Is your post-dated cheque just a security or more?

After a series of decisions delivered by different high courts, the Supreme Court of India, in the case of Sampelly Satyanarayana Rao v Indian Renewable Energy Development Agency Limited, has resolved the controversy as to whether dishonour of post-dated cheques issued as “security” for repayment of a loan would come within the ambit of section 138 of the Negotiable Instruments Act, 1881.

The appellant was a director of a company engaged in the field of power generation and also the co-accused. The respondent (a government enterprise) agreed to advance a loan to the appellant’s company to set up a biomass-based power project in Andhra Pradesh. Under the loan agreement, the company gave post-dated cheques to the respondent as security towards repayment of the loan amount in installments. The cheques were dishonoured and the respondent consequently filed complaints in the concerned court in Delhi.

The appellant asked Delhi High Court to quash the complaints on the ground that dishonour of post-dated cheques given by way of security did not fall under section 138 as: (a) the cheques were given by way of security; and (b) on the date the cheques were issued, no debt or liability was due. The appellant therefore contended that the cheques were for amounts payable in future. Delhi High Court rejected this contention.

This judgment was challenged before the Supreme Court where the question for consideration was whether on the facts of the case, the dishonour of the post-dated cheques given for repayment of loan installments, which was also described as “security” in the loan agreement, was covered by section 138.

The Supreme Court, relying on the relevant clauses of the loan agreement between the parties, was of the view that determining whether a post-dated cheque is for “discharge of debt or liability” will depend on the nature of the transaction.

The court highlighted the peculiarity of the case as evinced in clause 3.1(iii) of the loan agreement, which provided that the post-dated cheques were “towards repayment of installments of principal of loan amount in accordance with agreed repayment schedule and installments of interest payable thereon”. It was held that as soon as the installments fell due on the date of the post-dated cheques as per the loan agreement, they would fall within the ambit of section 138.

The court further ruled that: “Dishonour of cheque issued for discharge of later liability is clearly covered by the statute in question … Crucial question to determine applicability of Section 138 of the Act is whether the cheque represents discharge of existing enforceable debt or liability or whether it represents advance payment without there being subsisting debt or liability. Dishonour of cheque in the present case being for discharge of existing liability is covered by Section 138 of the Act, as rightly held by the High Court.”

Thus, the court, while dismissing the appeal, held that if the liability or debt exists or the amount has become legally recoverable on the date of the post-dated cheque, section 138 is attracted.

Furthermore, the Supreme Court distinguished its decision in the case of Indus Airways Private Limited v Magnum Aviation Private Limited (2014), where it was held that when a contract provides that the purchaser has to pay in advance and the cheque towards advance payment is dishonoured, it will not give rise to criminal liability under section 138, although the purchaser may be liable for breach of contract. This judgment was distinguished on the basis that there is difference between a purchase order transaction which is cancelled and a loan transaction where the loan has actually been advanced and its repayment is due on the date of the cheque.

The Supreme Court’s judgment in the Rao case will have far reaching consequences as it carves out a clear distinction between a post-dated cheque given as security and a post-dated cheque issued for satisfaction of a subsisting liability. It emphasizes that the expressions and terminology used in an agreement must be understood keeping in mind the context of the agreement and the intention of the parties.

In view of this judgment, where a post-dated cheque, though described as a “security”, is in fact issued to discharge or for satisfaction of an existing outstanding liability or debt, the provisions of section 138 will be attracted because the intention and purpose for the issuance of the post-dated cheque does not correspond to the nomenclature of “security” given to it.

The clarity provided in this judgment gives sufficient guidance to borrowers as to events and circumstances which may subject them to one of the most dreaded provisions of law.