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Legal Aspects Of Business

A Project On


Rajshree Sugars and Chemicals Limited

AXIS Bank Limited

Submitted To:-
Prof. Hari Parmeshwar

Submitted By:-
Anand Mallick (08)
Anant Kumar (09)
Sushree Sangita Mohapatra (24)
Manoj Kumar Singh (47)
Batch: 2008-2010


 Acknowledgement 02

 Executive Summary 03

 Introduction to Derivatives 05

 Derivative Cases that are before the Court 08

 The Case: RSCL vs. Axis Bank Ltd. 09

 Facts of the Case 12

 Key Issues in the Case 14

 Whether the contract entered is wager 15

 Is the contract Null and Void 16

 Can you sue your Banker if you have lost money by Investing
on his Advice 18

 Conclusion 20

 Bibliography 21


It gives us immense pleasure to express our deepest gratitude towards Professor Hari
Parmeshwar for providing us with the opportunity to undertake this project, which helped us
to learn so much about the real world situations.

We would also like to express our sincere thanks to all other faculty members as well as the
staff at library and computer lab who has helped us on the project work with the necessary
inputs. Their constant support has been the key to our achievements on the projects.

We would also like to thanks our parents, fellow colleagues and friends for helping out in
timely completion of the project report and for providing for their moral support, suggestions
and encouragement.

Anand Mallick (08)

Anant Kumar (09)

Sushree Sangita Mohapatra (24)

Manoj Kumar Singh (47)

Executive Summary

A derivative is a financial agreement that has its value determined from the price of a certain
asset, commodity, rate, index or the happening or significance of an event. The meaning of
the word derivative itself comes from the way in which the values of these agreements are
derived from the price of the item of significance. There are many known examples of
derivatives such as futures, swaps, forwards, and options, all of which can be joined with
traditional securities and loans thus creating structured securities, also commonly referred to
as hybrid instruments.

This project is about a derivative contract entered between a Coimbatore based company i.e.
Rajshree Sugars and Chemicals Limited (RSCL) and Axis Bank Limited. RSCL is a listed
company, engaged in the manufacture and export of sugar to foreign countries having
External Commercial Borrowings (ECB) from Banks. The company as an exporter and
borrower has receivables and payables in foreign currencies respectively. Pursuant to
fluctuating rate of exchange of foreign currencies RSCL decided to hedge the risk against
such fluctuations and accordingly, on 14.5.2004, entered into a I.S.D.A. (International Swaps
and Derivatives Association) Master Agreement with UTI Bank Limited (Now AXIS Bank
Limited). Pursuant to the ISDA Master Agreement, atleast 10 deals were struck between the
parties out of which 9 were already matured and the present dispute pertained to the 10th
deal. In terms of the above deal, Axis bank paid USD 100,000 to the RSCL. However, after 6
months, the RSCL sent a letter claiming that the entire structure as per the contract dated got
knocked out with no liability to either of the parties. Bank in reply challenged the claim and
contended that the contract was still alive and that the Bank was prepared to work out suitable
risk mitigation structures. RSCL by way of present suit challenged the deal as void ab-initio,
illegal, violative of RBI Guidelines, opposed to public policy and unenforceable and not
binding on the company. Whether deal liable to be outright rejection? RSCL assailed deal as
illegal contending that their receivables and payables were not denominated in Swiss Franc
and hence a FOREX option in USD/CHF was wholly unauthorised and not permitted. Held,

truly the RSCL's foreign currency payables and receivables were denominated only in US
Dollors and not in Swiss Franc, but as evident from the Master circulars and the Regulations
there was no compulsion for a person to have dealings only with reference to the Indian
rupee. Relevant Master circulars expressly permitted customers to hedge their receivables and
payables against a third currency instead of Indian rupee, subject only to two conditions
namely that such third currency should be a permitted currency and that it should be actively
traded in the market. Swiss Franc satisfies both conditions – Further conditions imposed by
Schedule-I to the "Foreign Exchange Management (Foreign Exchange Derivative Contracts)
Regulations, 2000 it was clear that even the currency of hedge and tenor was left to the choice
of the customer. Now, both the company as well as bank is fighting legal battle for the losses
they have occurred due to the contract.


A Derivative is a financial; instrument that is derived from some other asset, index, event,
value or condition (known as underlying). Rather than trade or exchange the underlying itself,
derivative traders enter into an agreement to exchange cash or assets over time based on the
underlying. A simple example is a futures contract: an agreement to exchange the underlying
asset at a future date.

Derivatives are often leveraged, such that a small movement in the underlying value can
cause a large difference in the value of the derivative.

Derivatives can be used by investors to speculate and make a profit if the value of the
underlying moves the way they expect. Alternatively, traders can use derivatives to hedge or
mitigate risk in the underlying, by entering into a derivative contract whose value moves in
the opposite direction to their underlying position and cancels part or all of it out.

Derivatives are usually broadly categorized by:-

 The relationship between the underlying and the derivative. For example, forward,
option, swap.
 The type of underlying. For example, Equity derivatives, FX derivatives, Credit
 The market in which they trade. For example, exchange traded or over-the-counter.

The uses of Derivatives are:-

 Hedging
 Speculation and arbitrage


Hedging is a technique to eliminate or reduce risk. Derivatives allow risk about the price of
the underlying asset to be transferred from one party to another.

Hedging also occurs when an individual or institution buys an asset and sells it using a future
contract. The individual or institution has the access to the asset for a specified amount of
time, and then can sell it in the future at a special price according to the futures contract. Of
course, this allows the individual or institution the benefit of holding the asset while reducing
the risk that the future selling price will deviate unexpectedly from the market’s current
assessment of the future value of the asset.

Speculation and arbitrage

Derivatives can be used to acquire risk, rather than to insure or hedge against risk. Thus, some
individuals and institutions will enter into a derivative contract to speculate on the value of
the underlying asset, betting that the party seeking insurance will be wrong about the future
value of the underlying asset. Speculators will want to be able to buy an asset in the future at
a low price according to a derivative contract when the future market price is high, or to sell
an asset in the future at a high price according to a derivative contract when the future market
price is low.

