Companies are the most popular form of business organization. However, they can take several other forms too including Limited Liability Partnership, Co operative society etc. In this write-up, we shall focus on various facets of co-operative societies.
Co operative societies are near universal concepts, and are prevalent across sectors including agriculture, finance, healthcare etc. The ultimate motive of these societies, is welfare of its members, who come together voluntarily to form a society. In fact, they work on the principle of mutual trust and welfare. The stated objective of most co operative societies, is to protect the interest of have not, weak and marginalized sections of the society.
“Co-operative society” are entities registered under State Co-operative Society Act or Multi State Co-operative Society Act, 2002. An example, include “The Punjab Co-operative Societies Act, 1961”. Such a society may be registered for promotion of the economic interest of its members in accordance with the co-operative principles.
The members of a co-operative society is generally constructed as “a person joining in the application for the registration of a co-operative society and a person admitted to membership after such registration in accordance with this Act, the rules and the bye-laws, and includes a nominal and an associate member and the Government when it subscribes to the share-capital of a society”.
“Nominal” and “associate member” in turn are defined as “a person admitted to membership as such after registration in accordance with the bye-laws” and “a member who holds jointly a share of a co-operative society with others but whose name does not stand first in the share certificate”.
Salient Features of Co operative Societies:
Different types of co operative society include Credit and Thrift Co operative Societies, credit unions, consumer co operatives, housing co operative society etc.
Co-operative Society Laws and Scams:
India is often criticized as an over-regulated economy. However, in-spite of such over regulation, there are loopholes in its archaic laws. These loopholes are not theoretical, but are already being exploited by white collar criminals to make good fortunes for themselves.
In the course of discussion, following aspects will be considered for analysis:
Indian law permits societies for the promotion of the economic interest of its members, as such many such societies have come up. Most of them deliberately use the words “Thrift” and “Credit” in their name e.g., “ABC Urban Co-operative Thrift and Credit Society Limited”.
The Oxford Dictionary defines them as:
Thrift - The habit of saving money and spending it carefully so that none is wasted
Credit - An arrangement that you make, with a shop/ store for example, to pay later for something you buy.
Such a nomenclature gives an impression to gullible citizens that it’s eligible to conduct operations similar to banking business
Can a Co-operative Society Conduct Banking Operations?
A co-operative society can engage itself in promoting the economic interest of its members. This includes lending and borrowing among its members, in accordance with the rules and by-laws that the society must adhere itself to.
However, there lies a difference in borrowing and lending operation of a co-operative society and a Scheduled Commercial Bank (SCBs). The difference is of operational scale.
Given the importance of banking business in the economy, they are regulated by Banking Regulation Act 1949 (license is granted under Section 22).
Section 22 in BANKING REGULATION ACT, 1949
22. Licensing of banking companies:
(1) Save as hereinafter provided, no company shall carry on banking business in India unless it holds a licence issued in that behalf by the Reserve Bank and any such licence may be issued subject to such condi¬tions as the Reserve Bank may think fit to impose.
(2) Every banking company in existence on the commencement of this Act, before the expiry of six months from such commencement, and every other company before commencing banking business in India, shall apply in writing to the Reserve Bank for a licence under this section:
Provided that in the case of a banking company in existence on the commencement of this Act, nothing in sub-section (1) shall be deemed to prohibit the company from carrying on banking business until it is granted a licence in pursuance of 3 this section or is by notice in writing informed by the Reserve Bank that a licence cannot be granted to it:
Provided further that the Reserve Bank shall not give a notice as aforesaid to a banking company in existence on the commencement of this Act before the expiry of the three years referred to in sub-section (1) of section 11 or of such further period as the Reserve Bank may under that sub-section think fit to allow.
