INSTITUTE OF MANAGMENT STUDIES, DAVV, INDORE

FINANCE AND ADMINISTRATION – SEMESTER IV

CREDIT MANAGEMENT AND RETAIL BANKING

DIFFERENT TYPES OF BORROWERS

The relationship between a banker and his customer is essentially a contractual relationship of Debtor
and Creditor. While sanctioning a loan proposal, we come across different types of customers.
Keeping in mind various legal aspects involved care to be taken in opening and conducting these
accounts.

MINOR

According to Section 3 of Indian Majority Act 1875 a person who has not completed 18 years of age
is a minor. According to Section 11 of Indian Contract Act, 1872, a minor is not capable of entering
into a valid contract and a contract entered into by a minor is void. A contract for supply of necessities
of life to a minor is, however, a valid contract. A banker should, therefore, be very careful in dealing
with a minor.

Loan proposal for sanction of Education loan can only be considered, preferably with parents as joint
borrower or guarantor. Otherwise, loan cannot be sanctioned to Minor even if guaranteed by third
person.

MARRIED WOMEN

Married women can enter into a valid contract with the bank.

A married woman has a legal entity of her own. She is equally competent/ capable of understanding
the transactions, and hence loan can be sanctioned to a married woman.

Marriage of a Hindu woman does not affect her right of Streedhan. Section 14 of the Hindus
Succession Act, 1956 provides that the property of a Hindu female shall be her absolute property.

The bank can also grant advance to a married woman provided she has independent source of
earning or has personnel assets (Stridhan) and the bank considers that advance could be recovered
from her. The husband of such woman can be made liable only when (i) the advance is given with his
consent/authority or (ii) for supply of necessities of life to her, in case the husband defaults in
supplying the same to her. It is, therefore, always better to take guarantee of husband while granting
loan to married women, if bank is of opinion that loan may be required to be recovered from husband
at a later date.

A married woman can be adjudicated insolvent in respect of her own debt, even though, her husband
has good financial standing.

PARDANASHIN WOMEN

A pardanashin woman remains in complete seclusion due to the customs of her community, & hence
does not deal or come in contact with people, other than her family members. Therefore, a contract
entered into by a Pardanashin woman is not a contract free from all defects and is always subject to
undue influence.

The other party to the contract i.e. bank shall have to prove that the contract with Pardanashin
woman was free from all defects in order to enforce the same.

Loan to an illiterate Pardanashin Lady, will not be considered as it will not be possible to ascertain her
identity.

ILLITERATE PERSONS

An illiterate person can enter into a valid contract, but as he cannot sign, the banker takes his thumb
impression as a substitute for signature. Banks also obtain copy of his recent photograph so that he
can be identified with the help of photograph when he affix his thumb impression in the presence of
an official of the bank.

For granting loan/advance to an illiterate person, a literate person is required as witness who certifies
that the thumb impression on the documents was placed in front of him and also the contents of the
documents were read over and made understood to the illiterate person in the language known to
him.

INSOLVENTS

A person is declared insolvent by the court when he fails to pay his debts. An undischarged insolvent
cannot obtain credit, and hence loan should not be sanctioned to an insolvent

JOINT HINDU FAMILIES (JHF)

- Joint Hindu Families (JHF) also known as Hindu Undivided Families (HUF) are governed by Hindu
Law.
-JHF is a legal entity. Legally JHF is a single person and continues even with change in members for
any reason. JHF does not require any registration.

JHF conducts ancestral family business. The family is not liable for the new business carried out
outside the ambit of ancestral business. Therefore, in order to save the interest of bank a JHF letter
should be signed by all the adult co-parceners.

The family business and its assets are managed by the eldest male member known as Karta. All the
major male members are known as Co- parceners. Unlike partnership there is no restriction on
number of co-parceners. Similarly unlike partnership firm, there is no relationship of agency between
karta and co-parceners.

The karta has an implied authority to take a loan, execute necessary documents and may pledge the
securities on behalf of the family for the purpose of the business of the family.