Institutions and individuals may also look for arbitrage opportunities, as when the current
buying price of an asset falls below the price specified in a futures contract to sell.

Types of Derivatives

There are mainly two types of derivatives:-

 Over-the-counter Derivatives
 Exchange-traded Derivatives

Over-The-Counter Derivatives

Over-the-counter (OTC) Derivatives are contracts that are traded directly between two
parties, without going through an exchange or other intermediary. Products such as swaps,
forward rate agreements, and exotic options are almost always traded in this way. The OTC
derivative market is the largest for derivatives, and is largely unregulated with respect to
disclosure of information between the parties, since the OTC market is made up of banks and
other highly sophisticated parties, such as hedge funds. Reporting of OTC amounts are
difficult because trades can occur in private, without activity being visible on any exchange.

Exchange-Traded Derivatives

Exchange-traded derivatives are those derivatives products that are traded via specialized
derivatives exchanges or other exchanges. A derivative exchange acts as an intermediary to
all related transactions, and takes Initial margin from both sides of the trade to act as a

Common derivative Contract Types:-

There are four major classes of derivatives:-

1) Futures
2) Forwards
3) Options
4) Swaps


Futures contracts are similar in many ways to forwards, with the exception that they are very
standardized. The future contracts which are commonly traded on the majority of organized
exchanges are so highly standardized that they are given the label of fungible - which means
that they can be easily substitutable for one for another. Fungibility is advantageous in that it
promotes trading and yields a larger trading volume in addition to greater market liquidity.


Forward deals are provide insurance against the possibility that exchange rates will fluctuate
and ultimately differ from what they are between the present and the delivery date of the
contract. A forward is also a simple common derivative because simply stated, it is a financial
agreement with its price rooted in another asset. The delivery price is the price in a forward
contract. This gives the investor the permission to fix the current exchange rate thus avoiding
changes in the forex exchange rates.


Options are contracts that give the owner the right, but not the obligation, to buy or sell an
asset. The price at which the sale takes place is known as the strike price, and is specified at
the time the parties enter into the option. The option contact also specifies a maturity date. In
the case of a European option, the owner has the right to require the sale to take place on the
maturity date; in the case of an American option, the owner can require the sale to take place
at any time up to the maturity date. If the owner of the contact exercises this right, the
counterparty has the obligation to carry out the transaction.


Swaps are contracts to exchange cash on or before a specified future date based on the
underlying value of currencies/exchange rates, bonds/interest rates, commodities, stocks or
other assets.

More complex derivatives can be created by combining the elements of these basic types. For
example, the holder of a swaption has the right, but not obligation, to enter into swap or on
before a specified future date.

Derivative Cases that are before the Court

There is a lot of problem in the derivative contracts between various firms and banks. On the
one side of this battle are private banks like Yes Bank, Kotak Mahindra Bank, Axis Bank, and
ICICI Bank, and on the other side a growing list of small and medium firms.

Rajshree Sugars is one of half a dozen firms that have all independently filed cases against
their respective banks, alleging they were sold exotic derivatives contracts for “speculative”
purposes. The list of firms that have gone to the court against their banks that sold such
derivatives products includes Sundaram Brake Linings Ltd and Sundaram Multi Papa Ltd,
and is likely to grow.

Legal firms expect many more cases to be filed in various courts across India as hundreds of
Indian firms that bought complex cross-currency options and structured products to
seemingly protect themselves from foreign exchange risk face significant losses. Many banks,
which sold derivatives within India in the past few years, are gearing up for legal battles with
their clients who are now questioning the legality of such products.

On the one side of this battle are some of the fastest growing new private banks in India: Yes
Bank Ltd, Kotak Mahindra Bank Ltd, Axis Bank, ICICI Bank Ltd, HDFC Bank Ltd, and their
lawyers, such as Amarchand and Mangaldas and Suresh A Shroff and Co., AZB and Partners
and Juris. Fighting them are a growing list of small and medium firms, J Sagar, the forensic
division of audit and consultancy firm KPMG India, and independent risk management
experts such as A.V. Rajwade, perhaps India’s leading expert on derivatives.

At the core of the battle is a debate whether these products were sold for hedging or

The derivative cases that are before the court are:-

Company Bank

Rajshree Sugars Axis Bank

Sundaram Multi Pap ICICI Bank
Sabare Int ICICI Bank
Precot Meridian Kotak Mahindra
Garg Acrylite ICICI Bank
Nahar Induatrial Axis Bank
NC Sugar ICICI Bank
Sundaram Brake Linings Kotak Mahindra

THE CASE: RSCL vs. Axis Bank Ltd.

Rajshree Sugars and Chemicals Limited (RSCL) is a public limited company listed on
National Stock Exchange and Bombay Stock Exchange. Their corporate office is in
Coimbatore and has interests across integrated fields such as Sugar, Distillery, Power and
Biotechnology. The company is mainly engaged in the manufacture and export of sugar to
foreign countries having External Commercial Borrowings from the banks.

Company as an exporter and borrower has receivables and payables in foreign currencies
respectively. The company started entering into foreign exchange derivative transactions in
2004 solely for the purpose of hedging its risk or genuine underlying exposure in respect of
fluctuation in the market.

The board has passed resolutions between March 2004 and January 2007 for entering into
derivative contracts only for the purpose of hedging currency fluctuations and reducing cost
of borrowings. Since 2004, certain forward contracts and derivatives transactions (currencies
swap and interest swap) were entered into between the company and various banks to manage
the risk of foreign currency fluctuation and FCNR-B loans and also to hedge interest rates.
FCNR (B) loans are a low cost, short-term funding source available to Indian corporates.
Banks have been permitted to provide foreign currency denominated loans to their customers
from the resources mobilised under the FCNR (B) scheme. RBI granted this permission to
help banks to deploy their FCNR funds in a more commercially viable manner and make
available a better avenue of credit at cheaper interest rates to resident borrowers.

