Dr. B. Gopalakrishnan and Reuben Mascreen | Lexology
This is an article which aims to analyze the powers of the shareholders of a banking company which is licensed to carry on the business of banking by the Reserve Bank of India under the Banking Regulation Act 1949 to remove the Managing Director and CEO of a banking company as appointed by RBI. Equally, this articles also analyses the powers conferred upon RBI under the Banking Regulation Act, with respect to the appointment of a Managing Director and CEO of a banking company, and whether RBI has powers conferred under the said Act to contain a situation where the shareholders of a banking company votes out the Managing Director and CEO so appointed by RBI.
The genesis of the above article stems from the two instances of a closely held private sector banks in India, namely Lakshmi Vilas Bank (LVB) since merged with DBS India Ltd. and Dhanlaxmi Bank Ltd., who in succession voted out the MD and CEO of the said two banks, in spite of RBI finding the said two MD and CEOs as ‘fit and proper’ under the Banking Regulation Act and the various guidelines issued by RBI from time-to-time.
It is also a matter of surprise to the authors and also those in the banking sector as to why in the above referred two instances which happened in quick succession of each other, RBI remained a mute spectator without exercising its powers under section 35 of the Banking Regulation Act, as also the inherent power vested with RBI to supersede the boards.
The above action of two closely held banking companies in the private sector and the silence of RBI on this issue may act as a catalyst in future for such action from shareholders of large private sector banks to ignore or oust RBI appointed MDs and CEOs and install a person of their choice, or the choice of the majority of shareholders.
The above bold action of two small scale private sector banks has also brought to light the formation of a coterie of likeminded shareholders to scuttle the dictums of RBI who is the sole regulator of the banking industry in India.
It is pertinent to trace the history of the Indian banking system, albeit in a condensed form to understand and fathom the powers of RBI under the Banking Regulation Act. RBI was established under the Reserve Bank of India Act, 1934 in a pre-independence era when the major banking system in India as it stood then was controlled by the Bank of Bengal, Bank of Madras and the Bank of Bombay. As it stood then, the said banks catered to the needs of the customer as also was appointed to formulate rules and regulations regarding the running of a bank in India, besides printing of currency notes. As a result, it became easy for the banks to formulate the schemes as also to manipulate the system in any manner as they chose with little or nil accountability. This led to the enactment of RBI as a regulator to regulate the banking industry in India, and also to control the printing and issue of currency notes. However, there was no specific enactment on which RBI can rely or derive their powers. The then existing laws were mostly oriented towards the British banking system as formulated by the East India Company. Therefore, immediately after achieving independence on 15.08.1947, the Indian Parliament in its wisdom came up with a law to license and regulate the banking companies in India.
A peek into the Banking Regulation Act 1949:
The salient features as contained in the statement of objects and reasons in a nutshell are contained as under
“The provisions of law relating to banking companies at present form a subsidiary portion of the general law applicable to companies and are contained in Part XA of the Indian Companies Act, 1913. These provisions, which were first introduced in 1936, and which have undergone two subsequent modifications, have proved inadequate and difficult to administer. Moreover while the primary objective of Companies Law is to safeguard the interests of the stock holder, that of banking legislation should be the protection of the interests of the depositor. It has therefore, been felt for some time that separate legislation was necessary for the regulation of banking in India. This need has become the more insistent on account of the considerable development that has taken place in recent years in banking, especially the rapid growth of banking resources and of the number of banks and branches. Regard must also be had to the fact that the banking system is likely in the post-war period to be more vulnerable by reason of the great expansion, both quantitatively and relatively, that has taken place in demand deposits, as compared with time deposits, during the war years. The enactment of a separate comprehensive measure as in consequence now become imperative”
From the above, it can be noted that many of the banking companies as it operated at the time of independence and continued to operate till the enactment of the BR Act 1949 was not protective of the depositors of the banking company, whereas it was protective of the stakeholders of the banking company. The legislature felt that it was necessary to have a separate legislation to regulate the banking companies in India. This stream of thought emanated from the fact that prior to independence in 1947, India was ruled by many princely states who had their own laws and procedures with respect to banking, albeit mostly copied down from British India. However, with the establishment of a Nation known as India, wherein the princely states became a part of the said Nation, it has become necessary to have a common regulator governing the entire banking system across the Nation.
Besides, there was no comprehensive definition of ‘banking’, and there was no prohibition for non-banking companies from accepting deposits on demand, there was no prescription with regard to minimum capital standards, there was no authority vested with the Reserve Bank of India for inspection of the books of a banking company, and above all widening the powers of Reserve Bank of India so as to enable it to come to the aid of the banking companies in times of emergency, and also empowering the central government to take action against banks conducting their affairs in a manner detrimental to the interest of the depositors. The said BR Act 1949 extends to the whole of India, and even though it is stated that the application of other laws are not barred, it is clarified in the said Act in clear terms that in the case of any dispute with regard to any interpretation of the applicability of the Banking Regulation Act, and or any other law especially the Companies Act, the former will prevail in the case of a banking company.
