Supreme Court clarifies conditions for leave to defend in summary suits: IDBI Trusteeship Services Ltd. vs. Hubtown Ltd. (2016)

Date of the Judgment: 15 November 2016
Citation: (2016) INSC 1093
Judges: Kurian Joseph, J., R.F. Nariman, J.
Can a defendant in a summary suit be granted unconditional leave to defend if they raise a triable issue? The Supreme Court of India addressed this question in a case involving a corporate guarantee. The Court clarified the principles for granting leave to defend in summary suits under Order XXXVII of the Code of Civil Procedure, 1908. This judgment is authored by Justice R.F. Nariman, with Justice Kurian Joseph concurring.

Case Background

In 2009 and 2010, Nederlandse Financierings-Maatschappij voor Ontwikkelingslanden N.V. (FMO) invested in Vinca Developer Private Limited (Vinca) through equity shares and compulsorily convertible debentures (CCDs). FMO held 10% of Vinca’s equity and 3 CCDs. Hubtown Ltd. (the Defendant) owned 49% of Vinca’s equity. The remaining 41% was owned by individual promoters. Upon conversion, FMO would hold 99% of Vinca’s equity.

Vinca used the funds from FMO to subscribe to optionally partially convertible debentures (OPCDs) issued by Amazia Developers Private Limited (Amazia) and Rubix Trading Private Limited (Rubix). IDBI Trusteeship Services Ltd. (the Plaintiff) acted as the Debenture Trustee for these investments.

The OPCDs were secured by a corporate guarantee from Hubtown Ltd. The Plaintiff claimed that Amazia and Rubix defaulted on payments. Consequently, the Plaintiff issued notices to Amazia and Rubix for payment of interest on the OPCDs. They also issued redemption notices to Amazia and Rubix to redeem all the OPCDs at par value on 3rd July, 2012. The Plaintiff then issued a demand certificate to Hubtown Ltd. on 3rd August, 2012, to enforce the guarantee.

The Plaintiff filed a summary suit in the Bombay High Court to recover ₹532,11,29,364.05 from Hubtown Ltd. based on the corporate guarantee. Hubtown Ltd. raised a defense that the transaction was structured to circumvent Foreign Direct Investment (FDI) regulations.

Timeline

Course of Proceedings

The Bombay High Court granted unconditional leave to defend to Hubtown Ltd. The High Court held that the transaction was structured to circumvent FDI regulations. The High Court found that the Plaintiff was acting at the instance of FMO. The High Court concluded that the corporate guarantee was part of an illegal scheme and thus unenforceable.

Legal Framework

The case involves the interpretation of the Foreign Exchange Management Act, 1999 (FEMA) and its regulations. Specifically, Regulations 4 and 5 of the FEMA Regulations were discussed. Regulation 4 restricts Indian entities from issuing securities to persons outside India. Regulation 5 permits foreign entities to purchase shares or convertible debentures of Indian companies under the Foreign Direct Investment Scheme.

The Court also considered Order XXXVII of the Code of Civil Procedure, 1908 (CPC), which deals with summary suits. The Court analyzed the pre-amendment and post-amendment versions of Rule 3 of Order XXXVII. The amendment in 1976 introduced changes regarding the conditions for granting leave to defend.

The relevant provisions of FEMA Regulations, 1999 are as follows:

“Restriction on an Indian entity to issue security to a person resident outside India or to record a transfer of security from or to such a person in its books :-
4.Save as otherwise provided in the Act or Rules or Regulations made thereunder, an Indian entity shall not issue any security to a person resident outside India or shall not record in its books any transfer of security from or to such person:-
Provided that the Reserve Bank may, on an application made to it and for sufficient reasons, permit an entity to issue any security to a person resident outside India or to record in its books transfer of security from or to such person, subject to such conditions as may be considered necessary.
Permission for purchase of shares by certain persons resident outside India :-
5. (1) (i) A person resident outside India (other than a citizen of Bangladesh or Pakistan) or an entity incorporated outside India (other than an entity in Bangladesh or Pakistan), may purchase shares or convertible debentures or warrants of an Indian company under Foreign Direct Investment Scheme, subject to the terms and conditions specified in Schedule 1.
Explanation.— Shares or convertible debentures containing an optionality clause but without any option/right to exit at an assured price shall be reckoned as eligible instruments to be issued to a person resident outside India by an Indian company subject to the terms and conditions as specified in Schedule 1.”