Board authorised its Chief Financial Officer and Company Secretary, Mr P.K. Viswanathan,
to deal with all matters concerning derivative transactions. Turnover of Rs 404 crore for year
ending March 31, 2007 and an export order of Rs 111 crore for the nine months ending
December 31, 2007. Company also imported goods and machineries to the tune of Rs 5.8
crore. It has foreign currency loans to the tune of $ 30 million as on December 31, 2007.

Totally 10 transactions were entered into by the CFO with the Axis bank. Of this, nine were
undertaken to reduce the cost of rupee loans as underlying or hedge the export receivables as
underlying. Only one transaction, which is under dispute, is totally un-connected with the
business and entered into by CFO without any authority.

This transaction – Contract No. OPT 727 – is an exotic transaction based on the probable
fluctuation of dollar and Swiss Franc. There is no rupee loan swap or a hedge against export
in this deal thereby making it purely speculative. Out of the 10 transactions, eight are totally
closed and they are all duly covered.

The contract was entered into on 22 June 2007 with the AXIS Bank, when the rate was $1 =
CHF 1.2355. On 28 June 2007, the Axis bank paid $100,000 to the plaintiff, which was duly
credited to the plaintiff’s bank account. This was net inflow of premium which the RSCL
received for writing this option in favor of Axis bank. Due to this the company would incur a
minimum loss of Rs 14.2 crore. Therefore, the company filed a case against Axis Bank Ltd. in
Madras Court.

Rajshree Sugars takes Axis to High Court

Coimbatore-based Rajshree Sugars and Chemicals filed a case against Axis Bank in Madras
High Court alleging that the forex derivative product sold to them by the bank did not take
care of their needs on 19th March 2008.

Madras High Court stays Axis Bank Proceedings against Rajshree Sugars

The Madras High Court on 12th April 2008 passed an interim order restraining Axis Bank
from enforcing the forex derivatives contract sold to its client Rajshree Sugars and
Chemicals. An injunction was passed today to maintain the status quo on the dispute by
withholding its enforcement.

The Coimbatore-based sugar manufacturer had taken Axis Bank (formerly UTI Bank) to
court for selling exotic forex derivative products.

Axis bank, however, filed a counter saying it was not within the Madras High Court’s
jurisdiction to entertain the case.

The bank took the plea that the contract document signed between the bank and the company
clearly states that disputes, if any, will be resolved only in the Mumbai High Court. The court
will hear the arguments of both the parties on April 27.

Madras Court rules in favours of Axis Bank

The Madras high court on 14th October 2008, ruled in favour of Axis Bank Ltd in a dispute
between it and Coimbatore-based Rajshree Sugars and Chemicals Ltd (RSCL). The high
court has held that the derivative contract is not a wagering contract, which means it is not
illegal. It has also been held that amount due to the bank (Rs46-50 crore) is a debt as defined
under the Debt Recovery Tribunal Act and hence the bank can approach the Debt Recovery
Tribunal (DRT).

The company has earlier obtained a stay order to prevent the bank from approaching the
tribunal for which an order has been passed and the stay has been vacated. The firm had
alleged that the bank “lured” it to enter into such an exotic contract “with misrepresentations
and false promises. The complaint by the company added that the contract was purely a
speculative contract and the plaintiff was lured into a wager or a gamble on the movement of
dollar against Swiss franc by entering into the contract.

On 10 April, rating agency Fitch downgraded RSCL’s Rs60 crore commercial paper
programme due to potential losses on account of its derivatives exposure and poor financial
performance in the third quarter. “Ruling against the company will result in substantial fresh
losses, and put further pressure on RSCL’s credit metrics beyond the current rating level,” the
agency said in a note.

RSCL’s net profit for the quarter ended 30 June rose to Rs8.67 crore, against Rs1.20 crore in
the corresponding quarter last year. Revenue for the quarter dipped to Rs87.46 crore from
Rs94.39 crore in the same period last year.

Therefore, in what is termed as a precedent-setting judgement, the High Court of Madras has
ruled that contracts of derivatives are not contracts of wager and are not null and void. The
case is of a dispute between the Axis Bank and Rajshree Sugars over whether the company is
liable to pay dues to the bank arising out of a derivatives contract. (Typically, in such
contracts, the bank will pay an agreed sum if one named currency moves in one direction
against another specified currency. If the movement is in the other direction, the company
would pay the bank.) Petitioners Rajshree Sugars had argued that the derivatives contract the
company entered into with Axis Bank (formerly UTI Bank) was a wager and speculative in
nature. Hence it could not be enforced.

Rajshree Sugars challenged High Court Order in Derivative Case

Rajshree Sugars and Chemicals (RSCL) appealed against the Madras High Court order,
which held that the company's derivatives contract with Axis Bank is valid. The company
also challenged the court's order, asking the bank to seek relief from the Debt Recovery
Tribunal. Since March this year, Rajshree Sugars and Axis Bank have been fighting a legal
battle over foreign exchange derivatives contracts sold by the bank to the company, which
resulted in losses for the company. The company had refused to pay to the bank, citing the
contract as a wagering deal and, therefore, not tenable. The Madras High Court had ruled,
saying the derivatives contract is valid, but the bank has to approach DRT to get an order,
asking Rajshree Sugars to pay around Rs 46-50 crore to the bank.

Supreme Court says Debt Tribunal can’t Hear Cases

The Supreme Court has cleared the way for civil courts to decide the question of derivative
instruments on foreign exchange, sold by banks to exporters and others. Setting aside the
bank's claims- SC believes civil courts are competent for handling fraud cases - how
appropriate. However, the Bench also allowed the banks to continue their debt recovery suits
in tribunals.

