Archive for category: NBFCs

– Archisman Bhattacharjee & Aditya Iyer  | finserv@vinodkothari.com

Introduction

The trust and fairness in a lender-borrower relationship is one of the most fundamental drivers of financial regulation, and ensuring this trust and fairness in lender-borrower relationships is crucial for the growth and stability of the financial sector.  NBFCs doing lending business are likely very conversant with the obligations captured in the RBI regulation on fair lending practices that details the general principles on adequate disclosure of the terms and conditions of a loan, and the adoption of non-coercive recovery methods. However, they may be unaware of the rights and obligations under the Consumer Protection Act, 2019 (‘CP Act’) which inter alia deals with “Unfair Contracts”. Interestingly, the CP Act defines a contract to be unfair if such contract significantly undermines consumer rights including clauses that restrict prepayment or contains clauses towards unilateral termination of agreements etc. These terms, which are also covered under the RBI’s Fair Practice Code, highlight a convergence in regulatory and statutory protections for borrowers.

In this article, we explore the rights of a borrower and the obligations of a lender under the CP Act and highlights the extant obligations under the Fair Practices Code, and other RBI regulations, and in doing so also explore the emerging convergence in these regulations concerning consumer protection norms.

Meaning of Unfair Contract and its impact 

Section 2(46) of the CP Act, defines an “unfair contract” as follows-

(46) “unfair contract” means a contract between a manufacturer or trader or service provider on one hand, and a consumer on the other, having such terms which cause significant change in the rights of such consumer, including the following, namely:

(i) requiring manifestly excessive security deposits to be given by a consumer for the performance of contractual obligations; or 

(ii) imposing any penalty on the consumer, for the breach of contract thereof which is wholly disproportionate to the loss occurred due to such breach to the other party to the contract; or 

(iii) refusing to accept early repayment of debts on payment of applicable penalty; or 

(iv) entitling a party to the contract to terminate such contract unilaterally, without reasonable cause; or 

(v) permitting or has the effect of permitting one party to assign the contract to the detriment of the other party who is a consumer, without his consent; or 

(vi) imposing on the consumer any unreasonable charge, obligation or condition which puts such consumer to disadvantage;

Based on the aforesaid definition, from the perspective of lenders, unfair contracts would include any agreement that significantly undermines consumer rights. Examples of unfair terms include:

1. Preventing early prepayment of debt, even with payment of applicable penalties;
2. Allowing the lender to unilaterally terminate the agreement without reasonable cause;
3. Assigning the contract to another party in a manner detrimental to the consumer, without their consent;
4. Imposing unreasonable charges, obligations, or conditions that disadvantage the consumer.

It is important to note that the aforesaid list is not exhaustive. Beyond these provisions, the RBI Fair Practice Code also identifies practices that can render contracts unfair, including:

1. Charging excessive interest rates.
2. Imposing interest during undisbursed loan periods.
3. Enforcing unreasonable lock-in periods in loan agreements or sanction letters, etc.

The CP Act permits the classification of any contract that results in an unreasonable bargain as unfair, and subject to review by consumer courts such as the State Commission (Section 47(iii)) and the National Commission (Section 58(ii)). Additionally, Sections 49(2) and 59(2) state that if a contract term is deemed unfair by these commissions, it can be declared null and void.

Further, via the principle of the doctrine of restitution, as outlined in Section 65 of the Indian Contract Act, 1872 if any part of a contract is declared void, the benefits received by any party must be returned or compensated to the party from whom they were obtained. 

Under the CP Act, an unfair contract exists where there is a manufacturer, trader, or service provider on one side, and a consumer on the other. Therefore, to assess the “unfair contract” aspect in loan contracts, a key consideration will be whether the borrower is a “consumer” as denoted thereunder.

