These are challenging times for chit fund operators. A scam involving the Saradha group allegedly conning customers under the guise of a chit fund, has raised serious questions for the industry. With a reported 10,000 chit funds in the country handling over Rs 30,000 crore annually, chit fund proponents maintain that these funds are an important financial tool. The scam has also sparked responses from both the centre and states: the Finance Ministry, Ministry of Corporate Affairs and SEBI have all promised to act and the West Bengal Assembly has passed The West Bengal Protection of Interest of Depositors in Financial Establishments Bill, 2013, with Odisha and Haryana considering similar legislation. What is a chit fund? A chit fund is a type of saving scheme where a specified number of subscribers contribute payments in instalment over a defined period. Each subscriber is entitled to a prize amount determined by lot, auction or tender depending on the nature of the chit fund. Typically the prize amount is the entire pool of contribution minus a discount which is redistributed to subscribers as a dividend. For example, consider an auction-type chit fund with 50 subscribers contributing Rs 100 every month. The monthly pool is Rs 5,000 and this is auctioned out every month. The winning bid, say Rs 1000, would be the discount and be distributed among the subscribers. The winning bidder would then receive Rs 4,000 (Rs 5,000 – 1,000) while the rest of subscribers would receive Rs 20 (1000/50). Winners cannot enter the auction again and will be liable for the monthly subscription as the process is repeated for the duration of the scheme. The company managing the chit fund (foreman) would retain a commission from the prize amount every month. Collectively, the subscribers to a chit fund are referred to as a chit group and a chit fund company may run many such groups. What are the laws governing chit funds? Classifying them as contracts, the Supreme Court has read chit funds as being part of the Concurrent List of the Indian Constitution; hence both the centre and state can frame legislation regarding chit funds. States like Tamil Nadu, Andhra Pradesh and Kerala had enacted legislation (e.g The Kerala Chitties Act, 1975 and The Tamil Nadu Chit Funds Act, 1961) for regulating chit funds. Chit Funds Act, 1982 In 1982, the Ministry of Finance enacted the Chit Funds Act to regulate the sector. Under the Act, the central government can choose to notify the Act in different states on different dates; if the Act is notified in a state, then the state act would be repealed[i]. States are responsible for notifying rules and have the power to exempt certain chit funds from the provisions of the Act. Last year the central government, notified the Act in Arunachal Pradesh, Gujarat, Haryana, Kerala and Nagaland. Under the Act, all chit funds require previous sanction from the state government. The capital requirement for establishing chit funds is Rs 1 lakh and at least 10% of profits should be transferred to a reserve fund. The amount of discount (i.e. the bid) is capped at 40% of the total chit fund value. States may appoint a Registrar who would be responsible for regulation, inspection and dispute settlement in the sector. Any grievances over decisions made by the Registrar can be subject to appeals directed to the state government. Chit fund managers are required to deposit the entire value of the chit fund (can be done in 50% cash and 50% bank guarantee) with the Registrar for the duration of the chit cycle. Prize Chits and Money Circulation Schemes (Banning) Act, 1978 The Prize Chits and Money Circulation Schemes (Banning) Act, 1978 defines and prohibits any illegal chit fund schemes (e.g. schemes where auction winners are not liable to future payments). Again, the responsibility for enforcing the provisions of this Act lies with the state government. Reports suggest that the government is discussing amendments to this Bill in the wake of the chit fund scam. West Bengal Protection of Interest of Depositors in Financial Establishments Bill, 2013 Last month the West Bengal Assembly passed the West Bengal Protection of Interest of Depositors in Financial Establishments Bill, 2013. This was a direct response to the chit fund scam in West Bengal. While not regulating chit funds directly, the Act regulates and restricts financial establishments to curb any unscrupulous activity with regards to deposits. Chit funds are specifically included under the definition of deposits. The state government will appoint a competent authority to conduct investigations. What is the role of RBI and SEBI? The Reserve Bank of India (RBI) is the regulator for banks and other non banking financial companies (NBFCs) but does not regulate the chit fund business. While chit funds accept deposits, the term ‘deposit’ as defined under the Reserve Bank of India Act, 1934 does not include subscriptions to chits. However the RBI can provide guidance to state governments on regulatory aspects like creating rules or exempting certain chit funds. As the regulator of the securities market, SEBI regulates collective investment schemes. But the SEBI Act, 1992 specifically excludes chit funds from their definition of collective investment schemes. In the recent case with Sarada Group, the SEBI investigation discovered that Sarada were, in effect, operating a collective investment scheme without SEBI’s approval.
