BANKING

&
INSURANCE LAW

- Khyati Nayak
 CONTENT OUTLINE:
5. Legal Aspects of Banking Operations
Obligations of a Banker - Precautions and Rights.
Mode of charging securities
Banker’s Lien, Bank Guarantee, Letter of Credit and Letter of Understanding.
Section 171, 174 and 126 of the Indian Contract Act.
Case: City Union Bank v C. Thangarajan, Stephen v. Chandra Mohan

Reference Reading :
∙ Understanding with the help of various cases and agreements
∙ Escrow Agreement,
∙ Bank Guarantee Agreement
∙ Cases :
∙ a. IL&FS
∙ b. PMC Bank case
∙ c. ICICI RPT case
∙ d. PNB Fraud case
∙ e. DHFL Fraud case
 BANK & BANKING OPERATIONS
According section-5(B) of Banking Regulation Act banking has been defined as :

“Accepting for the purpose of lending and investment of deposits of money from the public, repayable on
demand order or otherwise and with drawable by cheque, draft order or otherwise”.
Definition of Customer According to Sir John Paget’s view “To constitute a customer there must be some
recognizable course or habit of dealing in the nature of regular banking business”.
 Banks maintain operating accounts like Savings Bank, Current, Overdraft and Cash Credit accounts which are
operated by the cheques drawn by the account holders on their bankers.

 While handling these cheques, a banker may act as a paying banker (when cheques are drawn on him) or collecting
banker (when cheques are deposited with him).

 Banks are under statutory obligation to honour a cheque and make payment if it is in order as per relevant laws. As a
collecting banker, he should collect the cheques only for his customer and as per the provisions of the legal frame work the

Negotiable Instruments Act,1881.

 BANKER CUSTOMER RELATIONSHIP
⮚Relationship as Debtor and Creditor
⮚Relationship as Trustee and Beneficiary
⮚Relationship as principal and Agent
⮚Relationship as Lesser and Lessee
⮚Relationship as Pledger and Pledgee
⮚Relationship as Bailor and Bailee
⮚Relationship as Advisor and Client
⮚Relationship as Mortgagor and Mortgagee
⮚Relationship as Indemnity holder and Indemnifier
⮚Relationship as Hypothecator and Hypothecatee
 RBI Circular
Accordingly, in exercise of the powers conferred by Section 35A and Sections 45ZC to 45ZF of the Banking Regulation Act, 1949, read with Section 56 of the Act and
all other provisions of this Act or any other law enabling the Reserve Bank in this regard, the Reserve Bank being satisfied that it is necessary and expedient in public
interest to do so, hereby issues the detailed revised instructions on the above subject.

The Reserve Bank of India (RBI) prepared detailed instructions for the banks in regard to the safe deposit locker/safe custody article facility vide Circular No.
DOR.LEG.REC/40/09.07.005/2021-22 dated August 18, 2021 which came into effect from 01.01.2022. The circular under paragraph 7.2 states as follows:

“Liability of banks arising from events like fire, theft, burglary, dacoity, robbery, building collapse or in case of fraud committed by the
employees of the bank.
• It is the responsibility of banks to take all steps for the safety and security of the premises in which the safe deposit vaults are housed.

• It has the responsibility to ensure that incidents like fire, theft/ burglary/ robbery, dacoity, building collapse do not occur in the bank’s
premises due to its own shortcomings, negligence and by any act of omission/commission.

• As banks cannot claim that they bear no liability towards their customers for loss of contents of the locker, in instances where loss of
contents of locker are due to incidents mentioned above or attributable to fraud committed by its employee(s), the banks’ liability shall
be for an amount equivalent to one hundred times the prevailing annual rent of the safe deposit locker.”
 In the case of Amitabha Dasgupta vs. United Bank of India & Ors., the Supreme Court (SC) held that breaking open the locker in a manner other than that

prescribed under law is an illegal act which amounts to gross deficiency of service on the part of the bank as a service provider.

 The bank is liable for any loss or damage to the contents of the lockers caused by its carelessness, and it will exercise reasonable diligence in maintaining and

running its locker or safety deposit systems.

