :

"I find this a very narrow question but I have come to the E

- conclusion that the transaction whereby the claimed resulting trust.
in favour of the respondent was created was the agreement be-
tween the parties that, although funds were to be provided by both
of them. nevertheless the title to the house was to be in the sole
name of the appellant for the unlawful purpose of defrauding the
Department of Social Security. So long as that agreement remained F
unperformed neither party could have enforced it against the
other. However, as soon as the agreement was implemented by the
sale to the appellant alone she became trustee for the respondent
who can now rely on the equitable proprietary interest which has
thereby been presumed to have been created in her favour and has G
no need to rely on the illegal transaction which led to its creation."

Speaking for the majority, Lord Browne Wilkinson first observed at
page 85 as follows :

"Neither at law nor in equity will the court enforce an illegal H
82 SUPREME COURT REPORTS [1997] 3 S.C.R.

A contract which has been partially, but not fully, performed, How-
ever, it does not follow that all acts done under a partially per-
formed contract are of no effect. In pa11icular it is now clearly
established that at law (as opposed to in equity) property in goods
or land can pass under, or pursuant to, such a contract. If so, the
rights of the owner of the legal title thereby acquired will be
B enforced, provided that the plaintiff can establish such title without
pleading or leading evidence of the illegality. It is said that the
property lies where it falls, even though legal title to the property
was acquired as a result of the property passing under the illegal
contract itself."
c
(Emphasis added)

Lord Browne Wilkinson then considered the decisions in the cases
of Bowmakers Ltd. v. Bamet Instnunents Ltd., (1944) 2 All ER 579. Feret
v. Hill, (1854) 15 CB 207 (1843-60) All ER Rep 924; Taylor v. Chester, \
D (1869) LR 4 QB 309 (1861-73) All ER Rep 154; Alexander v. Rayson,
(1936) 1 KB 169 and observed at page 86 that : .

"From these authorities the following propositions emerge.

(1) Property in chattels and land can pass under a contract which
E is illegal and therefore would have been unenforceable as a
contract.

(2) A plaintiff can at law enforce property rights so acquired
provided that he does not need to rely dn the illegal contract for
any purpose other than providing the basis of his claim to a
F
property rights.

(3) It is irrelevant that the illegality of the underlying agreement
was either pleaded or emerged in evidence : if the plaintiff has
acquired legal title under the illegal contract that is enough."
G
Even in the minority judgment of lord Goff the passage from the
speech of Lord Denning in Sajan Singh case (supra), quoted earlier, was
noted with approval and at page 72, it was observed :

"Even so, the mere fact that a transaction is illegal does not
H have the effect of preventing property, whether general or special,
B.O.I.FINANCELTD. v. CUSTODIAN[KIRPAL,J.] 83

from passing under it. In Scmfe v. Morgan, (1838) 4 M & W 270 A
at 281, 150 ER 1430 at 1434 Parke B said that 'if the (illegal)
contract is executed, and a property either special or general has
passed thereby, the property must remain .. .' This principle has
been applied on numerous occasions. Notable examples are to be
found in Taylor v. Cheste1; (1869) LR 4 QB 309 - ((1861-73) All B
ER Rep 154; Alexander v. Rayson, (1936) KB 169 - (1935) All ER
Rep 185 and Sajan Singh v. Sardara Ali, (1960) 1 ALL ER 269 -
(1960) AC 167."

It was submitted by Mr. Setalvad that the principle of law enunciated
in the aforesaid decisions in England is restficted in its application to cases C
where the illegal contract has been performed and does not apply to an
illegal contract which has been P.erformed only in part. He contended that
inasmuch as the ready-forward contract had only been performed in part,
namely, as securities had been transferred under the first leg but the second
leg was still to be performed, the principle laid down in the English cases
would have no application. This contention of Mr. Setalvad cannot be D
accepted because the ratio of the said decisions is applicable even where
an illegal contract is partially performed as would be evident from the
following observation of Lord Browne Wilkinson :

"Neither at law nor in equity will the Court enforce an illegal E
contract, which has been partially but not fully performed. How-
ever, it does not follow that all acts done under a partially pe1fo1med
contract are of no effect. In particular, it is now clearly established
that at law (as opposed to equity) property, goods or land can pass
under or pursuant to such a contract". (Emphasis added)
F
It was contended by the learned counsel for the respondent, and Mr.
J ethmalani in particular, that the decisions of the courts in England should
not be applied in India. Where the validity of the contract has to be judged
according to the statutory law applicable in this country. It was submitted
that under the Indian Contract Act the entire contract was void. The G
original contract could not be legally entered into and the title in the
securities did not, in law, pass to the appellants.