The relevant provisions of Order XXXVII, Rule 3 of the Code of Civil Procedure, 1908 are as follows:

“3. Procedure for the appearance of defendant .
—(1) In a suit to which this Order applies, the plaintiff shall, together with the summons under Rule 2, serve on the defendant a copy of the plaint and annexures thereto and the defendant may, at any time within ten days of such service, enter an appearance either in person or by pleader and, in either case, he shall file in Court an address for service of notices on him.
(2) Unless otherwise ordered, all summonses, notices and other judicial processes, required to be served on the defendant, shall be deemed to have been duly served on him if they are left at the address given by him for such service.
(3) On the day of entering the appearance, notice of such appearance shall be given by the defendant to the plaintiff’s pleader, or, if the plaintiff sues in person, to the plaintiff himself, either by notice delivered at or sent by a prepaid letter directed to the address of the plaintiff’s pleader or of the plaintiff, as the case may be.
(4) If the defendant enters an appearance, the plaintiff shall thereafter serve on the defendant a summons for judgment in Form 4-A in Appendix B or such other Form as may be prescribed from time to time, returnable not less than ten days from the date of service supported by an affidavit verifying the cause of action and the amount claimed and stating that in his belief there is no defence to the suit.
(5) The defendant may, at any time within ten days from the service of such summons for judgment, by affidavit or otherwise disclosing such facts as may be deemed sufficient to entitle him to defend, apply on such summons for leave to defend such suit, and leave to defend may be granted to him unconditionally or upon such terms as may appear to the Court or Judge to be just:
Provided that leave to defend shall not be refused unless the Court is satisfied that the facts disclosed by the defendant do not indicate that he has a substantial defence to raise or that the defence intended to be put up by the defendant is frivolous or vexatious:
Provided further that, where a part of the amount claimed by the plaintiff is admitted by the defendant to be due from him, leave to defend the suit shall not be granted unless the amount so admitted to be due is deposited by the defendant in Court.
(6) At the hearing of such summons for judgment,—
(a) if the defendant has not applied for leave to defend, or if such application has been made and is refused, the plaintiff shall be entitled to judgment forthwith; or
(b) if the defendant is permitted to defend as to the whole or any part of the claim, the Court or Judge may direct him to give such security and within such time as may be fixed by the Court or Judge and that, on failure to give such security within the time specified by the Court or Judge or to carry out such other directions as may have been given by the Court or Judge, the plaintiff shall be entitled to judgment forthwith.
(7) The Court or Judge may, for sufficient cause shown by the defendant, excuse the delay of the defendant in entering an appearance or in applying for leave to defend the suit.”

Arguments

Appellant’s Arguments (IDBI Trusteeship Services Ltd.):

• The Appellant argued that there was no violation of FEMA Regulations. The suit was filed by an Indian company (IDBI) against another Indian company (Hubtown), with the beneficiary being Vinca, also an Indian company.
• The funds from FMO were used to purchase equity shares of Vinca in the form of fully convertible debentures. This was in compliance with FEMA Regulations.
• The Corporate Guarantee was unconditional, and there was no challenge to its invocation.
• The Appellant argued that the defense raised by the Respondent was frivolous and vexatious.
• Alternatively, the Appellant argued that they should be fully secured for the amount claimed in the plaint.

Respondent’s Arguments (Hubtown Ltd.):

• The Respondent argued that the transaction was a clear breach of FEMA Regulations. The structure was designed to circumvent FDI policy by providing FMO a fixed return on investment.
• The Respondent relied on the judgment in Immami Appa Rao vs. G. Ramalingamurthi, (1962) 3 SCR 739 to argue that the court should not assist a party in enforcing an illegal transaction.
• The Respondent claimed that the amendment of 1976 to O.XXXVII did not change the law significantly, except in cases where the defendant admits a certain amount is due.
• The Respondent argued that the case fell under clause (e) of the propositions laid down in paragraph 8 of Mechelec Engineers & Manufacturers v. Basic Equipment Corporation, (1976) 4 SCC 687, which allows for an order for deposit into court or security only when the defense is illusory or sham.

Submissions of the Parties

Issues Framed by the Supreme Court

The Supreme Court did not frame specific issues in a numbered list. However, the main issue was whether the judgment in Mechelec Engineers & Manufacturers v. Basic Equipment Corporation, (1976) 4 SCC 687 continues to be the law after the amendment of Order XXXVII in 1976. The Court also considered whether the High Court was correct in granting unconditional leave to defend to the Respondent.