PARTNERSHIP FIRM
Partnership is the relation between persons who have agreed to share the profits of a business
carried on by all or any of them acting for all. (Section 4 of Partnership Act, 1932)
Persons who have entered into a partnership with one another are called individually ‘partners’ and
collectively “a firm” and the name under which their business is carried on is called the ‘firm name”
A partnership thus cannot be formed for rendering social service.
Partnership Act is an extension of law of Agency, and hence no consideration is necessary to
create a partnership.
Minors as partner
According to Section 30 of the partnership Act minor cannot become a partner in a firm, but he
may be admitted to the benefits of partnership. It is however necessary that such admission is done
with the consent of all partners.
Number of partners
As per section 11 of the Companies Act Maximum number of partners for trading activity can be
50. If the number of partners exceeds the limit, the partnership becomes illegal and it cannot enter
into a valid contract.
Minimum number of partners (Major) can be 2.
TYPES OF PARTNERSHIP
 Partnership at will – No provision for duration of partnership or for termination or end.
Partnership will be dissolved by any partner by giving notice in writing.
 Partnership for fixed period – Partnership agreement is for fixed period and on completion of
period partnership comes to end.
 Particular partnership – Partnership entered for completing a particular assignment and on
completion comes to end.
RELATION OF PARTNERS
 A partner is an agent of the firm for purpose of business of firm.
 Every partner plays dual role, one as principal on his own behalf and other as agent for every
other partner.
 A partner can make the firm liable for his acts, if done in the name of the firm and in ordinary
course of business of the firm.
RETIREMENT OF A PARTNER
 Partner may retire – with the consent of all other partners, in accordance with express
agreement by partners or in case of partnership at will by giving notice to all other partners of
his intention to retire.
 The retiring partner will be liable to the third party for any act done by any of the partner on
behalf of firm, till the retiring partner gives public notice, of his intension to retire.
 A partner can also be expelled from the firm by majority of partners. Expelled partner is in the
same position as that of retiring partner.
 If a partner is adjudicated as insolvent, he ceases to be a partner from the date on which the
order is made. The order of adjudication of a partner may or may not dissolve the firm. If the
firm is not dissolved, estate of partner so adjudicated is not liable for any act of the firm as also
the firm is not liable for any act of the insolvent, after this date.

DISSOLUTION OF A FIRM
 A firm can be dissolved with the consent of all the partners or in accordance with the contract
between partners.
 Compulsory dissolution
 If all the partners (except one) is adjudicated insolvent or by happening of any event which
makes business or carrying partnership as unlawful.
 If partnership is carrying more than one separate business, illegality of one of them, business
may be continued for lawful adventures. There is no cause to dissolve the firm.
 Dissolution on happening of certain event
 The firm is dissolved in following cases, however, partners by express agreement can avoid
dissolution of firm by
- If partnership is for fixed period, then by expiry of term. By death of partner. By adjudication
of partner as insolvent.
 Dissolution by court
 By the suit of a partner on following circumstances by other partners, court may dissolve firm
on grounds –
- That a partner has become of unsound mind
- That a partner has become permanently incapable of performing duties
- That a partner is found guilty of conduct
- That a partner is willfully or persistently commits breach of agreement
- That a partner has transferred whole of his rights to third party
- That the business cannot be carried on except at loss
 A partner of the firm should give public notice to the effect that firm has been dissolved.
Liabilities of partners continue to the third party for any act done by any of them, until such
public notice is given.

Registration of Partnership
Partnership Act does not make the registration of the firm compulsory. No penalties are imposed
for non registration of the firm, but section 69 of the Partnership Act provides that an un- registered
firm cannot file a civil suit against an outsider. A suit filed by an unregistered firm is not maintainable
even if the firm is subsequently registered. Non registration of a firm, however, does not affect the
rights of lenders/outsiders.

Loan to partnership firm

The banker should insist all the partners of the firm to sign the documents in both the capacities i.e.
individually as well as in firms’ capacity. This will enable the banker to recover the amount from the
individual assets of the partners including credit balances in their individual accounts. In case of
insolvency of a partner, the partnership is dissolved unless a contrary instructions to the effect exists.
Thus while opening an account, or sanctioning a loan proposal of a firm bank should take following
precautions:
(1) The account should be opened in the name of the firm and not individually.
(2) All the partners should sign account opening form/ documents.
(3) A partnership letter should be obtained even if partnership deed is given, in order to make all the
partners jointly and severally liable.
(4) Partnership deed should be carefully scrutinized in order to see that no condition detrimental to
the interest of the bank is embodied.
(5) Number of partners does not exceed statutory requirement.
(6) If minor has been admitted in the firm, his date of birth should be recorded, and on attaining
majority a fresh partnership letter should be obtained.
(7) Clear instructions regarding who shall be operating the account must be obtained.
(8) A cheque payable to firm should not be credited to individual account otherwise bank may be
held for conversion and will lose protection available to the bank under Sec.131 of NI Act.

PROPRIETORSHIP FIRMS
An individual carrying a business activity in his own name or some other trade name, fully owned
by him is called as proprietorship firm. In such cases banks take declaration from the person that he
is the sole owner of the firm and no other person has any interest in the business of the firm.
Undertaking that he will be responsible for all debts present or future in capacity of firm as well as in
his personal capacity is obtained.