 In case of incidents such as fire, theft/ burglary/ robbery, dacoity, building collapse the banks’ are liable to pay for an amount equivalent to one

hundred times the prevailing annual rent of the safe deposit locker. If your locker rent is Rs 2000, bank will pay Rs 200,000, irrespective of the amount kept in

the locker.

 According to the SBI website, “Branches shall bear responsibility to ensure that incidents like fire, theft/ burglary/ robbery, dacoity, building collapse do not occur

in the bank’s premises due to its own shortcomings, negligence and by any act of omission/commission. Instances where loss of contents of locker are

due to incidents mentioned above or attributable to fraud committed by its employee(s), the banks’ liability shall be for an amount equivalent to one hundred times

the prevailing annual rent of the safe deposit locker.”

 According to the IDFC FIRST Bank, “The Bank does not keep record of contents of Locker placed by Locker Licensee/s (Customer) and would not be

liable to insure the contents of the Locker against any risk whatsoever.”
 NEW GUIDELINES
o Storage of Only Legitimate Items
Storing illegal substances or hazardous materials is strictly prohibited. If there is any suspicion of such items, the bank has the authority to take appropriate action against the
customer.

o Theft or Fraudulent Activities

bank's liability in such cases is restricted to a maximum of 100 times the annual rent of the rented locker.

o Natural Calamities

o Security
banks are now required to install closed-circuit television (CCTV) cameras in locker rooms to ensure monitoring. Additionally, it is mandatory for banks to retain the CCTV data for a
minimum of 180 days to facilitate the investigation of any potential discrepancies.

o Model Locker Agreement

Banks shall have a Board approved agreement for safe deposit lockers. For this purpose, banks may adopt the model locker agreement to be framed by IBA. This agreement shall be in
conformity with these revised instructions and the directions of the Hon’ble Supreme Court in this regard.

o New Agreement
The RBI has issued a directive to all banks, mandating that a minimum of 50% of their locker holders sign the new agreement before June 30, 2023. Furthermore, banks are
obligated to have 75% of their customers complete the agreement by September 30 and attain 100% compliance by December 31 2023. Banks are required to submit compliance
reports to the RBI through its DAKSH portal on a monthly basis.

o Allocation of Lockers
In order to facilitate customers making informed choices, banks shall maintain a branch wise list of vacant lockers as well as a wait-list in Core Banking System (CBS) or any
other computerized system compliant with Cyber Security Framework issued by RBI, for the purpose of allotment of lockers and ensure transparency in allotment of lockers. The
banks shall acknowledge the receipt of all applications for allotment of locker and provide a wait list number to the customers, if the lockers are not available for allotment.
 OBLIGATIONS OF A BANKER - PRECAUTIONS
AND RIGHTS

OBLIGATIONS
RIGHTS
I. The obligation of bankers to honor checks.
i. Rights of general lien.
II. The obligation of bankers to maintain secrecy.
ii. Rights of the set-off.
III. The obligation of bankers is to maintain proper
iii. Rights of appropriation.
records.
iv. Rights to Charge Interest and Commission
IV. The obligation of bankers to follow customer’s
v. Rights to Close the Account
instructions.

V. The obligation of bankers to give notice before

closing the account.
 BANKER'S LIEN
In legal terms, lien means rights of bailee to retain the goods & securities (held by bailee) owned by the bailor until the total debt
due to him is paid off. Lien is defined in Indian Contract Act, 1872. It is a right of a creditor to retain the possession of goods and
securities owned by the debtor, till the debts are fully paid off. However creditor does not get right to sell the securities.

There are two types of lien: The lien can be Particular lien or General lien.

 In case of particular lien only those goods and securities in respect of which debts are incurred, can be retained by the
creditor (if a wrist-watch is given to watch repairer for repairing, till the repairing charges are paid, the watch repairer has right
to retain the wrist watch in his possession). He cannot sell the watch for the recovery of service charges or also cannot retain
any other security of the debtor for these repairing charges.