Determination of ‘Consumer’ under the CP Act

Section 2(7)(ii) of the CP Act in respect of loans defines consumer as any person who has availed services for a consideration which has been paid or promised or partly paid by such person and partly promised, however, does not include any person who has availed of such service for any commercial purposes. Hence, in the context of loans, borrowers who have availed of loans for “commercial purposes” would not qualify as consumers under CP Act. As the law currently stands, any person who obtains loans for his personal use would still fall under the definition of the term “consumer”. However, there might be debates on whether a person availing business loans would fall under the ambit of the CP Act. The term “commercial purposes” per se has not been defined under the CP Act and thus, has been subject to judicial interpretation. 

We now proceed to analyse the current standing of the law in relation to business loans as well as retail loans and understand what qualifies as a service being taken for “commercial purpose”.

Are retail and commercial borrowers recognized as ‘consumers’

The definition of a “consumer” under S.2(7) of the CP Act includes any person who buys a good or hires a service for consideration paid or under any system of deferred payment. 

This would also cover in its ambit borrowers because in the context of Banks, the Supreme Court has held that persons who avail of any banking services is a consumer under the Consumer Protection Act¹. 

Additionally, as the National Consumer Disputes Redressal Forum, and the State Consumer Disputes Redressal Forum pass reasoned orders on the interests of borrowers obtaining facilities from NBFC, persons obtaining non-banking financial services shall also fall under the definition of “consumer”. 

Hence, borrowers of retail loans would be recognized as consumers. However, the definition of a “consumer” under S.2(7) of the CP Act does not cover persons who have obtained goods, or availed services for a commercial purpose. 

A commercial purpose includes business-to-business transactions between entities where there is a direct nexus with profit-generating activities. “Commercial” denotes activities pertaining to commerce, and connected with/engaged in commerce having profit as a main aim. Where there is ambiguity, it may be seen whether the dominant intent/purpose of the transaction was to facilitate some kind of profit generation for the purchaser / their beneficiary². Such activities or contracts would be out of the scope of the Consumer Protection Act³.

As regards loans, where a loan is obtained for a commercial purpose, the person who obtained such a loan does not come under the category of “consumer”⁴. 

A. Overdraft facility

In Shrikant G. Mantri vs Punjab National Bank⁵, the appellant took an overdraft facility to expand his business profits, and subsequently from time to time the overdraft facility was enhanced so as to further expand his business and increase his profits. The Supreme Court held that the relationship between the appellant and the respondent is purely a “business to business” relationship. As such, the transactions would clearly come within the ambit of ‘commercial purpose’ and accordingly the appellant is not a consumer under the Act.

B. Working Capital Loans

In the case of Standard Chartered Bank & Anr. v Mankumar Kundliya⁶, one Mankumar Kundliya was the sole proprietor of the proprietorship firm M/s Sahil Distributors, who had obtained working capital facility from the bank. The issue before the National Commission was on deciding whether the respondent was a “consumer” under the Act. The court negating the contention held that the working capital loan facility obtained by the respondent “cannot be said to be for earning livelihood of the Respondent, and the same are  inherently commercial in nature and the relationship between the parties is purely “Business to Business” in nature. Further, the Appellant also has independent commercial interests. Therefore, the transactions are essentially for ‘Commercial Purpose’ and the case does not fall under the exceptions to the term ‘Commercial Purpose’ carved out in the definition of the term ‘Consumer’ under the statute.”

C. Self Employment 

Loans obtained for the purpose of self-employment may be considered business loans from the perspective of the lender, but the CP Act views such borrowers as “consumers”⁷.

Would retail and commercial borrowers come under the ambit of “unfair contract” as per CP Act

As mentioned above, an unfair contract refers to a contract with a manufacturer, or trader, or service provider on one hand, and a consumer on the other having such terms as which would cause significant change in the rights of the consumer. 

Loan contracts are contracts that may be tested against this definition, and the definition of an unfair contract in the CP Act is an “inclusive definition”, i.e. it is not exhaustive. It can cover emerging industry practices not specifically captured in any legislation. The CP Act is to be construed in favour of the “Consumer” as it is a “social benefit oriented legislation”⁸, and lending entities would be well advised to review their restrictive covenants and terms against this definition, specifically in case of retail borrowers.

