State laws will not apply to Non­-Banking Financial Companies regulated by RBI: Supreme Court

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The Supreme Court on Tuesday held that Non ­Banking Financial Companies (NBFC) regulated by the Reserve Bank of India (RBI), will not come under the purview of State statutes [Nedumpilli FInance Company Limited v State of Kerala & Ors.].

A Bench of Justices Hemant Gupta and V Ramasubramanian held that such NBFCs, regulated in terms of the provisions of Chapter III­B of the Reserve Bank of India Act, 1934 cannot also be regulated by State enactments such as Kerala Money Lenders Act, 1958 and Gujarat Money Lenders Act, 2011.

“Once it is found that Chapter III­B of the RBI Act provides a supervisory role for the RBI to oversee the functioning of NBFCs, from the time of their birth (by way of registration) till the time of their commercial death (by way of winding up), all activities of NBFCs automatically come under the scanner of RBI. As a consequence, the single aspect of taking care of the interest of the borrowers which is sought to be achieved by the State enactments gets subsumed in the provisions of Chapter III­B”, the judgment stated.

The Court applied the Doctrine of Eclipse and held that once the Parliament stepped in to codify the law with regard to registration and regulations of NBFCs, the state enactments cease to be valid in that regard

“Assuming that the Kerala Act was valid in its application to NBFCs when it was made, on the ground that the business of money lending is traceable to Entry 30 of List II, it has to give way for the parliamentary enactment. The moment the Parliament stepped in to codify the law relating to registration and regulation of NBFCs, by inserting certain provisions in Chapter III­B of then RBI Act, the same would cast a shadow on the applicability (even assuming it is applicable) of the provisions of the Kerala Act to NBFCs registered under the RBI Act and regulated by RBI”, the Court held.

In the instant, the Court held that the Kerala Act and the Gujarat Act will have no application to NBFCs registered under the RBI Act and regulated by the RBI.

The Court was considering two sets of appeals.

One set was filed by the several NBFCs operating in the State of Kerala against the decision of the Kerala High Court dismissing their petitions seeking a declaration that NBFCs registered under the RBI Act will not come within the purview of the Kerala Act.

The NBFCs had previously approached the Government of Kerala seeking exemption but were unsuccessful in their attempt.

The second set of appeals were moved by the State of Gujarat against a Division Bench decision of the Gujarat High Court holding that the Gujarat Act of 2011 is ultra vires the Constitution for legislative incompetence, to the extent that it seeks to have control over NBFCs registered under the RBI Act.

In the background of the facts of the case, the legal issue arising for consideration was resolved by the Supreme Court by looking at the scheme of the two State enactments, the scheme of RBI Act and the relevant Entries in the appropriate List of the Seventh Schedule, to which these enactments can be traced.

At the outset, the top court clarified that the competence of the legislatures of the States of Kerala and Gujarat to enact a law for the regulation of the business of money lending cannot be questioned, as their power is traceable to Entry 30 of List­II of the Seventh Schedule.

But at the same time, the Court considered whether after the enactment of a law by the Parliament for the incorporation and regulation of financial corporations, such financial corporations would continue to be regulated also by the State enactments, on the ground that they may also fall within the definition of the expression “money lenders” under the State enactments.

The apex court found that the scheme of Chapter III­B of the RBI Act shows that the power of intervention available for the RBI over NBFCs, is from the cradle to the grave.

“In other words, no NBFC can carry on business without being registered under the Act and a NBFC which takes birth with the registration under the Act is liable to be wound up at the instance of the RBI. The entire life of a NBFC from the womb to the tomb is also regulated and monitored by RBI”, the judgment stated.

While the RBI is empowered to declare that any NBFC is not subject to the provisions of Chapter III­B, the court, in the instant, was only concerned with NBFCs registered under the RBI Act.

The top court also observed that NBFCs play a very vital role in contributing to the financial health of the country and therefore, to say that the RBI has no power over the interest rates charged by them would strike at the very root of the statutory power vested in the RBI.

Pertinently, the Court held that even if the State enactments had been valid prior to the Parliament codifying the law on regulation and registration of NBFCs, the State enactments have to give way to the Parliamentary enaction.

Accordingly, the Supreme Court allowed all the appeals filed by NBFCs against the judgment of the Kerala High Court. Likewise, it dismissed all the appeals filed by the State of Gujarat against the judgment of the Gujarat high Court.

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