 In case of general lien, for the general balance due, the creditor can retain the goods and securities of the debtor. Banks
in India enjoy not only right of general lien, they can even sell the goods and securities of the debtor in case of need to recover
debts. Banker’s lien is therefore called as an Implied Pledge. Since Limitation Act is not applicable to right of lien, banks can
recover time barred debts also.
Particular Lien:This is a lien wherein a person, who has made expenses either by rendering any services in the form of Labour or skills on a particular item, has a
right to retain such goods until the due remuneration is paid to him against the rendered services. This is mentioned under Section 170 of the Indian Contract Act, 1872.

For example, A gives his car to a mechanic for servicing against consideration of Rs. 4500. The mechanic after rendering the due scope of service will be right to keep A’s
car in his custody until he is remunerated for his services. A Bailee can exercise his right to a particular lien in scenarios, wherein:
• There is an involvement of any Labour or skills

• There is a performance of services as per the agreed scope of services.

• The payment is due to be made by the bailor.

General Lien: This is a lien wherein any goods bailed can be retained as security (in the absence of a contract to contrary) if any amount is due to Bailee. Such rights are
assigned and limited to the following category of people.:

• Bankers, Factors, Wharfingers (owner of dockyards used for parking ships), Attorneys of High Court, Policy Brokers.

The general lien is discussed under SECTION 171 of the Indian Contract Act, 1872. It is important to note that persons other than those mentioned above can have the
right to a general lien only in case any contract is explicitly made to the effect.

The goods excluded are the documents related to litigation, Contracts, and legal documents. This also includes lockers as the lockers are taken for the safe
custody of ornaments and important documents.
Conditions necessary for exercising right of lien:

1. Goods and securities (cheques, bills, shares, debentures etc.) must be owned by the debtor in his
own name.

Banks may sanction advance to a borrower against third party securities. Such securities cannot be subject matter of
lien (except in the name of guarantor).

2. Securities must be received in the capacity of Banker.

It means for securing loan and not for other purpose like safe custody, safe deposit vaults, specifically for
selling, inadvertently left in the bank, bank handling the securities as trustee or agent etc.

3. Reasonable notice must be given before the sale of securities.

4. There should not be any contract inconsistent to the right of lien.

Lien is not permissible in the following cases:

1. Where the valuables are received for safe custody. (Cuthbert v. Roberts and Bank of Africa and Cohen)

2. Where the entrustment of goods (documents of title) is for a specific purpose stated to the banker. (Greenhalgh v.

Union Bank of Manchester). When the deposit with the banker is for a specific purpose if the banker has implied or

expressed notice of such purpose.

3. Where there is an express contract like by way of counter-guarantee, providing reimbursement. (Krishna Kishore Kar

v. United Commercial Bank).

4. Where the banker has only a contingent debt. A contingent debt is that "no amount would be due on the date when he

wants to exercise lien".

5. Banker's Lien is not available against Term Deposit Receipt in Joint Names when the debt is due only from one of the

depositors.
 CITY UNION BANK LTD V/S
THANGARAJAN (2003)
In the matter of City Union Bank Ltd v/s Thangarajan (2003) 46 SCL 237 (Mad) it is pertinent to state certain principles with
respect to Banker's lien that was observed by court. The facts of the case are as follows:

1.The City Union Bank Limited, Thirukattupalli Branch, filed a suit in OS.No.193/1986, before the District Munsif Court,
Thiruvaiyaru, against (1) Kumaraswamy, (2) Chellapappa and (3) Thangaraj, for recovery of a sum of Rs.2568.15/-, with future
interest.

2.The case of the plaintiff Bank (City Union Bank) is that the defendant along with others executed a promissory note in
favour of the plaintiff/Bank on 19.11.1983 in Thirukkattupalli for Rs.4,000/-, agreeing to repay the same together with interest at
Rs.16.50/- per cent per annum (compound interest) with quarterly rests. The loan was advanced for commercial purposes. The
liability of the defendants interse is joint and several.

3. The Bank has filed the suit for recovery of the amount, in OS.No.193.1986, which was transferred and renumbered as
OS.No.205 /1987 before the Sub Court, Thanjavur and also driven one of the borrowers to file the suit in OS.No.119/1986 for
recovery of the amount.