A Supreme Court Bench headed by Justice S B Sinha has set aside the Punjab and Haryana
High Court judgment that transferred Ludhiana-based exporter Nahar Industrial Enterprises’
plea on derivatives pending before a Ludhiana civil court to the Debt Recovery Tribunal,

The trade in derivatives is done to hedge against risks due to foreign exchange fluctuation
against a specified underlying. The trading is regulated by the Foreign Exchange
Management Act (FEMA) and the guidelines issued under it by the RBI.

The reason that the banks were so keen for this to happen was that the DRT was set up
essentially for the purpose of aiding financial institutions to recover their debt and therefore
in this case the banks would have had a much stronger footing. Corporates on the other hand
obviously were not so keen, so they filed SC appeals against these transfer applications.

The question before the SC was whether a high court or SC have the power to transfer these
cases from civil courts to the DRT. The apex court ruled that this is not possible under law. At
this stage, proceedings at the DRT in forex disputes seem to be out of the question.

Facts of the Case

The plaintiff is a listed company, engaged in the manufacture and export of sugar to foreign
countries. It has External Commercial Borrowings (ECB) from foreign Banks. As an exporter,
the company has receivables in foreign currencies and as a borrower it has payables in
foreign currencies. Since the rate of exchange of foreign currencies keep fluctuating, the
plaintiff decided to hedge the risk against such fluctuations. Therefore, on 14.5.2004, the
plaintiff herein entered into a I.S.D.A. (International Swaps and Derivatives Association)
Master Agreement with UTI Bank Limited. The Master Agreement is in an internationally
standardised format developed by the association and the normal practice in the trade is to
keep the Master Agreement as the reservoir, from out of which several deals would flow.
There is a Schedule attached to the Master Agreement, which is flexible and which gives a
leverage for the parties to reduce the terms and conditions between the parties into specifics.
Accordingly, a Schedule was annexed to the Master Agreement dated 14.5.2004. By Part 4 (i)
of the said Schedule, the clause relating to "Governing Law and Jurisdiction" found in
Section 13(b) of the Master Agreement was replaced with the following provisions:

With respect to any suit, action or proceeding relating to this Agreement ("Proceedings") each
party irrevocably:

(i) submits to the jurisdiction of the High Court of Mumbai in India

(ii) waives any objection which it may have at any time to the laying of the venue of any
Proceedings brought in any such Court and waives the right to object, with respect to such
Proceedings, that such Court does not have jurisdiction over such party.

Nothing in this Agreement precludes either party from bringing Proceedings in any other
Court, tribunal or appropriate forum in India nor will bringing of Proceedings in any one or
more jurisdictions preclude the bringing of Proceedings in any other jurisdiction.

The aforesaid ISDA Master Agreement dated 14.5.2004 was signed for and on behalf of the
plaintiff, by their Chief Financial Officer and Company Secretary by name Mr.
P.K.Viswanathan, by virtue of the resolution of the Board of Directors dated 24.3.2004,
authorising him for the purpose. The authorisation given to Mr. P.K.Viswanathan was not
merely to sign the agreement but actually to deal with all matters concerning derivative
transactions. The resolution of the Board of Directors dated 24.3.2004 also recorded the
consent of the Board to enter into "interest rate and foreign currency derivatives including
interest rate and currency option contracts".

In pursuance of the ISDA Master Agreement dated 14.5.2004, atleast 10 deals were struck
between the plaintiff and UTI Bank (which later became AXIS BANK LTD). Admittedly, 9
out of those 10 deals have already matured without any dispute on either side. But the

plaintiff has come to court with regard to the 10th deal, bearing contract No. OPT 727. The
disputed deal is a USD-CHF (U.S.Dollars-Swiss Franc) Option Structure, entered into by the
said P.K.Viswanathan on behalf of the plaintiff on 22.6.2007 with the UTI Bank.

The structure of the deal was as follows:

(i) The plaintiff would receive USD 100,000 on 23.6.2008 if spot never trades at 1.2385 from
trade date namely, 22.6.2007 till fixing date 1 namely, 19.6.2008.

(ii) During the reference period from 22.6.2007 to 19.6.2008, if USD-CHF never touches
1.1250 and 1.2385 and if it ever touches 1.2385, there is no exchange of principal, but if it
ever touches 1.1250 and never touches 1.2385, the plaintiff should buy USD 20 million
against paying CHF at 1.3300.

During the reference period from 22.6.2007 to 15.6.2009, if USD-CHF never touches 1.1200
and 1.2385 or if it ever touches 1.2385, there is no exchange of principal, but if it ever
touches 1.1200 and never touches 1.2385, the plaintiff should buy USD 20 million against
paying CHF at 1.3300.

(iii) If the USD-CHF touches the level of 1.2385 ever during the period starting from
22.6.2007 to 15.6.2009, then the entire structure gets knocked out with no subsequent liability
and the plaintiff would receive USD 100,000 on the spot date of touch. However if spot
touches 1.2325, then the plaintiff would receive instant payment of USD 100,000, though the
structure will not get knocked out.

In terms of the above deal, entered into on 22-6-2007, the defendant paid USD 100,000 to the
plaintiff on 27-6-2007. The plaintiff received the said amount. However, after 6 months, the
plaintiff sent a letter dated 12.12.2007 claiming that the entire structure as per the contract
dated 22.6.2007 got knocked out with no liability to either of the parties. But, by a reply dated
7.1.2008, the Bank challenged the claim and contended that the contract was still alive and
that the Bank was prepared to work out suitable risk mitigation structures.

Not satisfied with the stand taken by the Bank, the plaintiff has come up with the
present suit seeking the following reliefs:

(i) To declare that the deal confirmation of U.S. Dollar v. Swiss Franc structure dated
22.06.2007 in OPT contract No. 727 with the schedule thereon purportedly made by the CFO
on behalf of the plaintiff with the defendant is void ab-initio, illegal, violative of RBI
Guidelines, opposed to public policy and unenforceable and not binding on the plaintiff

(ii) To declare that the deal confirmation of U.S. Dollar v. Swiss Franc contract dated
22.06.2007 in OPT Contract No. 727 with the schedule thereon purportedly made by the CFO
on behalf of the plaintiff with the defendant Bank is voidable at the instance of the plaintiff
and the plaintiff has therefore avoided the contract and therefore the contract is not binding or
enforceable against the plaintiff.