LIMITED LIABILITY PARTNERSHIP (LLP)

 LLP contained in LLP Act 2008 Rules 2009.
 LLP will be a body corporate and a legal entity separate from its partners.
 It will have perpetual succession.
 No partner would be liable on account of unauthorized action of other partners.
 LLP is viewed as an alternative corporate business vehicle that provides benefit of limited
liability still allowing flexibility of organizing internal structure as partnership on mutual agreed
terms.
 Salient features of LLP are:
- Body corporate and legal entity separate from its partners
- No partner would be liable on account of unauthorized action of other partners
- Every LLP will have at least 2 partners, as applicable to partnership act. And also have at
least two individuals as Designated Partners having Designated Partner Identification
Number (DPIN), and at least one should be resident of India.
- Indian Partnership act 1932 will not be applicable to LLP
- Winding up may be either voluntary or by National Company Law Tribunal (NCLT).

JOINT STOCK COMPANIES

A Joint Stock Company is an artificial person created by Law. A Company is considered as an
entity separate from its members. It possesses all powers to enter into valid contract. The company is
governed by Indian Companies Act, 1956, enacted with an objective of ensuring proper
administration of companies and prescribes uniform laws applicable to all companies in India.
FEATURES OF A COMPANY
 Registration - Company registered under Companies act 2013 or any prior act.
 Artificial legal person – created by law and can be dissolved by the law alone. It is invisible,
intangible and exists only in the eyes of law. It enjoys many rights of a natural person.
Company may enter into contracts in its own name and can acquire and dispose property.
Company is however not a natural citizen like an individual.
 Independent corporate personality – partnership firm is nothing but the aggregate of the
partners, while company after incorporation is in law a single person and is a distinct legal
personality, which is independent and different from members.
 Limited liability – limitation of liability is an advantage of incorporation of company. Existence
of Company is different from members and directors; hence members are not bound to
contribute anything more than the nominal value of the share held by them. Liability of partner
is unlimited.
 Perpetual succession – an incorporated company never dies, it is a legal entity with
perpetual succession. The insolvency or death of member does not affect continued existence
of company. Even if all the members change, company remains the same entity and company
goes on forever.
 Separate property – company is capable of holding property in its own name.
 Transfer of shares – a shareholder may sell his shares in open market and get back his
money without changing the capital of the company.
 Common seal – as the company is an artificial legal person, it is not capable of signing
documents for itself. Law therefore, provides common seal with name of company engraved
on it as substitute for signature. Any document bearing common seal is legally binding on
company. Company however, acts through natural persons who are directors appointed by
shareholders of company. Common seal is affixed in the manner stated in the article of
association.
 Corporate veil – although a company is separate legal entity distinct from shareholders, in
reality it is association of persons who are the beneficial owners of corporate property hence it
is necessary to know who are the persons behind the corporate veil.

DISTINCTION BETWEEN COMPANY AND PARTNERSHIP

Company Partnership
Registration Compulsory under No compulsory under
companies act, 1956 Partnership act, 1932
Number of members/ Minimum 2 max 200 in Pvt. Minimum 2 persons.
partners Minimum 7 max no limit in Maximum 50 or 100.
Public

Legal status Has legal status separate Does not have separate
from members legal existence different
from partners
Ownership of property Property owned by Property of firm is owned by
company itself and not its partners
members
Management Managed by board of Managed by partners
directors elected by except dormant or sleeping
shareholders partner
Perpetual existence Has perpetual existence Does not have
Contracts Members of company can Partner cannot contract
contract with company with partnership

Liability Liability of members is Liability of partner is

limited except in case of unlimited
company with unlimited
liability
Transfer Transferee of shares Consent of all partners is
become member of required for a person to
company and consent of all become a partner
members is not required
Death Death of members does not Partnership is dissolved
end existence of company with death of partner unless
deed provides otherwise
Agency Members of company are Every partner of firm is an
not agents of each other or agent of other partner
of company

TYPES OF COMPANIES
On the Basis of Incorporation
 Statutory company – incorporated by special act passed by central or state legislature. Enjoy
rights and privileges as per act, hence Memorandum of association not required. Example –
RBI.
 Registered with Companies act 1956 – registered under companies act. Example Tata Iron
and Steel Company
On the Basis of Liability
 Company Limited by shares – each share has a fixed nominal value (face value) and the
member is not bound to pay anything more than the fixed amount of share
 Company limited by Guarantee – liability of members is limited by memorandum of
association to such amount as members undertake to contribute to assets of company in event
of liquidation of company.
 Company with unlimited liability – liability of members is unlimited. Every member is liable
without any limit for its debts as in case of partnership.