4. Bank had invoked right to lien and withhold the Fixed Deposits maintained by the borrower.
HELD : The bank gets a general lien in respect of all securities of the customer including negotiable instruments and FDRs, but only to the extent
to which the customer is liable. If the bank fails to return the balance, and the customer suffers a loss thereby, the bank will be liable to pay
damages to the customer.

In the present matter the Court has based its decision on the principle that in order to invoke a lien by the bank, there should exist mutuality between the
bank and the customer i.e. when they mutually exist between the same parties and between them in the same capacity. Detaining the customer’s
properties beyond the total liability is unauthorised and would attract damages as a liability on banks.

The trial court further observed that the Bank has got a lien in respect of the property of its borrowers. But, however, when the debtor had got a fixed deposit
and that he owes amount to the Bank, both of them have got to be taken into consideration and after deducting the amount, due to the Bank, the Bank is
bound to return the balance amount to its customer.

Instead of adopting the said course, the Bank has filed the suit for recovery of the amount, in OS.No.193.1986, which was transferred and renumbered as
OS.No.205 /1987 before the Sub Court, Thanjavur and also driven one of the borrowers to file the suit in OS.No.119/1986 for recovery of the amount. The
fact that the Bank filed the suit would amount to giving up/ waiving up his right of lien and therefore, the Bank is not entitled to withhold the fixed
deposit amount. Retaining the customer's properties beyond his liability is unauthorized and would attract liability to the bank for damages.
 STEPHEN VS CHANDRA MOHAN AND ORS.,
(1987)
1. The first respondent pledged some ornaments and on their security secured a loan from the Iritty branch of the North Malabar Gramin Bank of which the petitioner is the
manager, after executing an agreement also. The bank demanded the amount back and the first respondent remitted the same. But the ornaments were not returned by "the
petitioner for the reason that a loan transaction by another person for which the first respondent stood surety was not discharged. The first respondent prosecuted the
petitioner before the Judicial First Class Magistrate, Mattannoor in C. C. No. 3 of 1986 for offences punishable under Sections 409 and 420, Indian Penal Code. The
petitioner seeks to quash the complaint invoking the inherent powers of this court. The short question for consideration is whether the facts constitute offences under the
above sections.

2. Section 409 involves criminal breach of trust by a public servant or by a banker, merchant or agent. In order to constitute criminal breach of trust as defined in Section
405 of the Indian Penal Code, there must be entrustment with property or with dominion over the same. Admittedly, there was entrustment of the ornaments. The other
ingredients required are dishonest misappropriation or conversion of the property by the accused for his own use. Those ingredients are not there because the ornaments
continued with the, bank as earlier and it was possessed only as security. The only difference is that when one transaction was closed, it was retained as security solely for
another transaction.

No question of misappropriation or conversion is involved. Dishonest use or disposal of the property in violation of any direction of law prescribing the mode in which the trust
is to be discharged, or of any legal contract, express or implied, which the accused made touching on the discharge of such trust is also sufficient to constitute the offence.
The argument was that the ornament was used by the petitioner, in his capacity as manager, as security for the transaction to which the first respondent was a surety, in
violation of the provisions of the legal contract entered into at the time of the pledge. There is no such allegation specifically. Still, that contention also could be considered
because such a case could be brought within the allegations.
3. Annexure 4 is a copy of the agreement executed by the first respondent at the time of the loan transaction. That agreement contains a provision by which the first,
respondent authorised the bank to treat the ornaments not only as security for that loan transaction but also for any other transaction or liability towards any branch of the
bank, existing or to be incurred in future. The liability of a surety is joint and several with that of the principal debtor.

Therefore, the liability as a surety also, whether existing or in future, comes within the ambit of the above provision in the agreement. The first respondent has no case that
he is not having the liability towards the bank as surety for the loan transaction of another person. The action of the petitioner in treating the ornament as security for that
transaction cannot, therefore, be said to be dishonest use or disposal in violation of the terms of the legal contract constituting an essential ingredient of the offence
touching on the discharge of trust. The petitioner was only acting according to the terms of the agreement. Treating the ornament as security for another transaction
coming within the purview of the agreement does not involve dishonest use or disposal in violation of a contract touching on the discharge of the trust.

