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CASE NO.: Appeal (civil)  3574 of 1998

PETITIONER: Asea Brown Boveri Ltd.

RESPONDENT: Industrial Finance Corporation of India & ors.

DATE OF JUDGMENT: 01//4\001@\006

BENCH: October 27, 2004

JUDGMENT: J U D G M E N T

R.C. Lahoti, CJI

       This is an appeal under Section 10 of the Special Courts  (Trial of Offences Relating to Transactions in Securities) Act,  1992 (hereinafter ’the Act’, for short), feeling aggrieved by an  order dated 28.7.1998 whereby rejecting an objection petition  preferred by the appellant, the Special Court has directed the  appellant to hand over possession of all the 56 cars to the  custodian within one week from the date of the order.

       The Industrial Finance Corporation of India (hereinafter  ’IFCI’, for short) is a Corporation constituted under the Industrial  Finance Corporation of India Act, 1948 and carries on the  business of financing moneys to various borrowers.  Vide  agreement dated 4.12.1990, the appellant entered into a Lease  Finance Agreement with M/s. Fairgrowth Financial Services  Limited (hereinafter ’Fairgrowth’, for short), the respondent No.  3.  Pursuant to the letter of offer dated 26.7.1990 under this  lease finance agreement, the appellant had taken lease finance  of total 57 cars out of which one car was foreclosed in or about  January, 1992, leaving 56 cars under lease finance with the  appellant.

       The case of the appellant as regards these 56 cars and the  relationship of the appellant and respondent No. 3 in so far as  these cars are concerned is stated as follows.  The Appellant  Company deposited total security amount on the 56 cars of Rs.  20,97,447.25 paise.  The total rental payable by the Appellant  Company for 5-year period amounted to Rs. 85,35,379/-.  The  total purchase price of 56 cars is Rs. 84,80,664/-.  As per the  terms of the lease finance agreement mutually agreed into by  the parties, the Appellant Company was required to pay 25% of  the purchase price of the cars as security deposit carrying  interest @ 5% per annum compounded half yearly, a lease  management fee of 1% and lease rental of Rs. 15/- per  thousand Rupees per month of the cash price of the assets which  was later revised to Rs. 16/- per thousand Rupees per month by  a subsequent letter."

       It is further alleged that it was the tacit understanding  between the parties that the cars were to be transferred to the  Appellant Company at the end of initial lease period of 5 years  for which the parties agreed in their agreement by stating that  the terminal fee will be 20%, meaning thereby that on payment  of 20% of the cost price of the cars the said cars would be  transferred by the Lessee Company to the Appellant Company or

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their nominee.  The term terminal fee is a well known term in  Lease Finance Transaction and has no other connotation than the  amount payable for transfer of the leased asset.  This lease  finance agreement was entered into on 4th December, 1990."

       Fairgrowth became a notified party under sub-Section (2)  of Section 3 of the Act due to certain illegal transactions covering  the period between 1.4.1991 and 6.6.1992.  The transaction  entered into on 4.12.1990 pursuant to letter of offer dated  26.11.1990 is not referable to the period during which the  alleged illegal transactions were entered into by Fairgrowth.

       The Central Government appointed IFCI as the custodian,  under sub-Section (1) of Section 3 of the Act, over the  properties belonging to Fairgrowth.  The Appellant Company  continued to make payment to IFCI in place of Fairgrowth as per  lease finance agreement.  An amount of Rs. 30,96,948.30 paise  was paid by the appellant to Fairgrowth till December, 1992.  An  amount of Rs.44,61,273/- was paid by the appellant to the  custodian IFCI.  Thus the total lease rentals actually paid by the  appellant company are Rs.75,31,842/- till May, 1997 whereas  the rentals which were payable by the appellant company were  Rs.85,34,379/- only.   