(3) Before granting any licence under this section, the Reserve Bank may require to be satisfied by an inspection of the books of the company or otherwise that the following conditions are fulfilled, namely:
5(a) that the company is or will be in a position to pay its present or future depositors in full as their claims accrue;
(b) that the affairs of the company are not being, or are not likely to be, conducted in a manner deterimental to the interests of its present or future depositors;
(c) that the general character of the proposed management of the company will not be prejudicial to the public interest or the interest of its depositors;
(d) that the company has adequate capital structure and earning prospects;
(e) that the public interest will be served by the grant of a licence to the company to carry on banking business in India;
(f) that having regard to the banking facilities available in the proposed principal area of operations of the company, the poten¬tial scope for expansion of banks already in existence in the area and other relevant factors the grant of the licence would not be prejudicial to the operation and consolidation of the banking system consistent with monetary stability and economic growth;
(g) any other condition, the fulfilment of which would, in the opinion of the Reserve Bank, be necessary to ensure that the carrying on of banking business in India by the company will not be prejudicial to the public interest or the interests of the depositors.
(3A) Before granting any licence under this section to a compa¬ny incorporated outside India, the Reserve Bank may require to be satisfied by an inspection of the books of the company or other-wise that the conditions specified in sub-section (3) are ful¬filled and that the carrying on of banking business by such company in India will be in the public interest and that the Government or law of the country in which it is incorporated does not discriminate in any way against banking companies registered in India and that the company complies with all the provisions of this Act applicable to banking companies incorporated outside India.
(4) The Reserve Bank may cancel a licence granted to a banking company under this section —
1. if the company ceases to carry on banking business in India; or
2. if the company at any time fails to comply with any of the conditions imposed upon it under sub-section (1); or
3. if at any time, any of the conditions referred to in sub-section (3) and sub-section (3A) is not fulfilled: Provided that before cancelling a licence under clause (ii) or clause (iii) of this sub-section on the ground that the banking company has failed to comply with or has failed to fulfil any of the conditions referred to therein, the Reserve Bank, unless it is of opinion that the delay will be prejudicial to the interests of the company’s depositors or the public, shall grant to the company on such terms as it may specify, an opportunity of taking the necessary steps for complying with or fulfilling such condition.
(5) Any banking company aggrieved by the decision of the Reserve Bank cancelling a licence under this section may, within thirty days from the date on which such decision is communicated to it, appeal to the Central Government.
(6) The decision of the Central Government where an appeal has been preferred to it under sub-section (5) or of the Reserve Bank where no such appeal has been preferred shall be final.
RBI has clarified that Co-operative Societies have not been authorized by RBI for doing banking business in India. The exact public order has been reproduced as follows:
Caution against various Co-operative societies using the word “Bank” in their names
It has come to the notice of Reserve Bank of India (RBI) that some Co-operative Societies are using the word “Bank” in their names. This is a violation of Section 7 of the Banking Regulation Act, 1949 (As Applicable to Co-operative Societies) (the B.R.Act, 1949).
It has also come to the notice of RBI that some Co-operative societies are accepting deposits from non-members / nominal members / associate members which tantamount to conducting banking business in violation of the provisions of the B.R.Act, 1949.
Members of the public are hereby informed that such societies have neither been issued any licence under B.R.Act, 1949 nor are they authorized by the RBI for doing banking business. The insurance cover from Deposit Insurance and Credit Guarantee Corporation (DICGC) is also not available for deposits placed with these societies. Members of public are advised to exercise caution and carry out due diligence of such Co-operative societies before dealing with them.
Ajit Prasad Assistant Adviser
Supreme Court Verdicts:
The honorable Supreme Court in the landlmark judgement “The Apex Co-operative Bank of Urban Bank of Maharastra and Goa Limited vs The Maharastra State”, on Oct 29, 2003 discussed the matter relating to banking business by Co-operative Societies in the most comprehensive manner.
The relevant paragraphs of the judgement have been reproduced below:
Question (a): Whether a Co-operative Society registered under the Multi State Act can be granted a License by the RBI to commence and carry on banking business?
