Central Bank of India vs. Ravindra and Ors.

Judges: Dr. A.S. Anand, C.J., K.T. Thomas, R.C. Lahoti, N. Santosh Hegde and S.N. Variava, JJ.

Facts:

The petitioner bank sanctioned a loan to the respondent no. 1 on the guarantee of respondent nos. 2 and 3. Respondent no. 1 executed a demand promissory note and also executed term agreement of hypothecation of the vehicle. The loan carried interest at the rate of 11% per annum with quarterly rests.

The total outstanding, inclusive of the interest charged as per agreement, was Rs. 1,51,825/- on the date, suit for the recovery was field by the petitioner bank.

The trial court passed a decree for Rs. 1,51,825 with future interest at the rate of 8% per annum from the date of the suit till realisation. High Court in appeal modified the decree of the trial court by awarding interest at the rate of 11% per annum.

However, the High Court directed the interest at the rate of 11% per annum to be payable only on Rs. 99,000/-, which was stated to be the principal sum, from the date of the suit till realisation, though the decree for Rs. 1,51,825/- i.e., amount due and payable on the date of the suit, was maintained.

Against the decree of the High Court to the extent to which future interest at the rate of 11% per annum has not been allowed on the entire sum of Rs.1,51,825/-, appeal was filed before the Supreme Court.

The appeal was initially heard by a three-Judges Bench, who referred the matter to a five-Judges Constitution Bench.

Issues:

(i) What is the meaning to be assigned to the phrases "the principal sum adjudged" and "such principal sum" as occurring in Section 34 of CPC [as amended by the Code of Civil Procedure (Amendment) Act (66 of 1956) w.e.f. 1.1.1957], with respect to suits for recovery of money, especially those filed by banking institutions against their borrowers?

Law:

Civil Procedure Code, 1908 - Section 34 - Power of Courts to order interest, at such rate as the Court deems reasonable, to be paid on the principal sum adjudged in a suit for the payment of money.

Contentions:

Petitioners

(i) Expression "the principal sum adjudged" used in Section 34 may have two meaning; the amounts actually disbursed to the borrower, or the amount due from the borrower on the date of the suit which amount would include the amount of interest due and payable on the date of the institution of the suit in the Court.

(ii) 'The principal sum adjudged' would include all sums as are due under the contract between the parties and have stood capitalised with the amount actually disbursed to the borrower.

(iii) Contract between the parties or an established bank practice (in the case of banking transactions) may provide for the interest on periodical rests being compounded and capitalised with the principal, in which event, the amount debited in the account of the borrower shall shed its character an interest and become the principal on being capitalised and therefore shall have to be adjudged as the 'principal sum' on the date of the suit.

(iv) The contract or established banking practice shall govern the relationship between the parties and bind the Court. The Court will not reopen the account so as to be separate from the amalgam-the interest charged and the sums actually advanced, and repaint the interest with the colour which had stood shed off unless mandate of law overrides the contract or practice and enables or compels the Court to do so.

(v) The 1956 amendment, which has substituted the words "on such principal sum" for the words 'on the aggregate sum so adjudged' has only this effect that prior to the amendment future interest was capable of being awarded on the aggregate of three components taken together, i.e. (1) the principal sum (so adjudged), (2) pre-suit interest (so adjudged), and (3) decretive costs.

(vi) By virtue of 1956 amendment, the amount of interest adjudged as interest on the date of the suit and decretal costs cannot be ordered to carry future interest, but the amount adjudged as principal sum though inclusive of interest which has stood capitalised and has partaken character of principal by virtue of contract of banking practice, is capable of bearing future interest because it will be 'the principal sum adjudged'.

Respondents

(i) Without regard to be fact that the interest for the pre-suit period has stood capitalised by force of contract or banking practice between the parties, and has assumed the colour and character of principal sum, the contract of banking practice ceases to be applicable once the suit is filed and the matter has entered the domain of Court under Section 34 of the CPC.

(ii) Nothing prevents the Courts, after filing of the suit, from unscrambling the amalgam so as to sieve out the principal from interest and confine the award of interest 2endent lite and post decree to principal sum only.