       According to the appellant company under lease finance  agreement, it had made a security deposit with Fairgrowth on  which an interest of 5% per annum compounded half yearly was  to be paid.  The appellant made a communication to the  custodian clarifying that the appellant would be entitled under  the agreement to the amounts on account of security deposit  and interest accrued thereon at the time of buyback or purchase  of lease assets by the appellant.  On 9.4.1997, the appellant  forwarded a cheque of Rs. 17,800/- in full and final settlement of  dues under lease finance agreement dated 4.12.1990.   According to the appellant, the payment of this amount squared  up fully and finally its liability for payment subject to adjustment  of security deposit and interest agreed thereon and all that  remained to be done thereafter was to transfer the said 56 cars  in favour of the appellant company after cancellation of the  hypothecation which obligation was to be discharged by the  custodian which had taken over the properties of Fairgrowth.   

       A perusal of the detailed order passed by the Special Court  shows that the Special Court refused to treat the transaction  between the appellant and Fairgrowth as one of lease finance  and instead treated it to be a transaction of lease only i.e. the  appellant holding 56 cars as lessee of Fairgrowth. The principal  reason which prevailed according to the Special Court is that in  its application, the appellant had stated the transaction to be of  "lease" and not of "lease finance".  Thus the Special Court has  rigidly applied the rules of pleadings but a perusal of the order  shows that there has been no effort to scrutinize and interpret  the documents evidencing the transaction so as to determine the  real nature thereof.

       This appeal was filed on 31.7.1998.  On 3.8.1998, the  court passed an interim order protecting the possession of the  appellant over the 56 cars.

       On being noticed, the custodian has in its response filed a  calculation sheet prepared by a Chartered Accountant appointed  by the Special Court and, according to his calculation, an amount  of Rs. 6,48,370/- was due and payable by the appellant to the  respondent No. 3.  as per the agreement entered into between

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the parties.  A perusal of this calculation sheet shows that the  main factor responsible for the variation in the ultimate figure of  balance payable is attributable to an amount of Rs.4,89,923/-  being sales tax calculated @5% on the amount of total lease  rent including terminal fee which figure of sales tax the  chartered accountant feels is leviable on the transaction and  hence payable by the appellant.  This is a highly debatable issue  but need not detain us.  Whether or not this amount is held to  be due and payable by the appellant, it will not change the  nature of transaction. The correctness of the calculation has  been disputed in the rejoinder filed on behalf of the appellant  wherein it is submitted that all sums due and payable under the  lease finance agreement dated 4.12.1990 were already paid and  nothing was due and payable at all to any of the respondents by  the appellant.  Even 20% terminal fee, as purchase price of the  56 cars, had been paid and nothing had remained to be done  except termination of hypothecation and transferring on paper of  the ownership of the cars to the appellant which was only a  matter of formality necessarily flowing from the obligation of  respondent No. 3 under the agreement and accounts having  already squared up.  The documents show that the registration  of the cars since inception stands in the name of the appellant.   

       During the course of hearing before this Court, it was  conceded at the Bar that so far as the transaction between the  respondent No. 3 and the appellant as evidenced by the  agreement dated 4.12.1990 is concerned, it is a transaction of  lease finance and the rights and obligations of the parties have  to be worked out accordingly.   

We have heard at length, the learned counsel for the  parties.  We also requested Shri Uday U. Lalit, Senior Advocate,  to assist the Court by pointing out the correct position of law  centering around lease finance transactions.  We place on record  our appreciation of the assistance rendered by the learned senior  counsel, Shri Uday U. Lalit.