As set out hereinabove the RBI in its letter dated 25th April, 1994 had taken the stand that a co-operative society registered under the Multi State Act would not be a co-operative bank as defined in the Banking Regulation Act. The same stand had been reiterated by the RBI in its affidavit before the High Court. However, surprisingly in its submission before this Court a contrary stand has been taken by RBI. For a consideration of this question the relevant provisions of the Banking Regulation Act need to be looked at. Section 5(b) and Section 22 of the Banking Regulation Act, 1949 read as follows:
"5. Interpretation: In this Act, unless there is anything repugnant in the subject or context, -
(b) "banking" means the accepting for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise;
(c) xxxx (cci) "co-operative bank" means a state co-operative bank, a central co-operative bank and a primary co- operative bank;
(ccvii) "central co-operative bank", "co-operative society", 'primary rural credit society' and "state co-operative bank" shall have the meanings respectively assigned to them in the National Bank for Agriculture and Rural Development Act, 1981;"
"22. Licensing of co-operative banks :-
(1) Save as hereinafter provided, no co-operative society shall carry on banking business in India unless -
(a) it is a primary credit society, or
(b) it is co-operative bank and holds a License issued in that behalf by the Reserve Bank, subject to such conditions, if any, as the Reserve Bank may deem fit to impose :
Provided that nothing in this sub-section shall apply to a co-operative society, not being a primary credit society or a co-operative bank carrying on banking business at the commencement of the Banking Laws (Application to Co-operative Societies) Act, 1965, for a period of one year from such commencement.
(2) Every co-operative society carrying on business as co-operative bank at the commencement of the Banking Laws (Application to Co-operative Societies) Act, 1965, shall before the expiry of three months from such commencement, every co-operative bank which comes into existence as a result of the division of any other co-operative society carrying on business as a co-operative bank or the amalgamation of two or more co-operative societies carrying on banking business shall, before the expiry of three months from its so coming into existence, every primary credit society which becomes a primary co-operative bank after such commencement shall before the expiry of three months from the date on which it so becomes a primary co-operative bank and every co-operative society other than a primary credit society shall before commencing banking business in India, apply in writing to the Reserve Bank for a License under this section :
Provided that nothing in clause (b) of sub-section (1) shall be deemed to prohibit -
(i) a co-operative society carrying on business as a co-operative bank at the commencement of the Banking Laws (Application to Co-operative Societies) Act, 1965; or
(ii) a co-operative bank which has come into existence as a result of the division of any other co-operative society carrying on business as a co-operative bank, or the amalgamation of two or more co-operative societies carrying on banking business at the commencement of the Banking Laws (Application to Co-operative Societies) Act, 1965, or at any time thereafter; or
(iii) a primary credit society which becomes a primary co-operative bank after such commencement, from carrying on banking business until it is granted a License in pursuance of this section or is, by a notice in writing notified by the Reserve Bank that the License cannot be granted to it.
xxx xxx xxx xxx xxx xxx Under Section 22, as it stood prior to the amendment brought about by the Amendment Act of 68 wherein Section 56 was inserted, the RBI had right to issue license to companies to carry out banking business and no company could carry on a banking business unless it held a license issued by the RBI. After the amendment certain types of co-operative societies, as were brought within the purview of the Banking Regulation Act, could be issued a license by the RBI. Section 22 as amended prohibits co-operative societies from carrying on banking business. The term "co-operative society", as used in Section 22, would include all types of co-operative societies. In other words no co-operative society can carry on banking business unless it falls within the permitted categories set out in Section 22. The term "co- operative bank" has been defined under Section 5(cci) as a state co- operative bank, a central co-operative bank and a primary co- operative bank. Thus the term "co-operative bank" does not include all co-operative societies. It only includes the above mentioned three types of societies. By virtue of Section 5(ccvii) the term "state co- operative bank" is to be understood as a state co-operative bank as defined in the NABARD Act. Thus unless a co-operative society is a state co-operative bank or a central co-operative bank or a primary co-operative bank (as defined under the NABARD Act), no license can be issued by the RBI. In view of these clear provisions it will have to be held that the stand taken by the RBI in its letter dated 25th April, 1994 was and is the correct stand.