Treatment of the Issue by the Court

Authorities

Cases Relied Upon by the Court:

• Milkhiram (India) (P) Ltd. v. Chamanlal Bros., AIR 1965 SC 1698 – This four-judge bench decision discussed the scope of O.XXXVII of the CPC. The court held that if a triable issue exists, then leave to defend should be granted, but the court may impose conditions. (Supreme Court of India)
• Mechelec Engineers & Manufacturers v. Basic Equipment Corporation, (1976) 4 SCC 687 – This case laid down five propositions governing O.XXXVII CPC. The court held that if a triable issue is raised, leave to defend should be granted unconditionally. (Supreme Court of India)
• Kiranmoyee Dassi Smt v. Dr J. Chatterjee, AIR 1949 Cal 479 – This case was referred to in Mechelec’s case and laid down principles for granting leave to defend. (Calcutta High Court)
• Immami Appa Rao vs. G. Ramalingamurthi, (1962) 3 SCR 739 – This case was cited by the Respondent to argue that the court should not assist a party in enforcing an illegal transaction. (Supreme Court of India)
• Municipal Corpn. of Delhi v. Suresh Chandra Jaipuria, (1976) 4 SCC 719 – This case followed Mechelec’s case. (Supreme Court of India)
• Sunil Enterprises v. SBI Commercial & International Bank Ltd., (1998) 5 SCC 354 – This case followed Mechelec’s case. (Supreme Court of India)
• State Bank of Saurashtra v. Ashit Shipping Services (P) Ltd., (2002) 4 SCC 736 – This case followed Mechelec’s case. (Supreme Court of India)
• Uma Shankar Kamal Narain v. M.D. Overseas Ltd., (2007) 4 SCC 133 – This case followed Mechelec’s case. (Supreme Court of India)
• SIFY Ltd. v. First Flight Couriers Ltd., (2008) 4 SCC 246 – This case followed Mechelec’s case. (Supreme Court of India)
• Wada Arun Asbestos (P) Ltd. v. Gujarat Water Supply & Sewerage Board, (2009) 2 SCC 432 – This case followed Mechelec’s case. (Supreme Court of India)
• R. Saravana Prabhu v. Videocon Leasing & Industrial Finance Ltd., (2013) 14 SCC 606 – This case followed Mechelec’s case. (Supreme Court of India)
• State Bank of Hyderabad v. Rabo Bank, (2015) 10 SCC 521 – This case followed Mechelec’s case. (Supreme Court of India)
• Defiance Knitting Industries (P) Ltd. v. Jay Arts, (2006) 8 SCC 25 – This case discussed the effect of the amendment to O.XXXVII. (Supreme Court of India)
• Southern Sales & Services v. Sauermilch Design & Handels GMBH, (2008) 14 SCC 457 – This case discussed the effect of the amendment to O.XXXVII. (Supreme Court of India)

Legal Provisions Considered by the Court:

• Regulations 4 and 5 of the FEMA Regulations, 1999 – These regulations govern the issuance of securities to persons outside India and the purchase of shares by foreign entities.
• Order XXXVII, Rule 3 of the Code of Civil Procedure, 1908 – This provision deals with the procedure for the appearance of a defendant in a summary suit and the conditions for granting leave to defend.

Treatment of Authorities

Judgment

The Supreme Court overruled the Bombay High Court’s decision. The Court held that the principles stated in paragraph 8 of Mechelec’s case were superseded by the amendment of O.XXXVII R.3 and the binding decision of four judges in Milkhiram’s case. The Court laid down new principles for granting leave to defend in summary suits.

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

The Court relied on Milkhiram’s case as a binding authority on the amended O.XXXVII provision. The Court held that the principles in Mechelec’s case were superseded by the amendment of O.XXXVII R.3 and the binding decision in Milkhiram’s case. The Court distinguished Immami Appa Rao’s case, stating that it would be attracted only if the illegal purpose is fully carried out. The Court referred to Defiance Knitting Industries and Southern Sales & Services for the effect of the amendment to O.XXXVII.