While there can be no dispute that the transactions in question have
to be viewed in the context of the law in this country but the decisions of
the courts in England, based on common law principles, have been applied H
84 SUPREME COURT REPORTS [1997] 3 S.C.R.

A and followed by the courts in India. This will be evident from fact that the
decision in Sajan Singh case, which was approved by the House of Lords
in Millingan case, has been followed by this Court in Smt. Surasaibalini
.,
Debi v. Phanindra Mohan Majmudar, [1965) 1 SCR 860.

B In Surasaibalini case the respondent (hereinafter referred to as the (
plaintiff) was employed at Calcutta in the Court of Wards an the service
rules did not permit him to start or carry on any trade or business of his
own. It was, therefore, arranged with one Rabinder Mohan Gupta
(hereinafter referred to as the defendant), who was the predecessor in
interest of the appellant, that the defendant should be held out to be the
C owner of the suit property, which was a Boarding House, of which the
plaintiff was a true owner and the plaintiff was put in its possession as
Manager. The plaintiff had to leave Calcutta on medical advice and he put
the defendant in possession on the understanding that when the plaintiff
returns the defendant would hand over the possession. When the plaintiff
D returned to Calcutta and asked the defendant to hand over possession, he
refused to do so. Thereupon, the plaintiff filed a suit in the Calcutta High
Court for a declaration that he was the sole proprietor of the Boarding
House, and also for the delivery of possession of the same.

The suit was decreed by the trial court, which decision was upheld
E in appeal. Before this Court it was contended by the defendant's successor
in interest, namely, the appellant, that the suit should have been dismissed
because the plaintiff admitted in his evidence that he had escaped payment
of income tax by submitting a separate return for the salary earned by him
in service, and by showing that the business income from the suit property
F belonged to the defendant and, therefore, the court should not coun-'- _
tenance his claim and assist him in attaining possession of the suit property
because that transaction had been entered into with a view to circumvent
or defeat the provisions of the Income Tax Act. The plaintiff, while denying
that the transaction was illegal, in the alternative, placed reliance on the
aforesaid decision of the Privy Council in Sajan Singh case and contended
G that he had equitable interest in the property and that the possession of
the property should be restored to him. Gajendragadkar, C.J. and Shah, J.
referred to the decision in Sajan Singh case but, while dismissing the
appeal, held that the transaction of running the Boarding House was not
entered into with a view to circumvent or defeat the provisions of the
H Income Tax and was, therefore, not illegal. Rajagopala Ayyangar, J. by a
B.0.1. FINANCE LTD. v. CUSTODIAN [KIRPAL, J.] 85

separate judgment, agreement that the appeal should be dismissed but he A
held that from the evidence on record it was clear that the object of the
agreement, entered into by the plaintiff, was to defeat the provisions of the
Income Tax Act and was not lawful. The learned judge, however, applied
the ratio of the decision in Sajan Singh case and held that the plaintiffs
claim to possession was independent and wholly disassociated from the· B
illegal transaction and, for this reason, the appeal should be dismissed.
While coming to this conclusion Iyyangar, J. extracted the above quoted
passage from the speech of Lord Denning in Sajan Singh case and then
observed as follows :

"It would thus be seen that besides the claim based on his title to C
the lorry, the plaintiff had also established that while the chattel
was in his possession, the defendant had unlawfully taken it away,
with his consent. Insofar as his claim was based on this deprivation
of possession, it was really an independent cause of action wholly
separated from the original purchase of the lorry which was to D
circumvent the law, and as to this claim in detinue there was no
question of its being tainted with any illegality.