4. Under Section 171 of the Indian Contract Act, in the absence of a contract to the contrary, bankers could retain, as a security for a general balance of account, any
goods bailed to them. This right is available only to certain categories of persons. Others could do so only if there is an express contract to that effect. The argument on
behalf of the first respondent was that annexure 4 contains a contract to the contrary as envisaged in Section 171 of the Contract Act and, therefore, that provision is not
applicable. 1 was not able to find any such contract to the contrary.

On the other hand, annexure 4 only contributes to the enforcement of the right under Section 171. Allegations in the complaint thus not only do not constitute an offence
punishable under Section 409 of the Indian Penal Code, but specifically exclude that offence. Even without the relevant provision in annexure 4, the petitioner, on behalf of
the bank, could have retained the ornament as security under Section 171 of the Contract Act, without incurring the risk of commission of an offence of criminal breach of
trust because such retention is allowed by law and it does not involve breach of any term of agreement.
NON-FUND BASED (a) Bank Guarantees
(b) Letter of Credit
FACILITIES (c) Underwriting
 NON-FUND BASED FACILITIES
TYPES OF CREDIT FACILITIES:

1. Fund Based

 Short term loans

 Cash credit or business overdrafts

 Term loans

2. Non Fund Based : In the business of lending, a banker also extends non-fund based facilities. Non-fund based facilities do not involve
immediate outflow of funds. The banker undertakes a risk to pay the amounts on happening of a contingency.

Non-based facilities can be of following types among other:

(a) Bank Guarantees

(b) Letter of Credit

(c) Underwriting and credit guarantee

 BANK GUARANTEE
126. 'Contract of guarantee', 'surety', 'principal debtor' and 'creditor'—A 'contract of guarantee' is a contract to perform
the promise, or discharge the liability, of a third person in case of his default.

A bank guarantee, like a letter of credit, guarantees a sum of money to a beneficiary. The bank only pays that amount if
the opposing party does not fulfill the obligations outlined by the contract. The guarantee can be used to essentially
insure a buyer or seller from loss or damage due to nonperformance by the other party in a contract.

Bank guarantees protect both parties in a contractual agreement from credit risk.

For instance, a construction company and its cement supplier may enter into a contract to build a mall. Both parties may
have to issue bank guarantees to prove their financial bona fides and capability. In a case where the supplier fails to
deliver cement within a specified time, the construction company would notify the bank, which then pays the company the
amount specified in the bank guarantee.
As part of Non-fund based facilities, banks issue guarantees on behalf of their clients. A Bank
Guarantee is a commitment given by a banker to a third party, assuring her/him to honour the claim
against the guarantee in the event of the non- performance by the bank’s customer.

A Bank Guarantee is a legal contract which can be imposed by law. The banker as guarantor assures
the third party (beneficiary) to pay him a certain sum of money on behalf of his customer, in case the
customer fails to fulfill his commitment to the beneficiary.

There are three parties in a guarantee:

(a) Customer (Applicant)

(b) Third Party (Beneficiary) and

(c) the Banker (guarantor)

 Financial Guarantee: The banker issues guarantee in favour of a government department against caution deposit or earnest money to be deposited by bank’s client. At the request of his
customer, in lieu of a caution deposit/ earnest money, the banker issues a guarantee in favour of the government department. This is an example of a Financial Guarantee. This type of
guarantee helps the bank’s customer to bid for the contract without depositing actual money. In case, the contractor does not take up the awarded contract, then the government department
would invoke the guarantee and claim the money from the bank.

Performance Guarantee: Performance Guarantees are issued by banks on behalf of their clients. For example: XYZ Ltd, the Indian engineering company undertakes an overseas project.
The project is to construct highways in one of the African nations. XYZ Ltd, required to furnish a bank guarantee. Since the company has undertaken an overseas project, the company is
called as project exporter. XYZ Ltd approaches his banker to issue a bank guarantee in favour of the African nation to whom the company is going to construct the highways. XYS’s bank
issues a bank guarantee and it will be a performance guarantee. Bank as guarantor guarantees the beneficiary that in case the project exporter (XYZ company) does not perform to
the satisfaction of the beneficiary, then within the validity period (including the claim period if any) of the guarantee, the beneficiary can invoke the guarantee and the banker
has to honour his commitment and pay the amount mentioned in the guarantee.