Section 5(c) of the BR Act 1949 for the first time introduced a clear cut definition of a banking company. As stated supra, section 5A of the Act states that the act shall override the memorandum and articles of a banking company. It states that save as otherwise expressly provided in this act the provisions of the Act shall have effect notwithstanding anything to the contrary contained in the memorandum or articles of a banking company, or in any agreement entered into or any resolution passed by its shareholders or its board of directors and whether such instruments are registered, executed or passed, either before or after commencement of the Banking Companies Act 1959.
Section 6 of the BR Act 1949 for the first time introduced the forms of business in which a banking company may engage. The introduction of this section was necessary after the advent of the Banking Regulation Act to ensure that the banks do not engage in a business that is not envisaged under this Act. Likewise, section 10A of the BR Act 1949 clearly specifies that not less than 51% of the total number of board directors should possess special knowledge on various subjects like accountancy, agriculture and rural economy, banking, co-operation, economics, finance, law, small scale industries, etc. Further, the said Act specifically states that the affairs of a banking company has to be managed by a whole time chairman or a managing director. Section 10BB of the Act allows RBI to step-in and appoint a whole time chairman or a managing director, whenever such a position falls vacant in a banking company. The Act clearly states that section 10A and section 10BB shall override all other laws in force.
Things being so, when a banking company, especially in the private sector where government holdings are neither nil or minimal, proposes to appoint a whole time chairman / managing director or CEO, has to be approved by RBI. Merely because the shareholders proposes a name to become a whole time chairman / managing director or CEO, it is not necessary for RBI to approve the said nomination. The nomination can be rejected by RBI even though it has the approval of the majority of the directors or the shareholders.
This provision of RBIs authority for approval of a bank’s chairman or MD, is a check on the shareholders of the banking company to ensure that unlike a company which is incorporated under the Companies Act, the shareholders cannot decide on the person to manage the company because RBI in its capacity as the regulator of banking companies has to have a conviction that the person so suggested by the board of directors and/or the shareholders is capable of running the show, and is having special knowledge with regard to banking.
Section 36 AA of the BR Act clearly grants power to RBI to remove any managerial or other persons from office. Therefore, even if a managing director or a director of a banking company has all the backing of the shareholders, if RBI is of the opinion that if all or any of the said persons at the helm of the banking company, is conducting the affairs of the banking company in a manner detrimental to the interest of the depositors or has failed in securing the proper management of a banking company, Reserve Bank of India has the power to remove the said person and appoint a person of their choice. Very recently in the case of Yes Bank, Reserve Bank of India has exercised the said power and has appointed an administrator who acts as a managing director and also has the powers of an entire board. Section 36 AC clearly states that any appointment or removal of a director, CEO or any other officer or employee pursuant to section 36AA or appointing additional directors under section 36AB shall override all the provisions to the contrary as contained in the Companies Act. Further section 36ACA again provides the RBI with power to supersede the board of directors.
In the case of Dhanlaxmi Bank, Mr. Sunil Gurbaxani took over the assignment as MD and CEO on 27.02.2020 for a period of 3 years. This appointment was found to be in order and approved by the RBI as ‘fit and proper’. The said Bank which was established almost 95 years back was not in good shape when Mr. Sunil Gurbaxani took over. The said Bank was placed by RBI under prompt corrective action (PCA) which means RBI has found that the said Bank’s financial health was not in good shape and prevented it from granting any fresh loans. The Bank was showing loss every quarter-after-quarter. In the said case, rightly or wrongly, the management of the Bank was not run professionally but it had the interference of a few shareholders who hold more than 5% on every stage. Therefore, any chairman or MD who did not dance to their wishes was shown the threat of their right and might to bring in a resolution at the shareholders meeting, and vote them out. Retired former bank employees were appointed under the guise of advisors but were given fancy titles, and they used to interfere in the running of the bank, albeit even attending board meetings. In short, corporate governance as envisaged in the banking industry was practically nil or negligent. It is a sad fact that, save and except, placing the Bank under the PCA framework, RBI did not dwell much on the functioning of the said Bank, and if reports are to be believed, independent directors were quitting the board like a pack of cards. It is a matter of surprise that RBI did not pay much attention to what is happening in the said Bank.
On a perusal of the agenda of the AGM meeting on 30.09.2020, there was precisely no agenda except to approve the appointment of Mr. Sunil Gurbaxani as the MD & CEO of the Bank, and also to appoint certain other independent directors. In the said meeting, the approval for the appointment of Mr. Sunil Gurbaxani was negated and turned into a vote against the said appointment.