Since an unfair contract requires one of the parties of the contract to be a “consumer”, it would not include commercial loan contracts where the parties would not be “consumers” under the Act, save and except in circumstances where such loans have been obtained by the borrower for purposes of self-employment. Consequently, remedies through the State Consumer Commission or the National Consumer Commission under Sections 47 and 58 of the Act respectively are not available. Therefore, recourse to these commissions is not an option for addressing issues related to unfair contracts in this context.

However, if terms of the contract are unfair, businesses can seek remedies through the Commercial Courts Act, 2015. According to Section 2(c)(i) of the Commercial Courts Act, such unfair contracts may form subject matter of a “commercial dispute”. As a result, businesses can still address these issues through the commercial courts, subject to the dispute meeting the quantum of “specified value” as provided under 2(c)(i) of the Commercial Courts Act. Alternatively, the business which has availed business loans will also have other common law remedies, and may file a suit before a court of appropriate jurisdiction to declare the terms of the Contract as unfair and void.

Common/ prevalent terms and covenants that qualify as ‘unfair’ 

The following terms have specifically been held to be an “unfair contract” or unfair trade practice by the Consumer Disputes Redressal Commissions with regards to lenders regulated by RBI: 

1. Excessive Penal Interest/Charge: Charging of excessive penalty/penal interest (in 2021), holding that incorporating such excessive terms into the loan agreement amounted to an unfair trade practice⁹.
2. Ceiling on interest rate: Even where RBI does not prescribe an upper limit for NBFC on rate of interest to be charged, the same can still be considered an unfair contract/unfair trade practice by the consumer courts¹⁰. 
3. Enhancement of interest without borrower consent: Enhancing of interest rate without obtaining written consent of the borrower. Additionally, where clauses of the loan agreement are not in conformity with RBI guidelines, the agreement itself becomes voidable being against the law of the land¹¹.
4. Repossession Clause: Forcible seizure of a vehicle particularly where no prior notice is given before seizing the vehicle, nor any opportunity given to pay dues constitutes an unfair trade practice, and a deficiency in service. The Supreme Court has in this context also held that any action for recovery in these cases may be struck down¹². 

In addition, the covenants demanding instant repayment of loan facilities by the Lender without the occurrence of any default may also be construed as an unfair contract and draw the remedies/penalties as has been provided below. 

Though remedies under the CPA may not be available in case of business loans, however, clauses as has been discussed under consumer loans may also form an unfair contract even in cases of business loans in case the same are present in the terms of the loan agreement with the business entity.

Remedies/ Penalties under the CP Act 

The terms of the contract may be declared null and void (by the National Commission and State Commission (S.59 and S.49 of the Act), and the District/State/National Commissions may issue orders to the opposite party directing them to discontinue the unfair practices. 

However, penal measures are not present towards business loans considering that persons availing business loans are not included within the ambit of the CP Act.

However, while the ambit of “Unfair Contract” under the CP Act is broader in its coverage, the Fair Practice Code of the RBI generally applies to retail loans as well as business loans, save and except to the circumstances where certain paras in the Fair Practice Code are explicitly made applicable on loans provided to individuals. Accordingly, the persons who have availed retail loans as well as persons who have availed business loans can raise their grievances with the RBI ombudsman in circumstances where the grievances have not been addressed by the lender to the satisfaction of the borrower.

