Sri Visalam Chit Funds Ltd. vs P.N. Srinivasa Mudaliar and Another

Ramaprasada Rao, J.—The unsuccessful Plaintiff in Original Suit No. 156 of 1967 on the file of the Court of the City Civil Judge, Madras,

is the Appellant in Appellant Suit No. 744 of 1969. The Plaintiff is a public limited company carrying on business in chit fund transaction in

Madras. On 8th February 1965 the 1st Defendant became a subscriber to a chit whose terms was 20 months, the monthly installment being Rs.

1,250. The value of the chit was Rs. 25,000. The chit was an auction chit. The 1st Defendant took in auction the chit by bidding for Rs. 16,025.

The 1st Defendant received the amount on 22nd June, 1965, as evidenced by exhibit A-2, Under exhibit A-3 the 2nd Defendant stood as

guarantor to the 1st Defendant for the due repayment of the amount due to the Plaintiff. The future subscriptions were paid upto and inclusive of

the fifteenth installment. Thereafter, the 1st Defendant defaulted. The Plaintiff, as per the by-laws regulating the chit, claimed under exhibit A-4 the

balance due by the 1st Defendant in a lump sum and included in the claim so made the dividend or kasar already earned and credited to the 1st

Defendant and also interest at 12 per cent per annum on the amount due from the date of default, namely, 9th May 1966. The Defendants

admitted their liability to pay the balance due in one lump sum together with the interest claimed bat their main defence was that the Plaintiff is not

entitled to deny the privilege already gained by the 1st Defendant in the matter of his entitlement of dividends already declared till date of default

and the provision in the by-laws governing the chit enabling the stack holder to forfeit such dividends is in the nature of a penalty. On the above

pleadings the following issues were framed:

What is the amount due to the Plaintiff?

Is the chit rule that deprives defaulting prized subscriber of the dividend penal and unenforceable at law?

To what reliefs are the parties entitled?

On issues 1 and 2 the Court upheld the contentions of the Defendants and ultimately on issue 3 gave a decree for the amount due for the last five

installments together with interest at 12 per cent per annum from 9th May, 1966 and proportionate costs. It is as against this the Plaintiff Chit Fund

Company has come up in appeal.

In Civil Revision Petition No. 880 of 1973 the relevant facts are as follows. With the same Chit Fund Company, the first Defendant in Small

Cause Suit No. 74 of 1972 on the file of the Court of the District Munsif, Kovllpatti, against whose decree the Civil Revision Petition arises,

became a subscriber in a chit the range of which was 20 months, each installment being Rs. 50. The first Defendant therein took the chit on the 7th

call and executed a promissory note for the amount due in respect of the subsequent calls. He paid upto the 18th call and defaulted to remit the last

two installments. After giving credit to the amonuts paid, suit was laid for the recovery of Rs. 180.55 which included the sum of Rs. 80.55 being

the dividends already earned by the subscriber as and towards kasar for the period earlier to the default. The contention of the first Defendant was

similar to the one raised in the appeal before us. The learned District Munsif accepted the plea of the Defendant that the forfeiture of earned

dividend amounts to a penalty, but decreed the suit only for Rs. 100 with proportionate costs. As against this, the Civil revision petition has been

filed.

Counsel for the Chit fund in both the cases raised identical contentions. The argument is that it is not penal to enforce a clause in a contract

solemnly entered into between the parties as according to them the forfeiture as to the earned dividend should be understood as an engagement

between the parties whereby that amount has been reckoned as liquidated damages payable by the defaulting subscriber the stake holder and that

it was a genuine preestimate thereof. In such a situation, it is said that without proof of loss the stake holder can seek for restitution of the same. In

any event, it is not a penalty to be relieved against in equity. Another hesitant argument was also raised mat a clause enabling the stake holder to

recover the entire unpaid installments in a lump sum, when a default in the manner of the payment a agreed to is committed, is neither illegal or

oppressive. No argument however was advanced on the right of the stakeholder to recover interest on the defaulted installments.

The clause with which we are concerned in these cases as reflected in the by-laws of the chit fund Company, which is effectively the contract

between the parties may be extracted for ready reference:

If a prized member defaults to pay any installments of the chit within 30 days of the due date thereof the fund is entitled to recover from the said

member, forthwith, and without reference to the date or dates of the subsequent installments, the total chit value of the chit concerned, less the

actual amount paid for the installments till them, without credit for dividends earned or to be earned in that chit, together with interests at 12 per

cent from the date of the earliest default in the due payment of installments.

We shall now take up the argument addressed before us by Mr. T.R. Ramachandran that the right to claim defaulted installments in one lump

sum is by itself not unconscionable and need not therefore, be relieved against. Though it does not strictly arise in this case, as the subject is of

considerable importance, the parties agreed to take an authoritative pronouncement from us after taking us through many ancient pronouncements

on the same. We have, therefore, considered it necessary to render a decision on the same.

For a considerable time ranging beyond a century chit fund transactions were resorted to as a means to earn profit and incidentally to save. The

engagement between stakeholder and a chit fund subscriber is special and has a distinct connotation. The stake holder throughout the period of the

chit acts as a sentinel, he having taken the sole responsibility for being answerable to all the subscribers as between whom there is no link,

contractual or otherwise. This special feature in chits necessarily enables the stakeholders to impose such strict and stringent conditions so as not

only to safe-guard his commercial interests, but also to the subscribers either individually or collectively. As pointed out by the Division Bench of

our court in Vaithinatha Iyer v. Govindaswami Udayar 42 M.L.J. 551, 557:

The stakeholder has necessarily to depend on punctual payments from his subscribers and to reserve to himself powers to enforce such payments.

For the stake holder alone is liable to each subscriber and there is no liability between the subscribers in terse ; and without punctual payments by

the individual subscribers the stakeholder could not discharge his liabilities to the successful bidders, as they arose.

When a subscriber bids at an auction and becomes the lowest bidder entitling him to be recognised as the successful bidder and takes the bid

amount after executing the usual document along with a surety, his debt to the chit fund is solved in preesenti but solvendum in future according to

the terms of the arrangement reflected in the document contemporaneously executed by him. In fact, our Court in P.N. Raghavan Pattar and

Others Vs. S. Arumugham by his mother and guardian Singarammal and Another, regarded the successful bidder in an auction as a purchaser of

the subject of the auction, i.e. a present sum of money. With great respect, this strange approach to a simple problem did not gain support either in

the decisions rendered earlier by our Court or later. As early as 1963, in Kamatchi Asari v. Appavu Pillai (1862) 63 M.H.C.R. 1 (F.B.) another

Division Bench consisting of the then Chief Justice brought out the essence of the transactions under consideration before us by saying.

It is simply a loan of the common fund to a subscriber. Ananthakrishnan Iyer, J. in Kunju Nair v. Narayanan Nair 65 M.L.J. 29 referred to this.

Ganesan, J. in Bathma Industry and Finance Private Limited v. Rajammal (Civil Revision Petition No. 717 of 1971) observed that it would be

artificial to characterise the transaction as a sale of money. We agree with Ganesan, J.

If, therefore, the subscriber who offers the highest discount as an auction is chosen as the person entitled to the loan from the common fund an in

consequence thereof he executes a loan bond subject to the terms and conditions under which the entire chit is run and agreed to be run by the

subscriber, it is for consideration whether the stipulation to claim back the defaulted installments in one lump sum is oppressive and unconscionable.

It is not every term of a contract, though prima facie appearing to be not normal, that has to be held as being penal in nature. The special

circumstances attendant upon the bargain between the parties the justifiable necessary for its adoption, the generality of the situation in which such

a contract is forged, have all to be considered before a Court could receive the same from enforcement. We have already noticed the heavy

responsibility assured by the stake holder and its duty to protect the other subscribing members. If in such circumstances any stipulation for the

payment of the totality of the unpaid installments in case of default of payment of one such in the sequence, cannot be viewed as a penal provision.

We shall now trace the case law on the subject and how our learned Judges have viewed the same in different times. We may usefully refer to

the general observations made by a Division Bench of our Court in 1902. In Periaswami Thalavar v. Subramanian Asari (1902) 14 M.L.J. 136

Benson and Bashyam Aiyangar, J. observed:

There is no allegation that the Defendant did not enter into the transaction with his eyes open, or was deceived as to its terms. The bond was

entered into in accordance with the rules of the chit fund, which are not in any way illegal. There is no ground for not allowing the rule to be given

effect to.

Vaithianathan Iyer v. Govindaswami Odayar 42 M.L.J. 551, 557 is the leading case on the point. That was of the year 1922. There on the

pleadings which we shall presently refer to, the learned Judges in a situation like the one with which we are faced expressed the view that in a suit

by the Plaintiff to recover the amount shown in the bond which was executed by the defaulting prized subscriber which represented the entirety of

the balance of the subscription payable by him on after the date of default and held:

that the terms of the bond as regards (1) the Defendant''s liability for future installments from the date of his default, (2) his deprivation of the

dividend and interest and (3) the imposition on him of liability for interest on the amount due from him at 18 per cent from the date of his default,

did not, either each taken by itself, or all together, amount to a penal stipulation.

In this case, however, as we snail point out in the course of our judgment, the question whether earned dividends by the prized subscriber could be

forfeited in cases of such default did not come up for consideration before them.

The above decision was not brought to the notice of Srinivasa Aiyangar, J., when he decided Ramalinga Adaviar and Another Vs.

Meenakshisundaram Pillai and Others, and Second Appeal No. 811 of 1924. Even in Muthukumarasamiah Pillai Vs. Subramanian Chettiar and

Others, Ramasami, J., who was party to the above did not seem to have adverted to his own decision.

But the decision of Srinivasa Aiyangar, J., no is longer good law is seen from the ratio in Subbiah Pillai v. Muthiah Pillai 65 M.L.J. 302, Kunju

Nair v. Narayanan Nair 65 M.L.J. 29, Ayyakannu Pillai and Another Vs. Doraiswami Pillai and Others, and Kannan v. Subramania ILR (1941)

Mad. 486 It is enough to refer to Subbiah Pillai v. Muthiah Pillai 65 M.L.J. 302. Thereafter, referring to Vaithinatha Iyer v. Govindaswami Odayar

42 M.L.J. 551 beasley C J. speaking for the Bench held that a clause in a security bond executed by the prized subscriber to the effect that in

default of payment of future installments as and when they fail due, the entire amount of the remaining installments was to become due and

immediately payable, was not of a penal nature. In Kannan v. Subramania ILR 1941 Mad. 486 Patan, J. Ali Sastri, J., reviewed the entire position

and after referring to Vaithianatha Iyer v. Govindasami Odayar 42 M.L.J. 551 and Kunju Nair v. Narayanan Nair 65 M.L.J. 29 observed as

follows:

In Subbiah v. Shanmugham AIR (1928) Mad. 246 Srinivasa Aiyangar, J, held that a provision for acceleration of payment of the future installments

was penal and unenforceable as there was no debitum in present in such cases, but this decision was reversed on appeal in Subbiah Pillai v.

Muthiah Pillai 65 M.L.J. 302. In P.N. Raghavan Pattar and Others Vs. S. Arumugham by his mother and guardian Singarammal and Another,

another Bench took the view that the successful bidder at an auction was a purchaser of the sum, and the contract thus being one of sale and not of

borrowing, no question of penalty could arise. They approved the decision of Ananthakrishnan Ayyar, J., in Kunju Nair v. Narayana Nair 65

M.L.J. 29 though it was based on a different ground.

Even under the Tamil Nadu Chit Funds Act, 1961 (as modified upto the 25th July, 1970) Section 24 makes the position clear and it runs as

follows;

Every prized subscriber shall pay his subscription regularly at the time and place and on the date mentioned in the chit agreement and on his failure

to do so, he shall be liable to make a consolidated payment of all the future subscriptions at once.

The foreman, however is entitled to claim the consolidated sum only after he makes a demand in writing. This is provided for in Section 25(1) of

the Act which reads as follows:

A foreman shall not be entitled to claim consolidated payment of all the further subscriptions from a defaulting prized subscribe unless he shall have

demanded the same in writing:

This provision also does not militate against the opinion we have expressed that the demand for payment of the totality of the unpaid installments in

case of default by the prized subscriber can never be held to be penal.

The other live contention raised by Mr. T.R. Ramachandran learned Counsel for the Appellant, is that in any event the bargain between the

stake holder and the auction purchaser resulting in a bond containing a stipulation that the dividend or kasar earned already or upto the date of

auction stands forfeited in case of default is not penal. His case is that this is equally a stipulation entered into with open eyes by the subscriber and

having regard to the nature of the trade and the hazards inhered therein, the stake holder is entitled to claim restitution of such monies even if it had

been paid over to the defaulting subscriber and a fortiori claim a forfeiture of the same in any event. Mr. P.S. Ramachandran for the Respondent

contends otherwise.

Whether a stipulation in a given contract is penal or not depends on myriad circumstances both internal and external. Internally, looking into the

by law, it appears to us that enforcing the clause as to forfeiture of earned kasar would amount to divesting of a vested right without lawful

justification. The past dividends nave reference to past events which are totally unconnected with the supervening default of the subscriber

concerned. If at least any reasonable nexus is perceivable between the later default and the earlier entitlement as to the right to receive the

dividend, then possibly the clause may be adjudged in relation to supervening circumstances. In the absence of such a link between the default and

the forfeiture, except the text of the claim, courts should be desitant to give effect to it as it would lead to unjust enrichment of the stake holder. It is

not pretended that such forfeited dividends are intended to be distributed to the other subscribers. Judged from any perspective, the enforcement

of that portion of the by law which would enrich the stake holder without any justification, but which would unjustifiably deprive the subscriber

from getting the fruits of his original bargain would certainly be oppressive and Courts cannot lead their badge of support to such bargains.

But it is said that such forfeiture could be supported on the principle that liquidated damages agreed to between the parties is recoverable in the

eye of law. There is a fallacy in the argument. Though the cobwebs of rules and distinctions made in English law between penalty and liquidated

damages are not strictly inviolable in India, having regard to the express statutory provision in Section 74 of the Contract Act, yet it is said that the

stipulation to forfeit the past kasar having reference to a past event doesn''t squarely come within the meaning of that auction. This very argument

was repelled by the Supreme Court in Fateh Chand v. Balkishan Dass (1964) 1 M.L.J. 60 (S.C.). This Supreme Court disturbed a ruling of the

Madras High Court in Natesan Aiyar v. Appavu Padayachi ILR Mad. 178 which held the filed for a long time, and said:

In these case the High Courts appear to have concentrated upon the words to be paid in case of suck breach in the first condition in Section 74

and did not consider the import of the expression the contract contains any other stipulation by way of penalty, which is the second condition

mentioned in the section. The words, ''to be paid'' which appear in the first condition do not qualify the second condition relating to stipulation by

way of penalty. The expression if the contract contains any other stipulation by way of penalty widness the operations of the section so as to make

it applicable to all stipulations by way of penalty, whether the stipulation is to pay an amount of money, or is of another character, as for example,

providing for forfeiture, of money already paid. There is nothing in the expression which implied that the stipulation must be one for rendering

something after contract in broken. There is no ground for holding that the expression ''contract contains any other stipulation by way of penalty'' is

limited to cases of stipulation in the nature of an agreement to pay money or deliver property on breach and does not comprehend covenants under

which amounts paid or property delivered under the contract, which by the terms of the contract expressly or by clear implication are liable to be

forfeited.

Again we do not consider the right of forfeiture of past dividend as reflecting a genuine estimate of the damages which the stake holder

apprehended when the subscriber bid at the auction and took the chit. No loss has been pleaded or proved.

Strong reliance was placed on Vaithinatha Iyer v. Govindaswami Odayar 42 M.L.J. 551. We saw the pleading in the above case. The Plaintiff

stake holder filed a suit for the recovery of Rs. 7,000 which represented the amount payable for 7 chit installments, such installment being Rs.

1,000. However forfeited the past dividend (called discount) in that case. In addition to the amount of Rs. 7,000, interest on the same at the

agreed rate was claimed. It was in those circumstances the Division Bench said that the deprivation of the dividend did not amount to a penal

stipulation. Having regard to the facts of this case, it is clear, as Ganesan, J., said in the above case, that it dealt with only forfeiture of dividend

payable in future which in point of time is subsequent to the auction. We do not, therefore approve of the decision of Kailasam, J. in Civil Revision

Petition No. 2606 of 1971 which was solely based on the decision in Vaithianathan Iyer v. Govindasami Odayar 42 M.L.J. 551. We are in

agreement with Ganesan, J. when he said:

The right of the Petitioner stakeholder to adequate compensation in all these cases are sufficiently safeguarded by the provisions in the rules that, in

default the Respondents-successful bidders along with their guarantors are bound to repay the entire balance in a lump sum with a fairly heavy

interest, and there is a further safeguard that it is open to the Petitioner stake holder to bring in fresh subscribers in case of default by the successful

bidder at the auction. The stipulation to forfeit the earned kasar appears to be harsh and oppressive and must therefore, be relieved, against

In the result, therefore, we hold that the stake holder is not entitled in law to forfeit the quondam discounts already earned by the prized chit holder

and he can only claim in full the installments to be paid after default together with interest thereon as per the contract rate. The Appellant in Appeal

Suit No. 744 of 1969 fails and the appeal is dismissed with costs.

In Civil Revision Petition No. 880 of 1973 the learned Small Cause Court Judge decreed the suit only for Rs. 100, which represented the

defaulted 19th and 29th calls, but did not award interest, he has rightly disallowed the sum of Rs. 80.55 which obviously represented the past

discount. The judgment of the Court below is modified to this extent, namely, that there will be a decree for Rs. 100 together with interest at 5 1/2

per cent per annum from the date of suit till the date of payment as the Respondent have been found to be agriculturists. There will be no order as

to costs in this civil revision petition.