(iii) To declare that in the alternative to prayers (a) and (b), this Hon'ble Court be pleased to
declare that the Contract is ultra vires the object Clause of the Memorandum of Association
of the plaintiff and is, therefore, not binding upon the plaintiff and/or is not enforceable
against the plaintiff.

(iv) For a permanent injunction restraining the defendants, their men, agents, servants from in
any way acting in furtherance of contract in OPT No. 727 dated 22.06.2007 with the schedule
thereon by initiating any proceedings for recovering any amount from the plaintiff or seeking
recovery of any amount from the plaintiffs under the contract and or initiating any measures
or proceedings to recover any amount from the plaintiff under the contract.

(v) For a permanent injunction directing the defendants to deposit with the Registry of this
Hon'ble Court all the papers and proceedings relating to the contract including transcripts of
any tape recorded conversation.

Along with the suit, the plaintiff filed 2 applications viz.,

(i) O.A. No. 251 of 2008, seeking an interim order of injunction restraining the respondents
from in any way acting in furtherance of the contract in OPT Contract No. 727 dated
22.6.2007 by initiating any proceedings for recovering any amount from the plaintiff or
seeking recovery of any amount from the plaintiff or initiating measures or proceedings to
recover any amount from the plaintiff under the contract and

(ii) O.A. No. 252 of 2008, seeking an interim order of injunction directing the respondents to
deposit in the Registry of this Court, all the papers and proceedings relating to the contract
including the transcripts of any tape recorded conversation.

Key Issues in the Case

The Key in the case are:-

 Whether the contract entered is wager.

 Whether the deal was unlawful and opposed to public policy.
 Is the contract entered is null and void.
 Are the derivatives contracts void?
 RBI should come out with clear stand on forex derivatives.

Whether the contract entered is wager.

Rajshree Sugars challenged the contract as being void, violative of the law of the land,
opposed to public policy and as a wagering contract. The company contended that the

contract is violative of the Master circulars and Regulations issued by the Reserve Bank of
India and consequently hit by Section 23 of the Contract Act. The company further contended
that since there was no underlying exposure, the contract was, per se, speculative and a
wagering contract, hit by Section 30 of the Contract Act. Whether contract in question hit by
Section 23 and/or Section 30 of the Contract Act. Held, the entire structure of the deal
between RSCL and Axis Bank under the impugned contract, showed some contingencies in
which USD 100,000 becomes payable by the Bank to the company and other contingencies
when the company becomes obliged to buy USD 20 million at the rate of 1.3300 Swiss Franc
per 1 USD from the Bank. Thus the company stands to gain at times, while the Bank stands to
gain at other times – Gain for the company is intended to off-set the loss that they may incur
in their foreign currency receivables or payables. Therefore, when the value of USD
appreciates against Indian currency, the value of their receivables go up in terms of Indian
rupee, but at the same time, the value of foreign currency payables would also go up on
account of ECB. A converse situation would arise if the value of USD depreciates. Therefore
the payment of USD 100,000 prescribed under the deal is to hedge the company against the
risk. Purchase under contract in question would certainly make the compnay lose a huge
amount but that by itself would not make the contract a wager. As per the terms the
performance of the contract can always be compelled by the company insisting on actual
delivery and if actual delivery can be compelled, it cannot be termed as a wager. Further
there was nothing to show any common intention between the company and the Bank to enter
into a wagering transaction, a sine quo non for the transaction to be dumped as a wager.
Sequence of events in the instant case also showed that the transaction in question, from its
very nature, cannot be termed as a wager.

Test to determine whether Contract a wager.

There exist three tests to be satisfied if a contract is to be termed as a wager:–

Firstly, there must be two persons holding opposite views touching a future uncertain event.

Secondly, one of those parties is to win and the other is to lose upon the determination of the

Thirdly, both the parties have no actual interest in the occurrence or non-occurrence of the
event, but have an interest only on the stake. In the instant case the first test was satisfied as
there are 2 parties, but, the second test may not be satisfied since the company may not
always stand to lose. If the company loses in the underlying contract on account of currency
fluctuation, it may get compensated by the hedging and vice versa. Therefore both parties
cannot be taken to be winners or losers in absolute terms. Present is a contract like a contract
of insurance, where, on the happening of an uncertain event, the sum assured becomes

Whether the deal was unlawful and opposed to public policy.

Rajshree Sugars contended the contract as illegal, violative of FEMA, 1999 and the
Regulations and Master Circulars issued by RBI and opposed to public policy and hence hit
by Sections 23 and 24 of the Contract Act. Held, the transactions in derivatives are age old, in
so far as commodities and stocks and securities are concerned, atleast about a couple of

decades old in so far as foreign currencies (and FOREX options) are concerned. Therefore the
contention of the company is pointless that the transactions were either prohibited by law or
opposed to public policy. What is expressly permitted by law, cannot be held to be opposed to
public policy. The Master Circulars issued by RBI from time to time and the Regulations
framed by RBI under the FEMA, 1999 permit such transactions, which also have the sanction
of law the world over.

Is the Contract Null and Void?

Maintainability thereof questioned for want of cause of action. Axis bank contended that
under OPT 727 no cause of action would arise till the contingency stipulated therein arises or
till the expiration date (or fixing date) is reached. Whether suit disclosed no cause of action.
Held, the bar is to be seen while enforcing the contractual obligations. When a contract is
assailed as null and void, the cause of action cannot be said to arise only on the expiration
date. In view of the nature of the reliefs prayed for, it cannot be said that the plaint disclosed
no cause of action.

Are the Derivative Contracts Void?