Key Takeaways 

Lenders		Borrowers
Consumer Definition: Retail Loans: Borrowers are recognized as consumers under the CP Act. Business Loans: Borrowers are not considered consumers if the loans are for commercial purposes.		Consumer Protection: Retail Loans: As a consumer, borrowers are protected under the CP Act, which includes rights against unfair contract terms and practices. Business Loans: Loans obtained for commercial purposes do not fall under the CP Act.
Unfair Contracts: Retail Loans: Lenders must ensure that contract terms do not qualify as unfair under the CP Act to avoid legal challenges. Business Loans: While the provisions relating to “unfair contract” as provided under the CP Act may not apply, lenders should be aware that such contracts could still be challenged under other legal frameworks.		Unfair Contract Terms: Retail Loans: Borrower can challenge unfair contract terms such as restrictions on prepayment, unreasonable lock-in periods, and excessive interest rates under the CP Act. Business Loans: Although  remedies under the CP Act might not apply, the borrower can seek redress through other legal means if unfair practices are present.
Common Unfair Terms:Lenders should avoid terms that restrict prepayment, impose unreasonable lock-in periods, charge foreclosure fees, or apply excessive interest rates. Even though the CP Act might not apply to business loans, similar terms can affect borrower satisfaction and lead to disputes.		Grievance Redressal: Retail Loans: Utilise the mechanisms for redressal, including filing complaints with the National or State Consumer Disputes Redressal Forums. Business Loans: Address grievances through the Commercial Courts Act, 2015, or common law remedies if contract terms are deemed unfair.
Remedies and Compliance: Retail loans: Lenders should be prepared to modify or eliminate unfair terms to comply with the requirements of the CP Act and avoid regulatory as well as statutory action. Business loans: Lenders should understand that while  remedies under the CP Act might not be available, there are still other legal avenues for addressing unfair practices.		Fair Practice Code:Both retail and business loan borrowers can escalate unresolved grievances to the RBI ombudsman under the Fair Practice Code.
Fair Practice Code:Ensure compliance with the RBI’s Fair Practice Code for both retail and business loans. Complaints can be escalated to the RBI ombudsman if unresolved satisfactorily.

Conclusion

In navigating the complex landscape of borrower rights and lender obligations under a financial transaction, the CP Act, and the RBI’s Fair Practices Code play pivotal roles. The CP Act safeguards borrowers by addressing “unfair contracts,” including terms that restrict prepayment or impose excessive penalties. While these robust protections are available for retail loans, they do not extend to business loans intended for commercial purposes. However, borrowers of business loans are still covered under the Fair Practices Code, which ensures fair treatment and provides a grievance redressal mechanism through the RBI ombudsman. 

We recommend that Lenders be vigilant in crafting fair contract terms to avoid legal disputes, and ensure compliance with both regulatory and statutory frameworks. For retail loan borrowers, avenues for challenging unfair practices are clear and accessible. For business loan borrowers, while direct remedies under the CP Act may not apply, alternative legal channels are available. Ultimately, understanding and adhering to these regulations is crucial for maintaining trust and fairness in lender-borrower relationships which constitutes the bedrock of the financial services sector. 

1. Arun Bhatiya vs. HDFC Bank and Ors. (08.08.2022 – SC) : MANU/SC/1210/2022. ↩︎
2. National Insurance Co. Ltd. vs. Harsolia Motors and Ors. (13.04.2023 – SC) : MANU/SC/0380/2023. ↩︎
3. Shrikant G. Mantri vs. Punjab National Bank (22.02.2022 – SC) : MANU/SC/0225/, . Lilavati Kirtilal Mehta Medical Trust vs M/S Unique Shanti Developers ↩︎
4. Gurumoorthy vs. The Canara Bank and Ors. (26.07.2023 – SCDRC Puducherry) : MANU/SZ/0001/2023 ↩︎
5. Refer footnote 3 of this article ↩︎
6. Standard Chartered Bank & Anr. v Mankumar Kundliya, 2023 ↩︎
7.  Refer footnote 4 ↩︎
8.  Ireo Grace Realtech Pvt. Ltd. vs. Abhishek Khanna and Ors. (11.01.2021 – SC) : MANU/SC/0013/2021 ↩︎
9.  Manish Sehgal v. L&T Finance Ltd. ↩︎
10.  Awaz And Others vs Reserve Bank Of India ↩︎
11. India Bulls Housing Finance Ltd. & Anr. Vs. Boota Singh Sidhu ↩︎
12. Citicorp.Maruti Finance Ltd vs S.Vijayalaxmi on 14 November, 2011 AIR 2012 Supreme Court 509 ↩︎