It must be mentioned that the Appellants accept this to be the correct provision. They only contest 1st Respondent's claim that the Appellants could not be declared a state co-operative bank under Section 2(u) of NABARD Act. In this behalf the relevant portions of the written submissions given by the learned Attorney General read as follows:
"10. It is submitted that a perusal of the BR Act and the NABARD Act would reveal the following scheme:
(i) for the Appellant to carry on banking business, Reserve Bank of India [hereinafter referred to as RBI] has to grant a license;
(ii) In order to get an RBI license, according to BR Act, the Appellant has to be a co-operative bank i.e. in this case a State Co-operative Bank;
(iii) For the Appellant to be a State Co-operative Bank, it has to be notified as such under Section 2(u) of the NABARD Act;"
Written submissions on behalf of the Appellants given by Mr. Andhyarujina also need to be noted. The relevant portion reads as follows:
"According to the scheme of the BR Act, for the grant of a license to the Appellant, it has to first come within the meaning of a "cooperative bank" i.e. either a state cooperative bank, central cooperative bank or a primary cooperative bank. It is only after a notification under section 2(u) of NABARD is issued the cooperative society becomes a cooperative bank within the meaning of section 5(cci) of the BR Act as amended by section 56(c) of the BR Act and thus became eligible to for license from the RBI under section 22 of the BR Act read with section 56(o) of the BR Act. Thus a notification under section 2(u) in these circumstances necessarily precedes the grant of a license by the RBI."
We hold that this is the correct position.
The same stands re-iterated in Mr.S.P.Sharma with Mr. Kaushal … vs on May 14, 2014 in Rajasthan High Court – Jodhpur.
How Co-operative Societies Bypass Banking License Requirement?
A co-operative society can lend and borrow from amongst its members for promotion of their economic interest. It’s akin to banking business albeit much smaller levels. By scaling it up sufficiently, they achieve scale of real world banking operations.
All it requires is to enhance the size of members. The co-operative societies, accomplish it by providing incentives to nominal, associate and additional members to subscribe to its share capital and by granting right to vote.
Once these conditions are met, a co-operative society is lawfully able to lend and borrow, without requirement of a valid Banking License under Banking Regulation Act, 1949. Since, thus is no cap on the number of members in a co-operative society, it is able to scale up its operations to virtually any level.
Acts which Regulate Co-operative Societies?
Following Acts can have bearing on Co operative Societies.
The Money Lending Act, 1938:
Section 3: Presumption where interest charged exceeds 20% p.a:
(1) Where, in any proceedings in respect of any money lent after the commencement of this Act or in respect interest of any agreement or security made or taken after the commencement of this Act in respect of money lent either before or after the commencement of this Act, it is found that the interest charged exceeds the prescribed rate per annum, the court shall, unless the contrary is proved, presume for the purposes of section 2 that the interest charged is excessive and that the transaction is harsh and unconscionable, but this provision shall be without prejudice to the powers of the court under that section where the court is satisfied that the interest charged, although not exceeding (2). In this section “prescribed rate” means such rate as the Minister may from time to time, by order, prescribe.
Section 9: Prohibition of compound interest and provision as to defaults:
Subject as hereinafter provided, any contract made after the commencement of this Act for the loan of money shall be illegal in so far as it provides directly or indirectly for the payment of compound interest or for the rate or amount of interest being increased by reason of any default in the payment of sums due under the contract:
Provided that provision may be made by any such contract that if default is made in the payment upon the due date of any sum payable to the lender under the contract, whether in respect of principal or interest, the lender shall be entitled to charge simple interest on that sum from the date of the default until the sum is paid, at a rate not exceeding the rate payable in respect of the principal apart from any default and any interest so charged shall not be reckoned for the purposes of this Act as part of the interest charged in respect of the loan:
Provided further that any such provision for the payment of simple interest in the circumstances aforesaid shall be in writing and signed personally by the borrower.