The moot question now to be considered is whether a person found fit and proper and appointed in accordance with the regulations of RBI can be removed by the shareholders of the banking company or not. In our considered opinion, the nomination of the said person which led to RBI approving the said person as the MD & CEO stems out of a procedure conducted by the board itself and the board in the instant case consists of the representatives of the major shareholders and their associates who together has a very high voting share and out of the 152 members present who voted, 112 members consisting of 76,21,692 votes representing 9.51% voted in favor of the resolution i.e. ratifying the appointment of the MD & CEO; and 42 members consisting of 7,25,08,796 votes representing 90.49% voted against the ratification.
The above actions of the alleged shareholders who have vested interest has factually and legally created a big question of law and is a direct attack on the authority of RBI and those fundamentally against the provisions of the Banking Regulation Act and set a bad precedent which if not contained shall strike on the very root of the RBI’s Supervisory Powers.
Section 5A of the Banking Regulation Act clearly states that the Banking Regulation Act overrides the Memorandums and Articles of any company who is licensed to undertake the business of banking under section 22 of the Banking Regulation Act. Therefore, it is to be considered whether it is necessary for RBI to allow a bank who is incorporated under the Companies law to ratify an appointment made by RBI in terms of Section 102 of the Companies Act 2013 as it stands now or whether it is only necessary for voting by the Board.
This issue in our humble submission has to be clarified by RBI in its capacity as a regulator of the Banking Industries especially considering the facts that the study group appointed by RBI has suggested that Corporate Houses and big NBFCs should be allowed to carry on banking business. If this is not nip in the bud any appointment by RBI specially when such promoters are allowed to hold upto 26% shares as per the study group in the bank may oust any person appointed by RBI.
Kind attention is also drawn to Section 10 BB subsection 3 which an unacquainted terms states that the appointment of a Chairman or a Managing Director so appointed by RBI can only be removed from the office by RBI therefore it explicitly states on a harmonious reading of Section 5 and Section 10BB that both the appointment and the removal of the MD and the power to do so shall solely rest with RBI and not by the Shareholders.
In the worst scenario, if the shareholders have any complaint against the MD or the Chairman they have to approach RBI with adequate proof to remove him and it does not mean that they themselves can remove the MD and Chairman by voting him out. This precedent if allowed would be alarming and would cause havoc in the regulatory affairs of the RBI on such Banks. This is further fortified by the fact that Under Section 36AA the power to remove the managerial or any other person of the Bank is only with RBI. Therefore, even in a case where there are no shareholders complain or if the shareholders have no reason to remove a Chairman on the contrary if RBI is of opinion that the said person has to be removed due to any reason whatsoever in its wisdom RBI can certainly remove the MD and Chairman for the reason to be recorded in writing by order.
Therefore, assuming a scenario where RBI finds a MD of the Bank is incompetent to run the bank and whereas the shareholders are opposing his removal, if this activism of the vested shareholders are allowed the shareholders can pass a resolution against RBI and stall the removal of MD or CEO guise that the shareholders have faith in the MD and CEO.
It is submitted that the RBI being a sole regulator of Banking Industry has been doing a fantastic and providing services to the Banking Industries and it is only because of the tight control exercised by the RBI the common people have faith in Banking System. My humble submission is that this way cannot be tampered or overturned by certain activist shareholders who have vested interest. Therefore, it is necessary for RBI to act on this by taking stringent action against the bank including if it deems fit to merge the said bank with another bank of its choice and run the bank in a professional manner.
In our opinion, if RBI allows shareholders who have vested interest to outsmart RBIs supervisory power that will be the saddest day for banking in India. RBI should not stand as a mute spectator watching what is happening in such small banks whose shareholders have vested interests and who does not have any knowledge or adequate expertise to run a bank. It is also necessary to take a leaf out of this episode and de-link ownership from the professional manner in which a bank has to be run. Ownership and the right to seek a board seat by virtue of ownership as contained in the normal companies law should be differentiated in the case of a banking company. If RBI does not take any remedial action and crush such ill-advised activism of shareholders who threw a challenge on the face of RBI, rest be assured that this will spread like wildfire and many banks will now start lobbying for bringing in their own preferred individuals as the CEO and Managing Director of a bank. Banking in India is in the process of taking a big leap to reach the masses in view of the various policies of the Government of India. It should not be allowed to fail by way of inaction of the regulator. It is a matter of pride to state that the swift action of RBI in saving Yes Bank and merging Laxmi Vilas Bank with DBS India Bank has only reinforced the faith and strength of RBI as a strong regulator of the banking sector. Therefore, the authors believe that RBI will rise to the action and save the depositors of Dhanlaxmi Bank and put an end to such unwarranted and ill-conceived shareholders activism.
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