Deferred Payment Guarantee: Under this guarantee, the banker guarantees payments of installments spread over a period of time. For example: A purchases a machinery on a long-
term credit basis and agrees to pay in installments on specified dates over a period of time. In terms of the contract of sale, B (the seller) draws Bills of Exchange on the customer for different
maturities. These bills are accepted by A. The banker (guarantor) guarantees payment of these bills of exchange on the due date. In the event of default by A, the banker need to honour the
claim to the seller (beneficiary).

Tender guarantees: This guarantee plays a role of security in those cases when the Company fails to perform its obligations to tender organization or other party that is stipulated in the order
received by winning the tender.

Advance payment guarantee: Acts as collateral for reimbursing the buyer's advance payment if the seller does not supply the specified goods per the contract.

Warranty bond guarantee: Serves as collateral, ensuring ordered goods are delivered as agreed.

Payment guarantee: Assures a seller the purchase price is paid on a set date.

Rental guarantee: Serves as collateral for rental agreement payments.

Bank Guarantee – There are risks of failure or refusal of one of the parties to fulfill its obligations to other
party during the partnership at local and international level. The bank guarantee is widely used all over the
world as a reliable protection of other party from financial losses.
Some Important Features:

❖ Bank’s obligation to pay is primary

❖ Banker’s commitment to honour the claim is primary, even if there is any dispute between the beneficiary and the debtor.
❖ Banker needs to honour the claim, irrespective of the customer’s balance in the bank account.
❖ Except in case of frauds, in other cases, the banker cannot refuse payments, when a claim is received within a stipulated time.

Courts also have refused to grant injunctions against banks from making payment under the guarantee,
except in cases of frauds.
 LETTER OF CREDIT:
Sometimes referred to as a documentary credit, a letter of credit acts as a promissory note from a financial
institution—usually a bank or credit union. It guarantees a buyer's payment to a seller or a borrower's payment to a
lender will be received on time and for the full amount. It also states that if the buyer can't make a payment on the
purchase, the bank will cover the full or remaining amount owed.

A letter of credit represents an obligation taken on by a bank to make a payment once certain criteria are met.
After these terms are completed and confirmed, the bank will transfer the funds. The letter of credit ensures the
payment will be made as long as the services are performed. The letter of credit basically substitutes the
bank's credit for that of its client, ensuring correct and timely payment.

For example, say a U.S. wholesaler receives an order from a new client, An Indian company. Because the wholesaler
has no way of knowing whether this new client can fulfill its payment obligations, it requests a letter of credit is
provided in the purchasing contract.
Parties : A Letter of Credit is issued by a bank (issuer) at the request of its customer (importer) in favour of the beneficiary
(exporter).

It is an undertaking/ commitment by the bank, advising/informing the beneficiary that the documents under a LC would
be honoured, if the beneficiary (exporter) submits all the required documents as per the terms and conditions of the LC.

The purchasing company applies for a letter of credit at a bank where it already has funds or a line of credit (LOC). The bank issuing
the letter of credit holds payment on behalf of the buyer until it receives confirmation that the goods in the transaction have been
shipped. After the goods have been shipped, the bank would pay the wholesaler its due as long as the terms of the sales contract are met,
such as delivery before a certain time or confirmation from the buyer that the goods were received undamaged.

 The trade can be classified into Inland and International. Due to the geographical proximities of the importers and the exporters, banks are
involved in LC transactions to avoid default in payment (credit risks).

 To facilitate trade and also to enable the exporter and importer to receive and pay for the goods sold and bought, letter of credit is used as a
tool. Letter of credit mechanism that the payment and receipts (across the globe) are carried out in an effective manner.
Letters of Credit – Parties
�1. Applicant (importer) - who requests the bank to issue the LC
�2. Issuing bank (importer’s bank which issues the LC [also known as Opening banker of LC])
�3. Beneficiary (exporter)

Different types of banks involved:

 Opening bank (a bank which issues the LC at the request of its customer [importer]).