On the Basis of Public Interest

 Private company – defined under section 3 of Companies Act 1956 according to which article
of association has following restrictions.
- Restriction on rights to transfer shares,
- Maximum number of members 200
- Cannot issue prospectus and cannot invite public to subscribe for any shares or debenture
of company
- Cannot invite or accept deposits from persons other than its members, directors or their
relatives.
- Should have a minimum paid-up capital of Rs.1 lac.
 Public company –
- Number of members unlimited. Any 7 or more members can make company
- Shares listed on stock exchange
- Minimum paid up capital 5 lacs.
 Some advantages to Pvt. Company – need not obtain certificate of commencement of
business, need not hold a statutory meeting and submit a statutory report to Registrar of
Companies.
 Government Company – company in which not less than 51% of paid up share capital is held
by – Central Govt., State Govt. or partly by both.
 It also includes subsidiary or a govt. company e.g. Bharat Heavy Electricals (BHEL), Bokaro
Steel Ltd. Etc.
 Foreign company – incorporated outside India but has a place of business in India.
 One Person Company – a company which has only one person as a member. OPC shall
indicate name of other person, who shall in the event of death or incapability to contract
become member of company. This should be done with his consent and filed with registrar at
the time of incorporation of OPC along with its memorandum and article of association.
 Subsidiary company – other company controls the majority composition of its board of
director with sole objective of controlling management, and that other company holds the
majority of shares.
 Holding companies subsidiary has its own subsidiary; it becomes subsidiary of first
mentioned company. Ex. If say company B is subsidiary of A and company C is subsidiary of
B, then company C will be subsidiary of A.

IMPORTANT DOCUMENTS OF THE COMPANY

Memorandum of Association
It is one of the important documents of a company which embodies its constitution and is called the
charter of the company. It contains the name of the company, its authorized capital, name of the state
in which the registered office of the company is to be situated, objects of the company, purpose of
forming company, relationship with the outsiders and the liabilities of members. Memorandum of the
company should be prepared with the help of Lawyer or chartered accountants.
Any contract entered into by a company not mentioned in the Memorandum of Association is ultra
vires and is unenforceable. Such contract cannot be ratified even by unanimous voting by the
members in general body meeting.

Article of Association
The Article of Association contains the rules and regulations of a Company regarding its internal
management. It contains matters like conduct of day to day business of the Company, rights and
powers of the directors, conduct of company meeting, powers to borrow money for the company or to
mortgage the company’s assets.
The banker should carefully see the powers vested in the directors of the company for conducting
affairs of the company, to borrow money and to mortgage the company’s assets.

Certificate of Incorporation and Certificate of Commencement of business

These certificates are issued by the Registrar of companies. A company cannot carry on its
business unless it is registered as a company under the Companies Act 1956.
Certificate of Incorporation is required to be obtained by the Private and Public Ltd Company.
Certificate of commencement of business is required to be obtained only by Public Ltd. Companies.
Now even Private ltd company has also required to obtain certificate of commencement of business.

Copy of Board Resolution

Before opening a bank account, or executing documents for loan, the bank should obtain a
certified copy of the resolution passed by the Board of Directors of the Company, appointing the bank
concerned as the banker of the Company name of the authorized person who shall be operating the
account on behalf of the company and names of persons who are authorized to execute the
documents or in whose presence the common seal of the company will be affixed on documents.

Registration of charge
Under Sec. 125 of the companies Act 1956 any charge (including mortgage) created on the assets
of the company is required to be registered with the registrar of companies within 30 days after the
date of its creation.
If bank fails to register a charge as described above, the lapse makes it void against the liquidator
and any other creditor of the company.

Operations in the account of companies

Cheques should be drawn, accepted or endorsed by and on behalf of the company. A cheque
payable to the company should not be credited to the personal account of directors otherwise bank
would be held negligent and banker will not get protection under Sec.131 of NI Act.
Death of the director does not affect the operations in the account and the cheques signed by the
deceased director can be paid by the bank if otherwise in order.

CLUBS / SOCIETIES
Clubs and Societies are non trading organizations and get legal entity only when registered as
society under the Societies Registration Act 1960 or incorporated as company under the Companies
Act 1956.
A copy of registration certificate or the certificate of incorporation must be obtained before opening
an account. Certified copies of rules and regulations, bye laws governing the society/club should be
obtained. A certified copy of the resolution passed by the managing committee, to open a bank
account should be obtained.
Details of the persons authorized to open, and instructions regarding operations in the account
should be obtained. It should be ensured that cheques payable to club/societies should not be
credited to the personal accounts of the signatories.
In case a loan is to be sanctioned to the registered society it should be ensured that resolution for
obtaining loan has been passed by the managing committee, the loan is within the borrowing capacity
and is not inconsistent with the objects of the club/society.

Prepared by
Arvind Paranjape, M.Sc. CAIIB
[email protected]
9425067026