What is a lease finance?  According to Dictionary of  Accounting & Finance by R. Brockington (Pitman Publishing,  Universal Book Traders, 1996 at page 136) :-

"A Finance Lease is one where the  Lessee uses the asset for substantially the  whole of its useful life and the lease payments  are calculated to cover the full cost together  with interest charges.  It is thus a disguised  way of purchasing the asset with the help of a  loan.  SSAP 23 required that assets held under  a finance lease be treated on the balance sheet  in the same way, as if they had been  purchased and a loan had been taken out to  enable this."                                                    (emphasis supplied)

       In Lease Financing & Hire Purchase by Dr. J.C. Verma (4th  Edition, 1999 at p.33), Financial Lease has been so defined :-

"Financial lease is a long-term lease on fixed  assets, it may not be cancelled by either party.   It is a source of long-term funds and serves as  an alternative of long-term debt financing.  In  financial lease, the leasing company buys the  equipment and leases it out to the use of a  person known as the lessee.  It is a full payout  lease involving obligatory payment by the

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lessee to the lessor that exceeds the purchase  price of the leased property and finance cost.

Financial lease has been defined by  International Accounting Standards Committee  as "a lease that transfers substantially all the  risks and rewards incident to ownership of an  asset.  Title may or may not eventually be  transferred."  Lessor is only a financier and is  not interested in the assets.  This is the reason  that financial lease is known as full payout  lease where contract is irrevocable for the  primary lease period and the rentals payable  during which period are supposed to be  adequate to recover the total investment in the  asset made by the lessor."

(emphasis supplied)

       According to Lease Financing & Hire Purchase by Vinod  Kothari (Second Edition, 1986, at pp. 6 & 7), a finance lease,  also called a capital lease, is nothing but a loan in disguise.  It is  only an exchange of money and does not result into creation of  economic services other than that of intermediation.  The  learned author has quoted T.M. Clark, one of the most authentic  writers on the subject who defines lease and operating lease in  the undergoing words :-

"A financial lease is a contract involving  payment over an obligatory period of specified  sums sufficient in total to amortise the capital  outlay of the lessor and give some profit."

"An operating lease is any other type of lease \026  that is to say, where the asset is not wholly  amortised during the non-cancellable period, if  any, of the lease and where the lessor does not  rely for his profit on the rentals in the non- cancellable period."

       The features of the financial lease, according to the  learned author are as under :

"1.The asset is use-specific and is selected for the  lessee specifically.  Usually, the lessee is allowed  to select it himself.

2. The risks and rewards incident to ownership are  passed on to the lessee.  The lessor only remains  the legal owner of the asset.

3.Therefore, the lessee bears the risk of   obsolescence.

4. The lessor is interested in his rentals and not in  the asset.  He must get his principal back along  with interest.  Therefore, the lease is non- cancellable by either party.

5. The lease period usually coincides with the  economic life of the asset and may be broken into  primary and secondary period.

6. The lessor enters into the transaction only as a

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financier.  He does not bear the costs of repairs,  maintenance or operation.

7. The lessor is typically a financial institution and  cannot render specialized service in connection  with the asset.

8. The lease is usually full-pay-out, that is, the single  lease repays the cost of the asset together with  the interest."

In our opinion, financial lease is a transaction current in  the commercial world, the primary purpose whereof is the  financing of the purchase by the financier.  The purchase of  assets or equipments or machinery is by the borrower.  For all  practical purposes, the borrower becomes the owner of the  property inasmuch as it is the borrower who chooses the  property to be purchased, takes delivery, enjoys the use and  occupation of the property, bears the wear and tear, maintains  and operates the machinery/equipment, undertakes indemnity  and agrees to bear the risk of loss or damage, if any.  He is the  one who gets the property insured.  He remains liable for  payment of taxes and other charges and indemnity.  He cannot  recover from the lessor, any of the above mentioned expenses.   The period of lease extends over and covers the entire life of the  property for which it may remain useful divided either into one  term or divided into two terms with clause for renewal.  In either  case, the lease is non-cancellable.  

All the abovesaid features are available in the transaction  entered into by the appellant.  In addition, we find that the  registration of the 56 cars stood in the name of the appellant  from the very beginning and on payment of full amount including  termination fee, as agreed upon, nothing more was needed to be  done to vest the appellant with ownership and only loan  documents were needed to be discharged and cancelled.