A lot of the forex derivatives contracts were purely speculative wagers and are not
permissible under Indian law which insists there must be a genuine underlying exposure.
Much confusion, both legal and commercial, prevails over the enforceability and validity of
forex derivative contracts between Indian banks and many corporates, most of them small-
and medium-sized enterprises.

Under Indian exchange control laws, an Indian corporate, being a person resident in India,
can enter into a foreign currency derivative contract only to hedge an exposure to foreign
exchange risk and not for speculating and chasing profits. "Genuine underlying exposure" is
the possible liability of an Indian party in respect of a transaction already entered into, which
is likely to present a forex risk, necessitating risk cover. Such exposures could be risks in
respect of forex-denominated borrowings, interest rate variables, export receivables or import

Whether there is such genuine underlying exposure will always be "a question of fact".
However, the RBI's guidelines have cast a duty on banks to ensure that they are satisfied,
after due diligence, including examining documentary evidence, about the existence of such
genuine underlying exposure. Merely taking a declaration from an Indian corporate that it has
an exposure will not suffice. A tape-recorded conversation where the Indian corporate
confirms words to this effect will also not suffice, if, in fact, there is no genuine underlying
Everything centres around this core issue. If there was indeed no such exposure, then the
contract will be legally void, being contrary to Indian law. To repeat an age-old first principle
of law, a statute (law) shall always prevail over a contract. Legally void would mean the
contract would not bind the parties. No court will enforce it. It is entirely immaterial that the
same Indian corporate has derived monetary benefit from earlier contracts of a similar nature
and is now crying foul when losing money.

The current situation is not a question of business ethics or respecting contractual obligations.
Whatever may be the business equities of a case, if a contract is contrary to the laws of the
land, it would be void, unenforceable and will not bind the parties. This may sound like a
commercially dishonest 'bad-loser' defence for an Indian corporate to take. However, that
makes not an iota of difference to the crystal-clear legal position. Of course, nothing prevents
the banks from contending that the profits of the corporates from similar earlier contracts
were also legally void and the Indian corporate should disgorge such past profits.

The other grounds to assail such contracts include the bank not explaining to the corporate the
exact nature of the inherent risk (mis-selling) or the existence of a conflict of interest between
a bank's advisory role for the product and counterparty role in the contract. Some corporates
have contended that such conduct vitiates consent due to misrepresentation, thereby making
the contract 'voidable', that is, capable of being avoided by the party to which the
misrepresentation was made. Such an approach would but be a secondary defence, to be used
only if the contract is held as not being legally void ab initio for being contrary to exchange
controls and contract law.
The woes do not end here. In some cases, the charter documents of the Indian corporate, and,
in some cases, even of the bank, do not contain the power to enter into derivative contracts.
The contract would then be ultra vires the charter documents.

Most such contracts are unsecured, that is, without collateral as security for obligations.
Therefore, a bank will not be able to resort to the stringent Securitisation and Reconstruction
of Financial Assets and Enforcement of Security Interest Act, 2002. The only forum would be
the Debt Recovery Tribunal. While the expression 'debt' has been defined very widely under
the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (the existence of
debt would itself be in dispute), corporates are bound to argue that the DRT is meant to only
recover loans granted by banks and for recovery of dues claimed under any other contract of a
Several affected corporates have started filing civil suits for declaring these contracts to be
legally void, and in the alternative, voidable, and for denying their liability. When the bank
files DRT proceedings, the civil suit would be regarded as a counterclaim against the bank.
In short, a protracted legal battle with uncertain outcome even on the forum having
jurisdiction is on hand.

In many cases, even while the corporate's liability is not crystallised, the corporates have
begun filing suits to declare the contracts void. Therefore, the bank would have no option but
to unwind the trades. Meanwhile, where the bank has entered into a back-to-back contract
with another counterparty bank, it would have to pay under that contract and seek to recover
the loss from the corporate. Until it does so, which may take several long years of litigation,
the bank may have to provide for such losses in its books.

RBI should come out with clear stand on forex derivatives.

Reserve Bank of India should come out with "unambiguous clarification" with regard to forex
derivatives trading, which has landed many banks including ICICI Bank and Axis Bank in
courts. In addition to ICICI Bank and Axis Bank (formerly UTI Bank), several small and
medium enterprises have filed cases in different High Courts against Yes Bank and Kotak
Mahindra Bank that are trying to recover losses from the corporates. Although SBI has

suffered huge losses, it is not facing court cases from clients.

Companies in all these cases are resisting recovery of losses incurred by banks. Pointing out
that only a small number of companies have filed court cases with regard to derivatives losses,
senior partner of law firm Titus and Co, Diljeet Titus, said "RBI should come out with clean
and unambiguous clarification in this regard with retrospective effect in order to ensure than
bank-client relationship is maintained." "In certain cases courts have stayed the recovery
proceedings as such agreements are prima facie void ab intio (right from beginning)," and
their purpose turned out to be speculative and thus unlawful, senior advocate and corporate
lawyer U K Chaudhary said. The absence of clarification by the RBI, Titus said, "would open
floodgates of litigation". Many banks, Chaudhary said, tried to earn money by speculating in
foreign currency derivatives and other related transactions and since they have incurred losses
on account of fluctuations, they are now trying to recover the money from their corporate

Among the cases filed in this regard, is the ones by home furnishings company Sabare
International against ICICI Bank and Coimbatore-based Rajshree Sugars and Chemicals
against Axis Bank in Madras High Court. In a similar case against ICICI Bank, NCS Sugars
has pleaded before Hyderabad High Court that the agreement between the company and the
bank is void ab-initio and not binding as per the provisions of the Indian Contract Act.

They can be used to manage risk, reduce cost and enhance returns. Indian companies entered
into these contracts to hedge risks on interest and currency rates. "As per the Reserve Bank of
India guidelines exporter and importer could hedge foreign currency risks and exposure
through banks but they were not allowed to speculate in foreign currency derivatives
transactions," Chaudhary said. He said that even banks never sought a clarification from the
RBI on the very issue as to whether they were allowed to undertake operations that amounted
to pure speculations in foreign currency derivatives.

