India: Should Master Circular Cover Derivative Transaction?

Last Updated: 10 December 2013
Article by PSA


Derivative is a financial contract that derives its value from a specific market reference, such as a common stock, index, interest rate, commodity, or currency. Derivatives are one of the three main categories of financial instruments; the other two includes equities and debt. Derivative transactions include a variety of financial contracts, including structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards, and various combinations thereof. Derivative contracts are entered either for risk management or for speculation and, therefore either of the contractual parties can be obligated to make payment to the other depending on the value of the underlying asset. The most crucial legal question that arises in such derivative transactions is whether the relationship of the parties can be construed as that of a lender and borrower and, consequently whether the Master Circular issued by RBI dated July 1, 2008 on "wilful default" ("Master Circular") becomes applicable. In the recent past, Supreme Court was confronted with the said question of law in a three separate appeals namely, (i) Kotak Mahindra Bank vs. Hindustan National Glass and Ind Ltd and Ors ("Calcutta case"), (ii) Emcure Pharmaceuticals Ltd and Anr vs. ICICI Bank Ltd and Ors and (iii) Finolex Industries Ltd and Anr vs. Reserve Bank of India and Ors ("Bombay cases"), wherein the Supreme Court has interpreted to decide whether a wilful default in meeting payment obligation to a bank under derivative transaction will be covered under the Master Circular. The present bulletin discusses the highlights of the appeal.

1. Facts of the Cases

The facts of all the three cases, Calcutta case and Bombay cases are similar, wherein the companies have entered into foreign exchange derivative transaction with respective banks and, accordingly credit facility of huge amount has been sanctioned to the companies for hedging foreign currency fluctuation. In the course of the transactions, huge sums have become due and payable by companies to their respective banks. Despite repeated requests, companies failed to pay the due amounts. Meantime, RBI issued the Master Circular requesting the banks and financial institutions to provide information on wilful defaulters. Consequently, the banks issued notices to the respective companies to show cause why they should not be classified as "wilful defaulter" as per the Master Circular. The companies contended that the Master Circular will be applicable only to the transactions constituting lender-borrower relationship and, therefore no action can be taken against the companies under the Master Circular. The issue was placed before the Grievance Redressal Committee and it was held that the Master Circular will also cover derivative transactions. Aggrieved, the companies filed writ petitions before Calcutta High Court ("CHC") and Bombay High Court ("BHC"). While CHC held that the Master Circular will not cover derivative transactions, BHC held that the Master Circular covers derivative transactions. Aggrieved parties of all the three cases filed Special Leave Petitions before the Supreme Court which were then heard and decided jointly.

1.1 Stand of the Companies

(i) Wilful default can arise only out of a lender – borrower relationship between the bank and its constituents and, therefore, unless the bank has given a loan or an advance to its constituent, the question of wilful default under the Master Circular does not arise.

(ii) The fundamental difference between a loan/ advance and a derivative transaction is that in the case of a derivative transaction, either party could be required to effect payment depending on the change in value of the underlying asset, whereas in the case of a loan or advance, it is the borrower alone who has to effect the payment.

(iii) The relationship that exists between the parties in a loan transaction is that of lender and borrower, but in a derivative transaction, the relationship existing between the parties is that of creditor and debtor.

(iv) BHC erroneously recorded a finding that wilful default covers default in payment obligations under derivative transactions by relying on the circulars issued by RBI which do not relate to wilful defaults, but relate to prudential norms, assets classification as non –performing assets etc.. It is a settled principle of statutory interpretation that a definition of one Act should not be imported to another Act1. The Master Circular should be construed on its own terms and language and if so construed, it does not contemplate or cover a creditor and debtor relationship.

(v) The functions of the banks are categorized under two broad heads namely a) core banking functions of accepting deposits and lending, and b) miscellaneous functions and services2. The Master Circular will apply only to core banking functions constituting lender- borrower relationship. Derivatives are part of the miscellaneous functions and services and hence do not create a lender-borrower relationship.

(vi) The Master Circular covers the dues under the borrower –lender relationship between the customer and the bank. Derivative transactions do not involve a borrower –lender relationship at all. So, it could not create a borrower-lender relationship subsequently on default of payment under the derivative transaction.

(vii) Categorizing the companies as wilful defaulters as per the Master Circular will have severe consequences such as criminal liability and restrictions in obtaining further loans and/ or credit facilities, which in turn affects the rights of the company/person to carry on any trade, business or occupation. Hence, the Master Circular will have to be strictly and/or narrowly interpreted and should not be applicable to derivative transactions. The information relating to derivative transactions should be treated as confidential and should not be disclosed either to RBI or any other banks. There is an implied contract between customer and bank that the bank will not disclose any information pertaining to its customer to third parties.