Besides this, Lord Denning himself pointed out that there were
many cases which showed that where a transfer of property was
effected in order to achieve an illegal purpose and that purpose E
was achieved, the plaintiff was disabled from recovering the
property for the reason that the Court will not assist him in that
endeavour.

It was rightly submitted by Mr. Shanti Bhushan that the aforesaid F
principles, now well settled with the decisions of the House of Lords in
Tinsley's case (supra), would be applicable in India as \veil. This is not a
case where the appellant is seeking to enforce an illegal contract. On the
other hand, it is the Custodian who referring to the illegality of the contract
with a view to recover posses:;ion of the securities, the title of which already
stands transferred in favour of the appellant. G

In the present case the appellants are basing their claim by relying
not on the terms of the ready,forward contract, but on the payment of
market price against delivery of the securities. The claim to title is inde-
pendent of the ready-forward agreement. H
86 SUPREME COURT REPORTS [1997) 3 S.C.R.

A There can be little doubt that the appellants, when they paid the
market price and took delivery of the securities, had become owners of the
same. According to Section 5 of the Transfer of Property Act, 1882,
'transfer of property' inter alia means as act by which a person conveys
property to another person. Section 6 of this Act deals with what property
may be transferred. What is relevant in Section 6(h) according to which no
(
B transfer can be made; (1) insofar is it is opposed to the nature of the
interest affected thereby, or (2) for an unlawful object, or consideration
within the meaning or Section 23 of the Indian Contract Act or (3) to a
-
person legally disqualified to be transferee. According to Section 23 of the
Contract Act the consideration or object of an agreement will be unlawful
C if it is forbidden by law; or is for such a nature that, if permitted, it would
defeat the provisions of any law; or is fraudulent; or involves or implies
injury to the person or property of another : or the court regards it as
immoral or opposed to public policy. In the instant case the object of the
contracts entered in between the banks are the notified parties was for the
transfer and, subsequently, re-transfer of the securities. The transfer took
D place on delivery of securities on payment of market price as consideration.
The consideration for the transfer of the securities, in the ready leg, was
the payment of market price.

The validity of the transfer of the securities has to depend on the
provisions of the Transfer of Property Act and the Sale of Goods Act
E relating to transfer and not to the validity of the agreement preceding the_
transfer. Like any other movable goods the securities could validly be
purchased on delivery against payment of price as per Sections 4, 19 and
20 of the Sale of Good Act. The price paid, while taking delivery, was the
consideration for the transfer of the securities. When the transfer of title
has taken place the agreement between the parties preceding this cannot
F invalidate the transfer. The ratio of the decisions in Sajan Singh v. Sardara
Ali and Tinsley v. Millingan and the observations of Rajgopal Ayyanger, J.
in Surasaibalini Debi v. P.M. Majmudar (supra) are clearly applicable in
the present case.

G Inasmuch as, the aforesaid reasons are sufficient for the appeals to
be allowed, we do not propose to deal with the other contentions which
had been raised on behalf of the appellants.

CONCLUSIONS :

H The following conclusions flow from the aforesaid discussion :
B.O.I. FINANCE LTD. v. CUSTODIAN [KIRPAL, J.] 87

(A) Infringements of the instructions issued by the Reserve Bank of A
India under the Banking Regulations Act prohibiting the banks from
entering into buy-back arrangements do not invalidate such contracts
entered into between the banks and it's customer's.

(B) The ready forward contract is severable into two parts, namely,
the ready leg and the forward leg. The ready leg of the transaction having B
been completed, the forward leg, which alone is illegal, has tci be ignored.

(C) With the ready leg having been performed the illegality of the
forward leg contained in the agreements cannot affect the transfers which
had already taken place.
c
The appeals are accordingly allowed. Judgment dated 14th Decem-
ber, 1993 of the Special Court is set aside, the effect of which would be
that the applications filed by the Custodian and the notified persons for
the return of the securities stand dismissed. There will be no order as to
costs.
D
S.M Appeals allowed.