 Advising bank (the issuing banker’s correspondent who advices the LC to beneficiary’s banker and/ or beneficiary).

 Negotiating bank (the exporter’s bank, which handles the documents submitted by the exporter. The bank also finances the exporter against
the documents submitted under a LC) OR Confirming bank (the bank that confirms the credit).

 Confirming bank (when a banker other than the Issuing bank, adds its own confirmation to the credit. In case of confirmed LCs, the beneficiary’s
bank would submit the documents to the confirming banker)

 Reimbursing bank (reimburses the LC amount to the negotiating/ confirming bank).

 TYPES OF LOC
(a) Sight Credit – Under this LC, documents are payable at sight/ upon presentation.

(b) Acceptance Credit/ Time Credit – The Bills of Exchange which are drawn, payable after a period, are called usance bills. Under acceptance credit usance bills

are accepted upon presentation and eventually honoured on due dates.

(c) Revocable and Irrevocable Credit – A revocable LC is a credit, the terms and conditions of the credit can be amended/ cancelled by the Issuing bank, without

prior notice to the beneficiaries. An irrevocable credit is a credit, the terms and conditions of which can neither be amended nor cancelled without the consent

of the beneficiary. Hence, the opening bank is bound by the commitments given in the LC.

(d) Confirmed Credit – Only Irrevocable LC can be confirmed. A confirmed LC is one when a banker other than the Issuing bank, adds its own confirmation to the

credit. In case of confirmed LCs, the beneficiary’s bank would submit the documents to the confirming banker.

(e) Back-to-Back credit – In a back to back credit, the exporter (the beneficiary) requests his banker to issue a LC in favour of his supplier to procure raw

materials, goods on the basis of the export LC received by him on back to back basis. This type of LC is known as Back-to-Back credit.

Example: An Indian exporter receives an export LC from his overseas client in Netherlands. The Indian exporter approaches his banker with a request to issue a LC in

favour of his local supplier of raw materials. The bank issues a LC backed by the export LC.
(f) Transferable Credit – While a LC is not a negotiable instrument, the Bills of Exchange drawn under it are negotiable. A
Transferable Credit is one in which a beneficiary can transfer his rights to third parties. Such LC should clearly indicate that it is a
‘Transferable’ LC.

(g) “Red Clause” Credit & “Green Clause” Credit – In a LC a special clause allows the beneficiary (exporter) to avail of a pre-shipment
advance (a type of export finance granted to an exporter, prior to the export of goods). This special clause used to be printed (highlighted
in red colour, hence it is called “Red Clause” Credit. The issuing bank undertakes to repay such advances, even if shipment does
not take place.

In case of a ‘Green clause’ credit, the exporter is entitled for an advance for storage (warehouse) facilities of goods. The advance
would be granted only when the goods to be shipped have been warehoused, and against an undertaking by the exporter that the
transportation documents would be delivered by an agreement date.

(h) Standby LC: In certain countries there are restrictions to issue guarantees, as a substitute these countries use standby credit.
In case the guaranteed service is not provided, the beneficiary can claim under the terms of the standby credit. In case of Standby LCs,
the documents required are proof of non- performance or a simple claim form.
 LETTER OF UNDERTAKING
Letter of Undertaking can said to be a sort of guarantee that is issued by a banking entity to the concerned person for attaining short term credit from the overseas

branch of an Indian bank.

Letter of undertaking (LOU) under this a bank can allow its customer to raise money from another Indian bank's foreign branch in the form of a short term credit. The LOU

serves the purpose of a bank guarantee for a bank's customer for making payment to its offshore suppliers in the foreign currency.

LoU Letter of Undertaking is an assurance given by one bank to another bank to meet a liability on behalf of its consumer.

• Letter of undertaking (LOU) is a form of bank guarantee under which a bank can allow its customer to raise money from another Indian bank's foreign branch in the form

of a short term credit. The credit is ideally meant for short-term only.

• For raising the LOU, the customer (importer) is supposed to pay margin money to the bank that issues the LOU and accordingly, they are granted a credit limit.

• Once the letter of credit is acknowledged and accepted, the lender (foreign branch of Indian bank) transfers money to the nostro account of the bank that has

issued the LoU. (Nostro comes from the Latin word for "ours," as in "our account on your books". Vostro comes from the Latin word for "yours," as in "your account on

our books“)

• As a matter of fact, letter of undertaking is a letter of credit issued by one bank (let's call it Punjab National Bank) that paves way for another bank (let's call it Allahabad

Bank-AB) to give money to supplier of Punjab National Bank's customer.

 PNB SCAM
PNB discovered that at least 2 individuals, deputy manager Gokulnath Shetty and clerk Manoj Kharat, from its Brady House branch in
Mumbai repeatedly issued Letters of Undertaking (LoU) to Nirav Modi's companies and their banks without following the processes,
without securing cash reserve or collateral and without recording the transactions in the bank's core banking software, the system
on which the bank's financial transactions are run and recorded.

For raising the LOU, the customer (importer) is supposed to pay margin money to the bank that issues the LOU and accordingly, they are
granted a credit limit. But in Nirav Modi's case, neither was there a credit limit, nor did he ever give any margin money.

Once the letter of credit is acknowledged and accepted, the lender (foreign branch of Indian bank) transfers money to the nostro account of
the bank that has issued the LoU. In this case, Nostro account is the Punjab National Bank's account held in another bank in a foreign
country for the purpose of holding foreign currency. And the money is transferred by AB to supplier of PNB's customer via a nostro
account that PNB holds in AB in abroad.

The credit is ideally meant for short-term only. In the Nirav Modi-Mehil Choksi case, the term of loan was allegedly extended far beyond
what is prescribed as per the rule book. Even the PNB and other lenders are slugging out over the loan term, which should not have
been extended, says PNB, longer than 90 days.
 FAILURE OF CORPORATE
GOVERNANCE :
(Important Cases)
� IL&FS
� SFIO— Non Credit-worthy Company

� PMC Bank case

� Unsecured Debts to stressed company — One Company— Multiple Accounts

� PNB Fraud case

� LoU– Without Security & Margin Money— No Record on the software

� DHFL Fraud case

� 17 Banks– Unsecured Credit to shell Companies– Promotors– Foreign Investment

� ICICI RPT case

� Bank CEO – Immediate family members and the Videocon group which got a Rs. 3,250-
crore— Internal Review Mechanism – CBI – SEBI
 ESCROW AGREEMENT
An escrow agreement is a legal agreement, which describes the terms and conditions applicable to the participants involved. An escrow agreement contains a detailed
responsibility of the parties involved. An escrow agreement typically includes a nonpartisan party who is referred to as the escrow agent. This party
will hold the security or asset of certain worth until the conditions mentioned in the agreement are fulfilled. Escrow agents will have to completely outline the terms and
conditions for all the parties participating in the agreement.

Understanding Escrow Agreements

 When it comes to escrow agreements, one of the involved parties will go on to deposit certain funds or assets with the escrow of the agreement. The escrow will hold the assets or funds until the
conditions outlined in the agreement are fulfilled.

 Once the outlined conditions are fulfilled, the escrow agent will go on to deliver the assets or funds to the beneficiary mentioned in the agreement. Escrow agreements are generally made use of in several
monetary transactions, specifically those involving massive volume. The best example for these agreements is real estate deals.

 Escrow agreements will fully describe all details and conditions between the participants involved in the agreement. Signing escrow agreements will ensure that the parties involved in the agreement are
going to fulfil all the conditions, and the transaction happens in a reliable and safe manner.

Importance
 Most escrow agreements are created when one of the parties involved in a contract wants to ensure that the other parties in the agreement are going to standby whatever they claim to do so. This is
extremely important in those agreements that involve some parties to perform something or meet certain obligations before the deal could go through.

 For example, the house owner could set up an escrow understanding so that the buyer is going to get his finances in place before the sale transaction happens. If the buyer cannot get his finances right,
then the escrow agreement will no longer be valid.
 - KHYATI NAYAK
Assistant Professor (Law)

THANK YOU KPMSOL, NMIMS, MUMBAI

Email :
khyati.nayak@nmims.edu