The Hon’ble Supreme Court has held that a contract is void if prohibited by a statute under a penalty.
It quoted that “If anything is against law though it is not prohibited in the statute but only a penalty is annexed the agreement is void.
In every case where a statute inflicts a penalty for doing an act, though the act be not prohibited, yet the thing is unlawful, because it is not intended that a statute would inflict a penalty for a lawful act.”
While dealing with the situation in the matter of Asha John Divianathan vs Vikram Malhotra dated 26 February, 2021, SC criticised that there is conflict of opinion and is not a case of consistent view of all High Courts, having occasion to deal with interpretation of Section 31 of the Foreign Exchange Regulation Act, 1973 (“Act”). Resultantly, SC had to undertake the exercise of analysing all the decisions so as to give proper meaning to Section 31 of the Act.
In this write-up, the author has discussed the facts of the case, its analysis, landmark judgements and key takeaways from the judgement.
Mrs. F.L. Raitt (Owner), widow of late Mr. Charles Raitt, a foreigner and the owner of the property in question, gifted it to Mr. Vikram Malhotra (Respondent) without obtaining prior approval of the Reserve Bank of India (RBI) under Section 31 of the Foreign Exchange Regulation Act, 1973.
However, before executing the gift deed, she had executed an agreement of sale in favour of one Mr. R.P. David, father of Asha John Divianathan (Appellant). That a formal permission of RBI under Section 31 of the 1973 Act was then sought for completing the transaction in favour of the father of the Appellant. The RBI granted that permission, permitting transfer of the immovable property in his favour. Consequent to the said permission of RBI, a registered sale deed came to be executed by Mrs. F.L. Raitt in favour of the father of the Appellant.
Later, the Owner filed a suit to declare the power of attorney executed in favour of Mr. Peter J. Philip as null and void and for cancellation and setting aside of the registered sale deed executed in favour of the father of the Appellant. The said Owner expired next year.
Trial Court’s order
Then the father of Appellant filed a suit against the Respondent praying that the gift deed and the supplementary deed allegedly executed in his favour in respect of portion of the larger property be declared as null and void and not binding and consequentially for relief of possession, permanent injunction and mesne profits. The suit was dismissed by the Trial Court.
High Court’s order
The High Court of Karnataka then dealt with the appeal and examined the solitary legal point raised by the appellant regarding validity of the stated gift deeds being in violation of Section 31 of the 1973 Act and, therefore, void and unenforceable in law. The High Court dismissed the appeal by stating that lack of permission under Section 31 of the 1973 Act does not render the subject gift deeds as void.
Appeal to Supreme Court
The Appellant appealed to the Hon’ble Supreme Court of India on the following point:
The gift deed in favour of the Respondent is null and void and not binding on the appellant; and in any case is unenforceable in law, in light of the mandate of Section 31 of the Act.
The avowed object of Section 31 of the Act is to minimise the drainage of foreign exchange by way of repatriation of income from immovable property and sale proceeds in case of disposal of property by a person, who is not a citizen of India. It is to put restrictions on acquisition, holding and disposal of immovable property in India by foreigners – non citizens.
Section 31 of the Act:-
“Restriction on acquisition, holding, etc., of immovable property in India.—
(1) No person who is not a citizen of India and no company (other than a banking company) which is not incorporated under any law in force in India or in which the nonresident interest is more than forty per cent shall, except with the previous general or special permission of the Reserve Bank, acquire or hold or transfer or dispose of by sale, mortgage, lease, gift, settlement or otherwise any immovable property situate in India……..”
In short, a person, who is not a citizen of India, holding immovable property situated in India was obliged to make disclosure and declaration in that behalf to the RBI; and in any case, if he/she intended to dispose of such property by sale, mortgage, lease, gift, settlement or otherwise, was expected to obtain previous general or special permission from the RBI. Only then, transfer so intended could be given effect to.
Contentions of Respondent
Section 31 is a directory provision; and not obtaining previous permission of the RBI would not render the gift deeds in question invalid. It is urged that since no consequence is provided in Section 31 or any other provision in the 1973 Act to treat the transaction in violation of Section 31 as void, the transfer in favour of the Respondent cannot be regarded as ineffective or invalid. Such a transfer would at best be voidable that too only at the instance of the RBI and none else.
The stipulation under Section 31 is only a regulatory measure and not one of prohibiting transfer by way of gift as such. The consequence of such violation is provided for as penalty under Section 50, for which the concerned parties can be proceeded against.
However, no action has been taken in that regard including by the RBI. The decision of the RBI to grant or refuse permission for transfer is made final. The RBI is exclusively entrusted with the task of determining the permissibility of the transaction, being the repository of management of foreign exchange of the country.
Supreme Court’s view:
It is true that the consequences of failure to seek such previous permission has not been explicitly specified in the same provision or elsewhere in the Act, but then the purport of Section 31 must be understood in the context of intent with which it has been enacted, the general policy not to allow foreign investment in landed property/buildings constructed by foreigners or to allow them to enter into real estate business to eschew capital repatriation, including the purport of other provisions of the Act, such as Sections 47, 50 and 63. Here, we deem it apposite to reproduce Sections 47, 50 and 63 as applicable at the relevant time, the same read thus:
“47. Contracts in evasion of the Act.— (1) No person shall enter into any contract or agreement which would directly or indirectly evade or avoid in any way the operation of any provision of this Act or of any rule, direction or order made thereunder.
(2) Any provision of, or having effect under, this Act that a thing shall not be done without the permission of the Central Government or the Reserve Bank, shall not render invalid any agreement by any person to do that thing, if it is a term of the agreement that that thing shall not be done unless permission is granted by the Central Government or the Reserve Bank, as the case may be; and it shall be an implied term of every contract governed by the law of any part of India that anything agreed to be done by any term of that contract which is prohibited to be done by or under any of the provisions of this Act except with the permission of the Central Government or the Reserve Bank, shall not be done unless such permission is granted….”