The Court stated that the principles in Mechelec’s case will now stand superseded, given the amendment of O.XXXVII R.3, and the binding decision of four judges in Milkhiram’s case, as follows:

• If the defendant satisfies the Court that he has a substantial defence, that is, a defence that is likely to succeed, the plaintiff is not entitled to leave to sign judgment, and the defendant is entitled to unconditional leave to defend the suit.
• If the defendant raises triable issues indicating that he has a fair or reasonable defence, although not a positively good defence, the plaintiff is not entitled to sign judgment, and the defendant is ordinarily entitled to unconditional leave to defend.
• Even if the defendant raises triable issues, if a doubt is left with the trial judge about the defendant’s good faith, or the genuineness of the triable issues, the trial judge may impose conditions both as to time or mode of trial, as well as payment into court or furnishing security.
• If the Defendant raises a defence which is plausible but improbable, the trial Judge may impose conditions as to time or mode of trial, as well as payment into court, or furnishing security.
• If the Defendant has no substantial defence and/or raises no genuine triable issues, and the court finds such defence to be frivolous or vexatious, then leave to defend the suit shall be refused, and the plaintiff is entitled to judgment forthwith.
• If any part of the amount claimed by the plaintiff is admitted by the defendant to be due from him, leave to defend the suit, (even if triable issues or a substantial defence is raised), shall not be granted unless the amount so admitted to be due is deposited by the defendant in court.

What weighed in the mind of the Court?

The Supreme Court was primarily influenced by the fact that a substantial amount of ₹418 crores was invested by FMO and was utilized in a building construction project. The Court also considered that payments were being made until 2011, after which they stopped. The Court was concerned that the defense raised by the Respondent was plausible but improbable, and therefore the Plaintiff needed to be protected. The Court also emphasized that the object of the provisions to assist expeditious disposal of commercial causes should not be defeated.

Sentiment Analysis of Reasons Given by the Supreme Court

Fact:Law Ratio Analysis

Logical Reasoning

The Court’s reasoning was that the defendant did not raise a substantial defense. The Court noted that a sum of ₹418 crores was invested by FMO and was utilized in a building construction project. The Court also considered that payments were being made until 2011, after which they stopped. The Court found the defense raised by the Respondent to be plausible but improbable, and therefore the Plaintiff needed to be protected. The Court held that the object of the provisions to assist expeditious disposal of commercial causes should not be defeated.

The Court considered the arguments on the FEMA regulations and the structure of the transaction. However, the Court was of the view that the defense raised was not substantial enough to grant unconditional leave to defend. The Court also considered the amendment of Order XXXVII and the binding decision in Milkhiram’s case.

The Court rejected the argument that the judgment in Mechelec’s case was still good law and held that the principles in Mechelec’s case were superseded by the amendment of O.XXXVII R.3 and the binding decision in Milkhiram’s case.

Conclusion

The Supreme Court set aside the Bombay High Court’s decision and held that the principles in Mechelec’s case were superseded by the amendment of O.XXXVII R.3 and the binding decision in Milkhiram’s case. The Court concluded that the Respondent had not raised a substantial defense and imposed a condition for leave to defend. The Court directed the Respondent to deposit 50% of the amount claimed in the suit within 8 weeks, failing which the Appellant would be entitled to judgment forthwith.

This judgment clarifies the conditions for granting leave to defend in summary suits under Order XXXVII of the CPC. It emphasizes that while triable issues should be considered, the court can impose conditions if the defense is not substantial or genuine. The judgment re-establishes the principle that the object of the provisions to assist expeditious disposal of commercial causes should not be defeated. The judgment also highlights the importance of the binding decision in Milkhiram’s case in interpreting the amended provisions of Order XXXVII.

Implications

The judgment in IDBI Trusteeship Services Ltd. vs. Hubtown Ltd. has significant implications for future cases involving summary suits under Order XXXVII of the CPC. The key implications are:

• Supersession of Mechelec’s Principles: The judgment clarifies that the principles laid down in Mechelec Engineers & Manufacturers v. Basic Equipment Corporation are no longer good law after the amendment of Order XXXVII and the binding decision in Milkhiram (India) (P) Ltd. v. Chamanlal Bros..
• Conditional Leave to Defend: The court has the power to impose conditions, such as depositing a part of the claimed amount, even if triable issues are raised. This is especially true if the defense is plausible but improbable.
• Focus on Substantial Defense: The judgment emphasizes that a defendant must raise a substantial defense, not just any defense, to obtain unconditional leave to defend. A defense that is frivolous or vexatious will not suffice.
• Expeditious Disposal of Commercial Causes: The judgment underscores the importance of the object of the provisions to assist the expeditious disposal of commercial causes. Courts should ensure that the process is not misused to delay proceedings.
• Binding Nature of Milkhiram’s Case: The judgment reaffirms the binding nature of the four-judge bench decision in Milkhiram’s case, which provides the correct interpretation of the amended Order XXXVII.

In essence, this judgment provides a more balanced approach to granting leave to defend in summary suits, protecting the interests of both the plaintiff and the defendant, while promoting the expeditious disposal of commercial disputes. It serves as a guiding precedent for lower courts in interpreting Order XXXVII of the CPC.