1.2 Stand of the Banks

(i) As per clause (c) of section 2 of the Credit Information Companies (Regulation) Act, 2005, the term "client" includes a person who not only obtains or seeks financial assistance from credit institution, but also obtains assistance in any other form or manner so that the person who has defaulted payment in derivative transactions would also fall under the ambit of a wilful defaulter.

(ii) Derivative transaction is a facility provided by banks to its customers for the management of risks arising from foreign exchange and interest rate fluctuations. It is a non- funded credit facility and, therefore the person who defaults payment in such transactions would also be covered under the Master Circular.

(iii) RBI is an expert body regulating the economy of the country and, therefore courts should not interfere with the decisions of RBI without concrete reasons as it would impact the credit system of the financial institutions and that of the country3 as a whole.

(iv) As per section 45A(b) and 45A(c) of the RBI Act, banks and/ or financial institutions have authority to disclose information with respect to derivative transaction dues to RBI.

1.3 The stand of RBI in the three civil appeals

(i) Clause 2.1 of the Master Circular defines the term "wilful default" as a default by a unit in meeting its payment/ repayment obligations to the lender‟, but the word lender has not been defined in the Master Circular.

(ii) The intention of RBI while issuing the Master Circular was to cover all eventualities where payment/ repayment obligations exist and, therefore the Master Circular would cover all banking transactions including foreign exchange derivative transactions.

(iii) The purpose of the Master Circular is to ensure that the clients of the banks who had defaulted in their payment/ repayment obligations are not provided additional finance and, therefore a client who had defaulted under foreign exchange derivative transaction would also be covered under the Master Circular.

(iv) Clause 2.1 of the Master Circular makes it clear in sub clause (a) that a wilful default will cover also a case where a unit has defaulted in meeting its payment obligations to the lender if it had the capacity to honour the said obligation. In a lender-borrower relationship there may be a repayment obligation to the borrower but no payment obligation, whereas in non-funded facility such as derivative transaction, there is no re-payment obligation but only a payment obligation. Thus, the Master Circular covers derivative transactions.

(v) The definition of "wilful default" under the Master Circular is wide enough to cover derivative transactions and it is the legislature which should keep in pace with the changing needs of business transactions. The Master Circular was issued to cover all

kinds of dues to the bank and, therefore as and when validity of new products such as derivative transactions are questioned, the Courts should interpret widely to cover such new products under the Master Circular.

2. Court's Judgment

The Supreme Court rejected the narrow approach adopted by CHC in deciding that the relationship of parties in derivative transactions should be construed as that of a lender and borrower just by relying on the definition of "wilful default" mentioned in the Master Circular which contains the word lender. The Supreme Court opined that CHC construed the meaning of the word "wilful default" literally and hence it must be interpreted in the context and subject matter in which it is actually used. In the present case, the Master Circular was issued at the instance of Central Vigilance Commission‟s ("CVC") letter dated November 27, 1988, intended for putting in place a system for disseminating credit information pertaining to wilful defaulters to all financial institutions, thereby to safeguard their interests and also to restrict such wilful defaulters from obtaining further finance. CVC‟s letter intends that all cases of wilful defaults of INR 2.5 million and above should be reported to RBI irrespective of whether the transactions involve lender – borrower relationship or not. Similarly, while deciding the issue, Supreme Court rejected the viewpoint of BHC related to payment obligations under derivative transactions by relying on the language of not only the Master Circular but also other circulars on prudential norms, assets classification as non performing assets etc, issued by RBI. The meaning of any word mentioned in the statute or and Act should be construed according to its purpose and, hence the Master Circular will cover dues payable under derivative transactions. The ratio of the Supreme Court was that the Master Circular itself does not have penal consequences and, therefore need not be strictly construed. Further, the Supreme Court has rejected the contention of the companies that banks and/or financial institutions act of sharing its customer information with RBI will amount to breach of confidentiality. It was further held that RBI Act includes provisions for confidentiality, as well as exceptions to the same and, therefore sharing of information by banks with RBI with respect to wilful defaulters under the Master Circular will not amount to breach of the confidentiality provisions.


In the present matter, Supreme Court has set an approach that language of the RBI circular should be construed according to its purpose and, accordingly held that derivative transactions will come under the aegis of the Master Circular and perhaps, a similar approach can be followed by the courts while interpreting other government regulators‟ notifications. The Supreme Court held that wilful defaults by parties of dues payable under derivative transaction are covered by the Master Circular and this ratio was given not because RBI wants the Supreme Court to take this view, but it is the judicial interpretation of the Master Circular. The Supreme Court has, in its judgment, only dealt with the question whether derivative transactions will be covered under the Master Circular and has not opined on the other individual transactions between banks and the companies.


1. Commissioner of Sales Tax, M.P v Jaswant Singh Charan Singh, 1967 (2) SCR 720

2. ICICI Bank Ltd v Official Liquidator of APS Star Industries Ltd, (2010) 10SCC 1

3. Peerless General Finance and Investment Co. Ltd and Anr v Reserve Bank of India, (1992) 2 SCC 343

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions