The Bombay High Court has clarified that a loan agreement cannot be declared void merely because it contravenes non-statutory guidelines issued by the Reserve Bank of India. The Court set aside an order that had cancelled a recovery certificate on the ground that the loan violated an RBI Master Circular, reaffirming that contractual obligations survive administrative non-compliance unless the contract itself is illegal under statutory law.
The Verdict
The petitioner-bank won. The Bombay High Court held that a loan agreement is not void under Section 23 of the Indian Contract Act, 1872, merely because it contravenes the Reserve Bank of India’s non-binding Master Circular. The Court set aside the revisional order that had cancelled the recovery certificate and restored the bank’s right to recover the outstanding loan amount under Section 101 of the Maharashtra Co-operative Societies Act, 1960.
Background & Facts
In December 2003, Respondent No.3 applied for a term loan of Rs.60 lakh from the petitioner-bank, the CKP Cooperative Bank Ltd. The bank sanctioned the loan on 29 March 2004, and Respondents Nos.3 to 6 executed all necessary security documents. Upon default in repayment, the bank issued a demand notice on 9 August 2007. When no payment was made, the bank filed an application under Section 101 of the Maharashtra Co-operative Societies Act, 1960, seeking recovery of the outstanding amount.
On 13 October 2008, the Joint Registrar, Cooperative Societies, issued two recovery certificates: one for Rs.64,46,520 relating to the term loan, and another for Rs.1,12,64,701 relating to a cash credit facility, both with interest at 16% and 16.5% respectively. Respondents Nos.3 to 6 challenged these certificates before the Divisional Joint Registrar, who allowed the revision application on the ground that the loan violated Clause 2.2.1 of the RBI Master Circular dated 30 June 2006. The Revisional Authority concluded that the loan contract was void under Section 23 of the Indian Contract Act, 1872, as it defeated the RBI’s regulatory framework.
The bank filed writ petitions under Article 226 of the Constitution, challenging this order. No counsel appeared for Respondents Nos.3 to 6 despite service of notice.
The Legal Issue
The central question was whether a loan agreement sanctioned in breach of a non-statutory RBI Master Circular qualifies as a contract that is void under Section 23 of the Indian Contract Act, 1872, on the grounds that it is contrary to public policy or defeats a statutory provision.
Arguments Presented
For the Petitioner
The bank contended that the RBI Master Circular is an internal administrative guideline, not a statutory or regulatory mandate with the force of law. It argued that Section 23 of the Indian Contract Act only voids contracts that are expressly prohibited by statute or that involve fraud, illegality, or injury to public interest. Merely violating an RBI circular does not render a contract illegal. The bank emphasized that the loan was disbursed, accepted, and utilized by the borrowers, who cannot now escape liability by invoking non-binding guidelines.
For the Respondent
The State, through the Additional Government Pleaders, supported the Revisional Authority’s view that the RBI Master Circular reflects public policy and regulatory intent. It argued that allowing loans in contravention of such guidelines undermines financial discipline and exposes the cooperative banking system to risk. The State maintained that contracts violating such norms should be treated as void to uphold the integrity of the financial regulatory framework.
The Court's Analysis
The Court rejected the Revisional Authority’s reasoning as legally unsustainable. It emphasized that Section 23 of the Indian Contract Act requires a contract to be illegal under a statute or to be opposed to public policy in a manner that is clearly defined and enforceable by law. The RBI Master Circular, while authoritative, is not a statute, rule, or regulation made under any legislative enactment. It is an advisory circular issued for prudent banking practices.
"Once the respondents have received the loan amount, they are under a legal obligation to repay the same, even if it is assumed that the loan was sanctioned contrary to the RBI Master Circular."
The Court cited established precedent that administrative guidelines, even those issued by statutory bodies, cannot be elevated to the status of statutory prohibitions unless explicitly so declared. The Court further noted that the borrowers had not alleged any fraud, misrepresentation, or coercion. Their mere receipt and use of the loan created a binding obligation to repay.
The Court also distinguished between regulatory non-compliance by the lender and the legality of the underlying contract. The bank’s internal procedural lapse, if any, may attract administrative or disciplinary action, but it does not extinguish the borrower’s civil liability. The recovery certificate issued under Section 101 of the MCS Act was therefore valid and enforceable.
What This Means For Similar Cases
This judgment provides critical clarity for cooperative banks and financial institutions pursuing recovery under Section 101 of the MCS Act. It confirms that borrowers cannot evade repayment by invoking non-statutory RBI guidelines as a defence. Practitioners may now confidently argue that breach of advisory circulars does not invalidate loan contracts under Section 23.
The ruling reinforces the principle that contractual obligations are enforceable unless they violate positive law or public policy as defined by courts. This limits the scope for collateral attacks on loan recovery proceedings based on regulatory technicalities. However, the judgment does not shield lenders from independent liability for violating statutory provisions such as the Banking Regulation Act or RBI directives that carry statutory force. Future litigation must carefully distinguish between advisory guidelines and binding legal norms.
The judgment also underscores the importance of procedural compliance in recovery applications under the MCS Act. While the substantive contract remains valid, lenders must ensure that their recovery applications are properly documented and supported by evidence of default and notice.