Section 13: Exemptions:
(k) An entity –
(i) which is established by a statutory body or authority; and
(ii) the primary purpose of which is to lend money
Thus, neither 20% p.a as maximum rate nor compounded penal rate is disallowed for a Co-operative society.
Banning of Unregulated Deposit Schemes Act, 2019:
It is an “Act to provide for a comprehensive mechanism to ban the unregulated deposit schemes, other than deposits taken in the ordinary course of business, and to protect the interest of depositors and for matters connected therewith or incidental thereto”.
THE FIRST SCHEDULE - [See section 2 (15)]
REGULATED DEPOSIT SCHEMES:
The Regulator and Regulated Deposit Scheme refers to the regulators and schemes and arrangements listed in the following Table, namely:
The State Government- (i) Any scheme or an arrangement made or offered by a or Union territory co-operative society registered under the Co-operative Government Societies Act, 1912 (2 of 1912) or a society being a society registered or deemed to be registered under any law relating to co-operative societies for the time being in force in any State or Union territory
"Explanation III.— The amounts accepted by a co-operative society from the members or shareholders, by whatever name called, but excluding the amounts received as share capital, shall be deemed to be deposits for the purposes of this clause, if such members or shareholders are nominal or associate members, by whatever name called, who do not have full voting rights in the meetings of such co-operative society.".
PART III - AMENDMENT TO THE MULTI-STATE CO-OPERATIVE SOCIETIES ACT, 2002:
In the Multi-State Co-operative Societies Act, 2002, in section 67, in sub-section (1),—
(a) after the words "receive deposits", the words "from its voting members" shall be inserted;
(b) the following Explanation shall be inserted, namely:—
"Explanation.—For the removal of doubts, it is hereby clarified that a multi-State co-operative society shall not be entitled to receive deposits from persons other than voting members.".
Thus, a Co-Operative Society or Multi-State Co-Operative Societies who grants full voting rights to its nominal or associate members, does not come under the ambit of BUDS Act, 2019.
How some Societies Allegedly Exploit Members?
There have been allegations that these societies exploit members by:
a) Diverting funds meant for the operations of society and welfare of its members to shell companies
b) Lending at highly exorbitant rates, typically at 30 – 50% p.a and accumulating capital at much low rates, typically at 5 – 10 % p.a
c) Having compounded penal rates etc
These societies many times lack grievance redressal system. The victim has to resort to arbitration for settlement of dispute. For example,
The Punjab Co-operative Societies Act, 1961
Section – 55: Disputes which may be referred to arbitration:-
(1) Notwithstanding anything contained in any law for the time being in force, if any dispute touching the constitution, management or the business of a co-operative society arises –
(a) among members, past members and persons claiming through members, past members and deceased members; or
(b) between a member, past member or person claiming through a member, past member or deceased member and the society, its committee or any officer, agent or employee of the society or liquidator, past or present; or
(c) between the society or its committee and any past committee, any officer, agent or employee, or any past officer, past agent or past employee or the nominee, heirs or legal representatives of any deceased officer, deceased agent, or deceased employee of the society; or
(d) between the society and any other co-operative society, between a society and liquidator of another society or between the liquidator of one society and the liquidator of another society; such dispute shall be referred to the Registrar for decision and no court shall have jurisdiction to entertain any suit or other proceeding in respect of such dispute.
(2) For the purpose of sub-section (1), the following shall be deemed to be disputes touching the constitution, management or the business of co-operative society, namely –
(a) a claim by the society for any debt or demand due to it from a member or the nominee, heirs or legal representatives of a deceased member, whether such debt or demand be admitted or not ;
(b) a claim by a surety against the principal debtor where the society has recovered from the surety any amount in respect of any debt or demand due to it from the principal debtor as a result of the default of the principal debtor, whether such debt or demand is admitted or not; and
(c) any dispute arising in connection with the election of any officer of the society.