Analysis:

Interest once capitalised, sheds its colour of being interest and becomes a part of principal

(i) There is nothing wrong in the parties voluntarily entering into transaction, evidenced by deeds incorporating covenant or stipulation for payment of compound interest at reasonable rates, and authorising the creditor to capitalise the interest on remaining unpaid so as to enable interest being charged at the agreed rate on the interest component of the capitalised sum for the succeeding period.

(ii) Interest once capitalised, sheds its colour of being interest and becomes a part of principal so as to bind the debtor/borrower.

Phrase 'Such Principal' in Section 34 of CPC - Meaning of

(i) Expression "the principal sum adjudged" may include the amount of interest, charged on periodical rests, and capitalised with the principal sum actually advanced, so as to become an amalgam of principal in such cases where it is permissible or obligatory for the Court to hold so.

(ii) Where the principal sum (on the date of suit) has been so adjudged, the same shall be treated as "principal sum" for the purpose of "such principal sum" - the expression employed later in Section 34 CPC.

(iii) The expression "principal sum" cannot be given different meanings at different place in the language of same section, i.e., Section 34 of CPC.

Interest - How should be capitalised

(i) Though interest can be capitalised on the analogy that the interest falling due on the accrued date and remaining unpaid, partakes the character of amount advanced on that date, yet penal interest, which is charged by way of penalty for non-payment, cannot be capitalised.

(ii) Further interest, i.e. interest on interest, whether simple, compound or penal, cannot be claimed on the amount of penal interest. Penal interest cannot be capitalised. It will be opposed to public policy.

(iii) Novation, that is, a debtor entering into a fresh agreement with creditor undertaking payment of previously borrowed principal amount coaled with interest by treating the sum total as principal, any contract express or implied and an express acknowledgement of accounts, are best evidence of capitalisation.

(iv) Acquiescence in the method of accounting adopted by the creditor and brought to the knowledge of the debtor may also enable interest being converted into principal. A mere failure to protest is not acquiescence.

(v) The prevalence of banking practice legitimatizes stipulations as to interest on periodical rests and their capitalisation being incorporated in contracts. Such stipulations incorporated in contracts voluntarily entered into and binding on the parties shall govern the substantive rights and obligations of the parties as to recovery and payment of interest.

Capitalisation method - Foundation of

(i) Capitalisation method is founded on the principle that the borrower failed to make payment though he could have made and thereby rendered himself a defaulter.

(ii) To hold an amount debited to the account of the borrower capitalised it should appear that the borrower had an opportunity of making the payment on the date of entry or within a reasonable time or period of grace from the date of debit entry or the amount falling due and thereby avoiding capitalisation.

(iii) Any debit entry in the account of the borrower and claimed to have been capitalised so as to form an amalgam of the principal sum may be excluded on being shown to the satisfaction of the Court that such debit entry was not brought to the notice of the borrower and/or he did not have the opportunity of making payment before capitalisation and thereby excluding its capitalisation.

Award of interest 3endent lite and post-decree - Whether discretionary

(i) In a given case if the Court finds that in the principal sum adjudged on the date of the suit, the component of interest is disproportionate with the component of the principal sum actually advanced, the Court may exercise its discretion in awarding interest pendente lite and post-decree interest at a lower rate or may even decline awarding such interest.

(ii) The discretion shall be exercised fairly, judiciously and for reasons and not in an arbitrary or fanciful manner.

Conclusions:

(i) Subject to a binding stipulation contained in a voluntary contract between the parties and/or an established practice or usage, interest on loans and advances may be charged on periodical rests and also capitalised on remaining unpaid. The principal sum actually advanced, coupled with the interest on periodical rests so capitalised, is capable of being adjudged as principal sum on the date of the suit.

(ii) The principal sum so adjudged is 'such principal sum' within the meaning of Section 34 of CPC on which 'interest pendente lite' and 'future interest' i.e. post-decree interest, at such rate and for such period which the Court may deem fit, may be awarded by the Court.

Important Precedents:

(i) Corporation Bank Vs. H.S. Gowda and Anr. MANU/SC/0788/1994

(ii) Bank of Baroda Vs. Jagannath Pigment & Chemicals & Ors. MANU/SC/1565/1994