There are certain tax benefits which by styling the  transaction like a financial lease become available to the lessor  (financer) and the lessee (borrower) both.  Accounting standards  have been devised consistently with which the entries are made  in the accounts so as to satisfy the requirements of tax laws and  to avail the best benefits by way of tax planning to both the  parties.   

However, so far as the Act is concerned, we have to go by  the provisions of the Act, keeping in view the real nature of the  transaction ascertaining the real intention of the contracting  parties in the light of the facts and circumstances of a given  case.  Once a party has been notified under sub-Section (2) of  Section 3 of the Act then under sub-Section (3), notwithstanding  anything contained in any other law for the time being in force  with effect from the date of notification under sub-Section (2),  any property, movable or immovable or both belonging to  notified party stands attached simultaneously with the issue of  the notification and becomes liable to be dealt with by the  custodian in such manner as the Special Court may direct.  A  person is liable to be notified by reference to transaction in  securities between 1.4.1991 and 6.6.1992.  Any contract or  agreement entered into between 1.4.1991 and 6.6.1992, in  relation to any property of the notified party is liable to be  cancelled, if found to have been entered into fraudulently or to  defeat the provisions of the Act. Analysing the provisions of the  Act, it was held in B.O.I. Finance Ltd. Vs. Custodian and  others, (1997) 10 SCC 488, that the custodian under the Act is

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required to assist in the attachment of the notified person’s  property and to manage the same thereof.  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 not a receiver  nor is he a final liquidator so as to enjoy control over the  properties.  In other words, the position of the custodian is the  same as that of the notified person himself.  We are, therefore,  of the opinion that the custodian remains bound by the  obligations incurred by the notified party itself, if not incurred  fraudulently or to defeat the provisions of the Act.

For the purpose of deciding the controversy before us, it is  not necessary for us to examine whether the transaction entered  into between the appellant and Fairgrowth, the respondent No.  3, would at all attract the applicability of the provisions of the  Act in view of sub-section (2) of Section 3 thereof.  The learned  counsel for the appellant has taken a very fair stand submitting  that the appellant is prepared to pay if anything is still found to  be due and payable by it but in any case the 56 cars could not  have been held liable and directed to be delivered to the  custodian.  It was a simple case of accounting.  If the appellants  have cleared all their payments in accordance with the  agreement dated 4.12.1990, initially to Fairgrowth and  thereafter to the custodian including payment of terminal fee  subject to adjustment for security deposit and the interest  accrued thereon, then all that had remained to be done was the  transfer of ownership on paper which the custodian should have  been directed to do, submitted the leaned counsel.  But, as we  have already noticed, the registration of the cars already stands  in the name of the appellant.  On a scrutiny of the accounts, if in  the opinion of the Special Court, nothing had then remained to  be paid by the appellant, then it was only a matter of calculation,  the difference between the appellant’s statement of account and  the one prepared by the Chartered Accountant at the instance of  the custodian being bonafide, the appellant could, at best, have  been directed to pay the deficit.  But in no case submitted the  learned counsel for the appellant, the 56 cars could have been  directed to be delivered to the custodian.  In spite of having  made full payment (bonafide error or dispute as to calculation  excepted), direction for delivery of cars to the custodian has  caused failure of justice.  We find ourselves in agreement with  the submission so made.

The appeal is allowed.  The impugned order dated 28.7.98  passed by the Special Court is set aside.  The application filed by  the appellant shall stand restored on the file of the Special  Court.  The Special Court shall look into the accounts after  affording the parties an opportunity of hearing and determine if  any amount, and if so to what extent, remains still payable by  the appellant to the custodian, for and on behalf of Fairgrowth,  the respondent No. 3.  In the event of any amount being held  liable to be so paid, the same shall be paid by the appellant  within the time appointed by the Special Court failing which the  appellant shall be liable to be proceeded against including for  attachment of property.

No order as to the costs.