Demystifying the Nature of Loan Defaults: Reasoning of the Supreme Court

[Jai Shanker Bajpai and Aastha Bidsar are students at School of Law, University of Petroleum and Energy Studies, Dehradun]

The difference between breach of contract and cheating under section 415 of the Indian Penal Code, 1860 (“IPC”) is a fine one. It is due to this fine line that errors are sometimes committed in interpreting the demarcated difference. Earlier this year, in Satishchandra Ratanlal Shah v. State of Gujarat (3 January 2019), the Supreme Court has once and for all defined the boundaries of both the offences. It was pertinent to set a precedent on this issue so as to clear the air on the nature of loan defaults.

Facts of the case

The dispute simply arose out of a loan transaction and a subsequent default on it. The respondent, being the director of a money lending company named Dharshan Fiscal Pvt. Ltd, lent the appellant a loan of Rs. 27,00,000 (twenty seven lakh rupees). Subsequently, the appellant did not repay the loan amount. A first information report (“FIR”) was filed by the company director under section 406, 409, 417, 420, 294 (b) and 506 (2) of IPC.

The appellant filed an appeal in the Gujarat High Court under section 482 of Criminal Procedure Code (“CrPC”) for quashing the FIR. Simultaneously, the respondent filed a summary suit for recovery of the loan amount. The High Court dismissed the quashing petition and observed that a prima facie offence of cheating under section 420 of IPC exists and referred the case to the trial court. Being aggrieved by this decision, the appellant preferred an appeal in the Supreme Court.

Decision of the Supreme Court

The Supreme Court held that the High Court cannot base its decision of quashing the charge on the basis of the quality or quantity of evidence; rather, the enquiry must be limited to a prima facie examination. The Court observed that it is well settled that such exercise needs to be undertaken by the High Court in exceptional cases (State of Bihar v. Ramesh Singh, 1977 CriLJ 1606).

Making a clear distinction between a breach of contract and cheating, the Court held that the distinction depends upon the elements of fraudulent inducement and mens rea (Hridaya Ranjan Prasad Verma v. State of Bihar, 2000 4 SCC 168). It was observed that mere inability of the appellant to repay the loan amount cannot amount to a criminal prosecution for cheating unless fraudulent or dishonest intention is shown right from the inception of the transaction, as mens rea is the crux of the offence. The Court, on examination of evidence, held that no such dishonest representation or inducement could be found or inferred so as to constitute the offence of cheating. The Court also cautioned against criminalizing civil disputes, such as contractual disputes, and observed that it could lead to a dissonance with established legal principles which clearly draw a line between civil and criminal offences (Gian Singh v. State of Punjab, (2012) 10 SCC 303).

Analysis

The Supreme Court arrived at the same decision as the Madras High Court did in the year 1985 in K. Periasami v. Rajendran, another, 1985 Cr LJ 1721). The Madras High Court observed in this case that the controversy of loan defaults were purely civil in nature and the total absence of dishonest intentions to dupe contractions’ right from the inception of the relationship makes it distinct from a criminal offence. To hold a person guilty of cheating it is necessary to prove that the person had a fraudulent or dishonest intention at the time of making the promise. It is sine qua non for the offence of cheating.

Merely on the basis of a failure to keep up a promise subsequently, culpable intention right at the beginning, i.e., when the promise is made, cannot be presumed (State of Kerela v. A.P. Pillai, 1972, Cr LJ 1243 SC). In a case where the amount was not paid due to the failure of applying a loan amount to start a business, it was held that it only amounted to breach of contract and not a criminal offence due to the absence of dishonest intention (Hari Prasad Chamaria v. Bishnukumar Surekha, 1974 Cr LJ 352). It is pertinent to note that deception is the essence of the offence. Mere failure to honor a promise does not by itself constitute the offence of cheating (Ramautar Choukhany vs Hari Ram Todi, 1982 Cr LJ 2266).

The courts have long emphasized the distinction between civil and criminal wrongs and they must not permit a person to be harassed even though no case for taking cognizance of the offence has been made out (GHCL Employees Stock Option Trust v. India Infoline Ltd., 2013 4 SCC 505). Where it prima facie appears that an alleged act gives rise to a civil liability, such an act cannot be dressed up as a criminal offence.

As seen in Satishchandra Ratanlal Shah, sometimes the facts of the case may seem to be of a commercial or civil nature and, in certain circumstances, it may be coupled with ingredients of criminal offence. Even then, such disputes will be entertained and the peculiar facts and circumstances of each case would determine the nature of proceedings (Arun Bhandari v. State of U.P., 2013 2 SCC 801). As in Satishchandra Ratanlal Shah , the Supreme Court relied on the lack of evidence to conclude that the offence of cheating is not made out. However, if such a criminal intention is found to be present, a criminal and a civil case can proceed simultaneously (Vitoori Pradeep Kumar v. Kaisula Dharmaiah, 2001 Cr LJ 4948 SC).

Jai Shanker Bajpai & Aastha Bidsar

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