Registration under Money-Lending laws

Aanchal Kaur Nagpal and Parth Ved (corplaw@vinodkothari.com)

Introduction

More often than not, the term ‘lending activities’ instantaneously brings the ‘Reserve Bank of India’ (‘RBI’) to mind. However, lending business is not the domain of RBI alone. Amidst multiple RBI guidelines governing numerous financial institutions, the state legislations on money-lending have become long forgotten.

Money-lending laws were introduced with an intention to curb non-regulated indigenous lenders from charging exorbitant interest rates to borrowers. These laws typically require licensing of money lenders, impose a ceiling on rate of interest that money lenders can charge, and generally provide that a court shall not take cognizance of a matter filed by an unlicensed money lender.

While financial entities such as non-banking financial companies (‘NBFCs’), banks, insurance companies etc. have been exempted from obtaining money-lending licence as these are regulated by other laws, the question arises whether non-regulated entities undertaking the ‘business’ of lending would require to register under the money-lending laws.

Who are money lenders?

Although there is a strong network of financial institutions, recourse to such institutions, at most times, is not accessible to the rural parts of the country. Further, it is difficult for banks to extend loans to small farmers due to their rigid requirements for KYC and collateral. Money lenders perform a gap-filling function as they majorly cater to a class of borrowers whom other financial institutions, including banks, cannot reach.

Since they have been such an important link between the formal lending sector and the informal borrowing sector, there was a need for a strong framework to regulate their working. According to Entry 30 of List II (i.e. State List) of the Seventh Schedule to the Constitution of India, the State Legislature has exclusive power to make laws on activities relating to money-lending. To regulate the transactions of money-lending in the State of Maharashtra, the state legislature has enacted Maharashtra Money-Lending (Regulation) Act, 2014 (‘Money Lending Act’). However, other states too, have their respective money-lending laws. Our article deals with provisions under the Maharashtra Money Lending Law.

Applicability for registration and exemption

The Money Lending Act states that no money lender shall carry on the business of money-lending except in the area for which he has been granted a licence. The term used here is “business of money-lending”. Business of money-lending is defined as the business of advancing loans whether in cash or kind and whether or not in connection with, or in addition to any other business.

The above definition provides clarity on the following aspects –                                            

  • Money-lending transactions should constitute a business for the lender.
  • It may or may not be the primary business of the lender.
  • It may or may not be in cash.

This raises an important question as to what constitutes ‘business of money-lending’. Are there any lending transactions which are excluded from its purview? The money lending laws exclude certain kinds of loans and lenders. Accordingly, below we discuss various transactions which may not be classified as business of money-lending:

Exclusions from business of money-lending

1.     Secluded or isolated lending transactions

Including secluded or isolated lending transactions in the definition of money-lending business could result in classification of any loan of any amount given by anyone as a business of money-lending. Surely this could not have been the intention of the legislature. Recognising this, the Hon’ble Bombay High Court in Mandubai Vitthoba Pawar v. The State of Maharashtra & Ors. observed:

“11.             …for constituting a business of money lending there has to be a continuous and systematic activity by application of labour or skill with a view of earning income and then it could be called “business”. In order to do business of money lending, it would be necessary for the State to point out multiple activities of money lending done by the petitioner. Merely referring to one isolated transaction claimed to be a loan transaction or money lending would not be enough to attract the provisions of the Act and to brand the petitioner to be a person involved in business of money lending without having any license.”

This was again reiterated in Uttam Bhikaji Belkar vs The State of Maharashtra. This makes it clear that there has to be a continuous lending activity with profit motive to constitute a business of money-lending. If this condition is satisfied, the money lender has to obtain a valid license to carry on such business. Therefore, providing one-time loans with no intention to carry on the business of lending money, will not trigger the requirement of adhering to the money lending laws.

2.     Inter-corporate deposits

The intention of a company giving an Inter-corporate Deposit (ICD) is not to engage in a money-lending transaction but to earn a surplus on the idle funds available with them. In Pennwali India Ltd. and others vs Registrar of Companies it was observed that there exists a relationship of a debtor and a creditor in both cases – loans and deposits. But ICDs could also be for safe-keeping or as a security for the performance of an obligation undertaken by the depositor. Further, in the case of ICD, which is payable on demand, the deposit would become payable when a demand is made. In Housing and Urban Development Corporation Ltd. v. Joint Commissioner of Income Tax, the Hon’ble Income Tax Appellate Tribunal, Delhi Bench held:

“22. …the two expressions loans and deposits are to be taken different and the distinction can be summed up by stating that in the case of loan, the needy person approaches the lender for obtaining the loan therefrom. The loan is clearly lent at the terms stated by the lender. In the case of deposit, however, the depositor goes to the depositee for investing his money primarily with the intention of earning interest.”

Therefore, the money-lending transactions shall not include ICD and companies shall not be required to obtain a license for undertaking such transactions.

3.     Loans to group companies (subsidiary, associate etc.)

In lending transactions between companies within the same group, the intention is not to earn interest on such loan but to facilitate availability of funds to the group company for furtherance of business. Further, loans by companies are governed by Section 186 of the Companies Act, 2013. Section 2(13)(i) of the Money Lending Act states that “a loan does not include a loan to, or by, or deposit with any corporation (being a body not falling under any of the other provisions of this clause), established by or under any law for the time being in force which grants any loan or advance in pursuance of that Act”. Including such transactions under the scope of money-lending business would not be in line with the objects of the Money Lending Act which is to prevent the harassment to the farmers-debtors at the hands of the money lenders or to curb charging exorbitant interest rates.

4.     Parking of money

Parking of or investing idle funds in fixed deposits with Banks is in the nature of investments to earn a surplus on idle funds. Further, since regulation of banking and financial corporations is a matter of List I (i.e. Union List) of the Seventh Schedule to the Constitution of India, Section 2(13)(h) of the Money Lending Act explicitly states that “a loan shall not include a loan to, or by, a bank”, thereby excluding Banks from its purview.

5.     Loans by Non-banking Financial Companies

The term money lender, as defined in the Money Lending Act, includes individuals, HUF, companies, unincorporated bodies of individuals who carry on the business of money-lending or have a principal business place in Maharashtra.

However, it has excluded from its purview, non-banking financial companies (NBFC) since they are regulated by RBI under Chapter IIIB of the Reserve Bank of India Act, 1934.

Further, other regulated entities such as insurance companies, banks etc. from its purview.

Our write-up giving a detailed analysis of the definition of NBFC can be accessed here.

Accordingly, NBFCs shall not be required to obtain a license to carry out money-lending business in the State of Maharashtra.

Lending in multiple states

In case a company lends in multiple states,  it will have to adhere to provisions under the money lending laws of each such State.

Consequences of non-registration

Section 39 of the Money Lending Act states that whoever carries on the business of money-lending without obtaining a valid licence, shall be punished with –

  • imprisonment for a term which may extend to 5 years; or
  • with fine which may extend to Rs.50,000; or
  • with both.

Conclusion

Even though getting a valid license under the Money Lending Act helps money lenders to carry on business lawfully and have legal recourse against the defaulters, one of the major reasons for non-registration is the ceiling on interest rate. Many lenders are not even aware about the requirement of such registration. Considering the serious nature of punishment for lending money without a valid license, it’s imperative for entities to identify if they are undertaking business of money-lending and whether they have a valid license to do so.

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