"If we rip off all the financial and legal jargon's from the agreement between the banks and
companies then one may struggle to differentiate it from gambling. There was no business
ethics by the banks. It was only a naked greed of the institution, as per the views already
expressed by other experts," he said.

Can you Sue your Banker if you have Lost Money by Investing on his

(An article by Ranjeev Dubey on businessworld.in dated 28th November 2008)

Maybe it’s because I have been assaulted by one self appointed ‘relationship officer’ too
many but I have a huge agenda on new age private banks. For three straight years, I have
been hit relentlessly with endless calls advising me take my money out of Fixed Deposit and
stick it into some mutual fund or tax free bond or half wit Ponzi scheme. Since I have a bit of
dollar income, I have also been asked to subscribe to some forex derivative gobbledegook
which was going to give me money for nothing. Not once have these super-bankers been able
to explain to me how they have been able to breach their much touted ‘Chinese walls’ we are
always told about and learnt about my FDs and income source. They have also failed to allay
my fundamental concern on the inherent conflict of interest in this kind of cross selling.
Naturally, I am not surprised that many people have succumbed to these come-ons and now
find themselves facing losses bound by contracts they do not understand. If you are one of
those people who bought into the pressing advice of your own relationship officer, you are in
very august company!

Take forex derivatives. I hear Credit Suisse has reported that Indian corporations may have
suffered MTM losses of Rs 12,000 crore to 20,000 crore. The same report also apparently
states that Indian private banks may have lost 1.8 per cent of their book value: about $328
million or thereabouts. Naturally, litigation is the flavour of the money. ICICI Bank has had
two well reported cases against them — Sundaram Multi Pap and Sabare International — and
both customers have stated that they were hustled into buying incomprehensible contracts.
There are currently some two dozen cases all told around the country on substantially the
same basis. It doesn’t seem to surprise anyone that these companies are suing their own
bankers for defrauding them.

Not that these companies have much choice: derivative trading losses result in the companies
becoming NPAs: the Securitization Act triggers and the Company’s assets are gone in a jiffy.
ICICI Bank managed to get an injunction obtained against it by NCS Sugars vacated and it
succeeded in persuading the Bombay High Court to order Sundaram Multi Pap to pay them
Rs. 2.92 crore. So, if you were dragged into a mess not of your making, do you have a

I would say any remedy here would be an uphill battle but two thoughts come to my mind.
First, you could argue that a banker in a fiduciary relationship has misled his customer so you
must be protected from your rogue advisor. Second, and this depends on which money-for-
nothing scheme you bought into, you could argue that your subscription was no better than
betting on how many runs Saurav Ganguli will not score on his last test appearance. Since
betting is illegal in India, the courts should not enforce such contracts. Let’s look at how
credible these arguments are.

Very generally, there are three types of misrepresentations with which one would be
concerned in India. At the top of the heap are the hard core fraudulent ones where your
advisor tells you something knowing it to be false and you act on that advice. This is a crime
and you can act on it. In the second category is a case where an advisor is careless in the
advice rendered — not fraudulent — but negligent. In this case, you can sue him in a civil
court. Finally, there is the relatively innocuous type of misrepresentation: the type where no
misrepresentation was intended meaning that the advisor believed what he advised even
though it was false. In this case, you are on thin ground but you can still sue him. The point of
this long dip into the law is that there is a wide distinction between these three categories of
misrepresentation but so far as Indian law is concerned, the customer has remedies in relation
to all three.

However, within the context of banks cross selling derivatives instruments to customers, the
courts have taken a rather different view. Forex futures recently came up before the Tamil
Nadu High Court in Rajshree Sugars & Chemicals v. Axis Bank Ltd. (MANU/TN/0893/2008,
C.S. No. 240 of 2008) when RSC, a sugar exporter, agreed with Axis Bank that RSC would
receive $100,000 if the US dollar never touched 1.2385 Swiss Franc till a specified date but
would be obliged to buy $20 million USD from the Bank if the exchange rate touched 1.3300
at that rate. RSC actually produced material to show that the Bank had in fact represented to
the exporter that US Dollar would never reach the stipulated level. One would think that this
would be powerful stuff: while it is historically true that the Swiss Franc never fell below a
certain level to the dollar, there is a big difference between saying ‘this has never happened in
the past’ and saying ‘this will never happen’. My bank manager is not the friendly
neighborhood soapbox messiah. If I trust him with my money, I trust his advice. Not so, says
the court, taking the view that there could be no misrepresentation since no one could ever
really anticipate which way the currency would go and how far.

That takes us to the other argument: the one about gambling. Gambling has always been a
strange animal in Indian Law. It is illegal with cards but legal with horses. It is legal in
Sikkim and Goa: illegal pretty much everywhere else. Betting contracts are not enforceable in
law because it’s against public policy but it is not prohibited so some ancillary rights in such
contracts will be enforced. All this makes for a bewildering mix. Section 30 of the Contract
Act states that:

“Agreements by way of wager are void; and no suit shall be brought for recovering anything
alleged to be won on any wager, or entrusted to any person to abide by the result of any game
or other uncertain event on which any wager is made.”

So what is a wager? The principle goes back to the English Carbolic Smoke Ball Co case
which every law student is still obliged to study.

“wagering contract is one by which two persons professing to hold opposite views touching
the issue of a future uncertain event, mutually agree that, dependent upon the determination
of that event, one shall win from the other, and that other shall pay or hand over to him, a
sum or money or other stake; neither of the contracting parties having any other interest in
that contract than the sum or stake he will so win or lose, there being no other real
consideration for the making of such contract by either of the parties.”