Section 47 clearly envisages that no person shall enter into any contract or agreement which would directly or indirectly evade or avoid in any way the operation of any provision of the 1973 Act or of any rule, direction or order made thereunder.
“50. Penalty.— If any person contravenes any of the provisions of this Act [other than section 13, cl. (a) of subsection (1) of section 18 and cl. (a) of subsection (1) of section 19] or of any rule, direction or order made thereunder, he shall be liable to such penalty not exceeding five times the amount or value involved in any such contravention or five thousand rupees, whichever is more, as may be adjudged by the Director of Enforcement or any other officer of Enforcement not below the rank of an Assistant Director of Enforcement specially empowered in this behalf by order of the Central Government (in either case hereinafter referred to as the adjudicating officer).”
Section 50 reinforces the position that transfer of land situated in India by a person, who is not a citizen of India, would visit with penalty.
“63. Confiscation of currency, security, etc.— Any court trying a contravention under section 56 and the adjudicating officer adjudging any contravention under section 51 may, if it or he thinks fit and in addition to any sentence or penalty which it or he may impose for such contravention, direct that any currency, security or any other money or property in respect of which the contravention has taken place shall be confiscated to the Central Government and further direct that the foreign exchange holdings, if any, of the person committing the contravention or any part thereof, shall be brought back into India or shall be retained outside India in accordance with the directions made in this behalf.”
Section 63 empowers the court trying a contravention under Section 56 which includes one under Section 51, to confiscate the currency, security or any other money or property in respect of which the contravention has taken place.
Difference between void and voidable transaction
The Supreme Court demystified the purport of expression “void” and “voidable”. In the case of Dhurandhar Prasad Singh v. Jai Prakash University & Ors, it was highlighted that it is necessary to distinguish between two kinds of invalidity. The one kind is where the invalidity is so grave that the list is a nullity altogether. In which case there is no need for an order to quash it. It is automatically null and void without more ado. The other kind is when the invalidity does not make the list void altogether, but only voidable. In that case it stands unless and until it is set aside.
SC commented that “It is well established that a contract is void if prohibited by a statute under a penalty, even without express declaration that the contract is void, because such a penalty implies a prohibition. Further, it is settled that prohibition and negative words can rarely be directory.”
In Mannalal Khetan & Ors. v. Kedar Nath Khetan & Ors, the court noticed that in every case where a statute imposes a penalty for doing an act, though, the act is not prohibited, yet the thing is unlawful because it is not intended that a statute would impose a penalty for a lawful act. When a penalty is imposed by statute for the purpose of preventing something from being done on some ground of public policy, the thing prohibited, if done, will be treated as void, even though the penalty if imposed is not enforceable.
In the Union of India & Ors. v. A.K. Pandey it was held that where a contract, express or implied, is expressly or by implication forbidden by statute, no court will lend its assistance to give it effect. Further, a contract is void if prohibited by a statute under a penalty, even without express declaration that the contract is void, because such a penalty implies a prohibition.
Similarly, in the case of Union of India v. Colonel L.S.N. Murthy & Anr, the Court opined that the contract would be lawful, unless the consideration and object thereof is of such a nature that, if permitted, it would defeat the provisions of law and in such a case the consideration or object is unlawful and would become void and that unless the effect of an agreement results in performance of an unlawful act, an agreement which is otherwise legal cannot be held to be void and if the effect of an agreement did not result in performance of an unlawful act, as a matter of public policy, the court should refuse to declare the contract void with a view to save the bargain entered into by the parties and the solemn promises made thereunder.
The Court relied to the exposition in the earlier decision in Shri Lachoo Mal v. Shri Radhey Shyam as to “what makes an agreement, which is otherwise legal, void is that its performance is impossible except by disobedience of law.”
Supreme Court Judgement
From the analysis of Section 31 and upon conjoint reading with Sections 47, 50 and 63 of the same Act, it was held that the requirement of taking “previous” permission of the RBI before executing the sale deed or gift deed is the quintessence; and failure to do so must render the transfer unenforceable in law.
The dispensation under Section 31 mandates “previous” or “prior” permission of the RBI before the transfer takes effect. For, the RBI is competent to refuse to grant permission in a given case. The sale or gift could be given effect and taken forward only after such permission is accorded by the RBI. There is no possibility of ex post facto permission being granted by the RBI under Section 31 of the Act.
Before grant of such permission, if the sale deed or gift deed is challenged by a person affected by the same directly or indirectly and the court declares it to be invalid, despite the document being registered, no clear title would pass on to the recipient or beneficiary under such deed. The clear title would pass on and the deed can be given effect to only if permission is accorded by the RBI under Section 31 of the 1973 Act to such transaction.
How can a penalty provision nullify a contract?
In the given case, provision for penalty under Section 50 for contravention of Section 31, does not mean that the requirement of previous permission of RBI is directory or a mere formality. It is open to the legislature to provide two different consequences for the violation. As already noted hitherto, despite the absence of express provision declaring the transfer void, the intent behind enacting Section 31 and its purport renders the transfer in contravention thereof unenforceable until permission for such transaction is granted by the RBI.
Note: There has been a paradigm shift in the general policy of investment by foreigners in India and more particularly, the 1973 Act itself stands repealed. Accordingly, SC deem it appropriate to overrule the decisions of the High Courts which have been taking contrary views, albeit, prospectively.
“A contract is void if prohibited by a statute under a penalty, even without express declaration that the contract is void, because such a penalty implies a prohibition.”