(3) If any question arises whether a dispute referred to the Registrar under this section is or is not a dispute touching the constitution, management or the business of a co-operative society, the decision thereon of the Registrar shall be final and shall not be called in question in any court.
The arbitration process can be tiring because of Sections similar to –
Section - 79: Notice necessary in suits.
No suit shall be instituted against a co-operative society or any of its officers in respect of any act touching the business of the society until the expiration of three months next after notice in writing has been delivered to the Registrar or left at his office, stating the cause of action, the name, description and place of residence of the plaintiff and the relief which he claims, and the plaint, shall contain a statement that such notice has been so delivered or left
Real Life Scams by Co-operative Societies:
The most infamous scam has been committed by Adarsh Credit Co-operative Society. The Wikipedia page reads as follows for the Society:
The Adarsh Credit Co-operative Society (ACCS) is a Ponzi scheme fraudulently registered under the MSCS Act w.e.f. 1986. It opened in 1999, primarily to bluff the public in Rajasthan, and all money has been siphoned off by the family members of the owners to buy properties and dupe investors of funds worth Rs. 8,000 Crore.
Founded by Mukesh Modi, Adarsh Credit Ponzi Scheme was led by Rahul Modi (Managing Director & CEO). Adarsh Credit Co-operative Society Ltd. has over 3.3 lakh advisors and is serving more than 1.9 million members across India as on 30 Jan 2018.
Adarsh Credit opened its 100th branch in 2008 and was granted the stature of Multistate Co-Operative Society by the Ministry of Agriculture, Government of India. It had 809 branches (as on August 31, 2016) in PAN India (except Dadra & Nagar Haveli and Lakshadweep) and become India’s leading credit co-operative society in terms of branch network, advisor strength, deposit procurement and running shell companies out of poor people's money.
Need for RBI’s Regulation:
The regulation of banking operations are meant to safeguard the interest of both depositors and lenders – to prevent frauds. E.g., Maharastra Co-operative bank fraud type incidents.
An unregulated regime would lead to frequent scams, leading to breakdown of faith in the banking operations. Hence, the regulation by India’s Central Bank which includes:
Thus, regulatory oversight by RBI is needed for prudent banking operations.
SCBs and NBFC:
Scheduled Commercial Banks and NBFCs follow meticulously drafted rules and regulations by RBI for lending, lending rates, penal rates, recovery procedure etc.
Fair Code Practices for NBFCs:
The Reserve Bank vide its circular dated September 28, 2006, issued guidelines on Fair Practices Code (FPC) for all NBFCs to be adopted by them while doing lending business. The guidelines inter alia, covered general principles on adequate disclosures on the terms and conditions of a loan and also adopting a non-coercive recovery method.
The Fair Code Practices for NBFC deal with:
Base Rate for Scheduled Commercial Banks:
There are similar provisions for SCBs.
1) Granting them Status Similar to Nidhi Companies:
Nidhi means a company which has been incorporated with the object of developing the habit of thrift and reserve funds amongst its members and also receiving deposits and lending to its members only for their mutual benefit. It is a type of company in the Indian non-banking finance sector, recognized under section 406 of the Companies Act, 2013.
Their core business is borrowing and lending money between their members. They are also known as Permanent Fund, Benefit Funds, Mutual Benefit Funds and Mutual Benefit Company. They are regulated by Ministry of Corporate Affairs. However, Reserve Bank of India is also empowered to issue directions to them in matters relating to their deposit acceptance activities. They are governed by Nidhi Rules, 2014.
Similar to Nidhi Companies, Co-operative Societies engaged in banking business can be granted a special status. And, similar to Nidhi Rules, 2014 a new set of rules can be drafted for these special kind of societies.
Restricting/ Capping Number of Associate / Nominal / Additional Member:
The solution would require amendments to State Co-operative Societies Acts, to cap the number of associate/ nominal / additional member. This will prevent operational scaling by co – operative societies to reach SCBs like stature. E.g., the capping can be kept at 1000 total members.
The process shall require will power of different states to amend their respective Co-operative Societies Acts.