Just for the record, the Supreme Court has affirmed Carbolic Smokeball in the two
Chamarbaugwala cases (A 1957 SC 628) and in the Satyanarayana case (A 1968 SC 825)
and said that a competition where success depended on substantial skill was not 'gambling'. It
also said that a competition of skill which had an element of chance did not make it gambling.
With respect, I think it is commonly understood that since card hands even out in the long
run, the better player always wins. By that token, nothing is gambling unless it’s something as
rudimentary as betting on coin tosses.

Naturally, since all futures contract take some skill to judge, futures contracts would logically
not be wagering contracts. The Supreme Court thought so too in the Pratapchand Neopaji
case (AIR1975SC1223) but also echoed Carbolic Smokeball, stating that “in a wagering
contract, there has to be mutuality in the sense that the gain of one party would be the loss of
the other on the happening of the uncertain event which is the subject matter of the wager”.

Since commodity futures do not have this feature, it did not matter that “each party knew that
their object was to indulge in speculation”.

I suppose there are larger forces at play here. If we widen the definition of wagering, we
would end up banning practically every business that has unknowns, especially the stock
market. Indeed, you could argue that since all business is ultimately a reward for managing
risk, all business is at one level speculation!

The last word has not been heard on this subject of course but all my new age prejudices
about new age bankers seem vindicated. You cannot trust your doctor not to send you for an
unnecessary caesarian section any more than you can trust your banker not to sell you a
dummy only because he has monthly targets to meet. Fiduciary relationships alas are dead.
And needless to state, if you bought into an instrument you didn’t understand, your goose has
been cooked.


'Derivatives are time bombs and financial weapons of mass destruction' said Warren Buffett,
one of the world's greatest investors, who overtook Microsoft Maestro in 2008 to become the
richest man in the world and who is known as the 'Sage of Omaha or Oracle of Omaha'.
Derivatives, according to him, can push companies on to a spiral that can lead to a corporate
melt down. He compared derivatives business to hell, easy to enter and almost impossible to
exit. In response to a query as to whether a nuclear war would be the worst case scenario, a
famous daily web log commented that 'the economic collapse triggered by the popping of the
derivatives bubble' presented the worst case scenario.

True to the above criticism, the world of finance and investments, was swept by many a
tsunami in the past decade and a half. Some of the 'derivatives disasters' which plunged
several institutions and millions of investors into severe crisis (and even led to the homicide
by a 46 year old former IITian of his entire family followed by his suicide in US) are as

(i) The bankruptcy of Orange County, CA in 1994, the largest municipal bankruptcy in U.S.
history. On December 6, 1994, Orange County declared Chapter 9 bankruptcy, after losing
about $1.6 billion through derivatives known as "reverse floaters" whose values move
inversely with market interest rates.

(ii) The collapse of the 233 year old Barings Bank when Nick Leeson, a trader at Barings
Bank, made poor and unauthorized investments in index futures. Through a combination of
poor judgement, lack of foresight, a naive regulatory environment and unfortunate outside
events like the Kobe earthquake, Leeson incurred a huge loss that bankrupted the centuries-
old financial institution. The loss suffered by the Bank was estimated at $ 27 billion.

(iii) The crumbling of the heavy-into-hedges trading firm known as 'Long Term Capital
Management' under the weight of derivatives worth $ 1.4 trillion, in 1998. But it was bailed
out by the joint efforts of the US Federal Reserve and a few Banks in order to minimise
public outcry.

(iv) The hedge fund fiasco of Amaranth Advisors in September 2006, to the extent of about $
6 Billion, due to miscalculation of the price of natural gas futures.

(v) The collapse of the largest investment Bank Lehman Brothers and the leading American
insurer AIG, due to extensive exposure to Credit Default Swaps (CDS) threatening a potential
collapse of the United States financial system in 2008, leading to a $ 700 billion bailout plan
whereby the U.S. Treasury agreed to buy out the underlying defaulted and endangered debt
instruments from banks, brokerages and other financial institutions in an attempt to keep the
country's credit market from shutting down and creating a global economic crisis.

Similar examples of derivative contracts as the maker and breaker of economic institutions in
the society can be traced back in India as well. Great industrialists like Mittal, big business
houses like Reliance and established banks like ICICI have all been affected directly and/or
indirectly by these contracts. Some of the institutions have come on the verge of extinction
due to the credit policies. But comparing the present situation in India with other countries we
are having an upper hand. Our situation is better as compared to other countries as the affect
of multinationals on the economy is not the same as in other countries. One of the basic
nature of people in European countries is that they are prone to savings and this characteristic
works in positive direction for India as well. Still the uncertainty of future with regards to
these contracts requires us to be careful as every step we make towards this direction.

Therefore, it is better for both i.e. Rajshree Sugars and Chemicals Limited as well as Axis
Bank Limited to go for a out of court settlement and look for a possible outcome in which
both companies suffer minimum.


 http://www.livemint.com/2008/03/25000334/Rajshree-Sugars-gets-8216st.html
 http://www.emecklai.com/mecklai/forex/regulatory/NTFxFCNR4Mc.html
 http://timesofindia.indiatimes.com/Rajshree_Sugars_takes_Axis_to_HC_on_forex_los
 http://www.moneycontrol.com/india/news/business/madras-hc-stays-axis-bk-
 http://www.thehindubusinessline.com/2008/10/16/stories/2008101652270600.htm
 http://www.moneycontrol.com/india/news/cnbc-tv18-comments/forex-derivative-
 http://dealcurry.com/article.php?blog_id=7336

 http://articles.manupatra.com/PopOpenArticle.aspx?ID=c6c91cd5-336a-4fc5-87e4-
 http://www.rediff.com/money/2005/apr/19perfin1.htm
 http://www.rediff.com/money/2008/mar/29guest2.htm
 http://www.thehindubusinessline.com/2008/04/09/stories/2008040950520300.htm
 http://www.livemint.com/2008/10/15000453/Derivatives-Madras-court-rule.html
 http://www.business-standard.com/india/storypage.php?autono=319858