[i] The central act repeals the Andhra Pradesh Chit Funds Act, 1971; the Kerala Chitties Act, 1975, the Maharashtra Chit Funds Act, 1974’, the Tamil Nadu Chit Funds Act, 1961 (applicable in Chandiragh and Delhi), the Uttar Pradesh Chit Funds Act, 1975, Goa, Daman and Diu Chit Funds Act, 1973 and Pondicheery Funds Act, 1966.
In law, the addition or deletion a single punctuation or a single word can have a major impact on the effect of that law. One such example can be seen from the recommended changes in the Civil Liability for Nuclear Damage Bill, 2010 by Parliament’s Standing Committee. The Civil Liability for Nuclear Damage Bill, 2010 was introduced in the Lok Sabha on May 7, 2010. The Bill was referred to the Parliamentary Committee on Science and Technology, Environment and Forests, which submitted its report on the Bill yesterday (August 18, 2010). The Committee has made a number of recommendations regarding certain clauses in the Bill (See summary here). One of these may have the effect of diluting the provision currently in the Bill. The main recommendations pertain to:
Clause 17 of the Bill which gives operators a right of recourse against those actually causing damage had been opposed as it was felt that it was not strong enough to hold suppliers liable in case the damage was caused by them. Clause 17 gave a right of recourse under three conditions. The exact clause is reproduced below: The operator of a nuclear installation shall have a right of recourse where — (a) such right is expressly provided for in a contract in writing; (b) the nuclear incident has resulted from the wilful act or gross negligence on the part of the supplier of the material, equipment or services, or of his employee; (c) the nuclear incident has resulted from the act of commission or omission of a person done with the intent to cause nuclear damage. Under this clause, a right of recourse exists when (a) there is a contract giving such a right, or (b) the supplier acts deliberately or in a grossly negligent manner to cause nuclear damage, or (c) a person causes nuclear damage with the intent to do so. If any of the three cases can be proved by the operator, he has a right of recourse. The Committee has stated that “Clause 17(b) gives escape route to the suppliers of nuclear materials, equipments, services of his employees as their willful act or gross negligence would be difficult to establish in a civil nuclear compensation case.” It recommended that Clause 17(b) should be modified to cover consequences “of latent or patent defect, supply of sub-standard material, defective equipment or services or from the gross negligence on the part of the supplier of the material, equipment or service.” The Committee also recommended another change in Clause 17. It recommended that clause 17(a) may end with “and”. This provision may dilute the right of recourse available to operators. The modified clause 17 would read as: The operator of a nuclear installation shall have a right of recourse where — (a) such right is expressly provided for in a contract in writing; and, (b) the nuclear incident has resulted as a consequence of latent or patent defect, supply of sub-standard material, defective equipment or services or from the gross negligence on the part of the supplier of the material, equipment or services.; (c) the nuclear incident has resulted from the act of commission or omission of a person done with the intent to cause nuclear damage. This implies that for Clauses 17(b) or (c) to be applicable, the condition specified in clause 17(a) has to be compulsorily satisfied. Two examples highlight the consequence of the recommended change in Clause 17(a) of the Bill:
The effect of the changes recommended by the committee may thus dilute the provision as it exists in the Bill. The table below compares the position in the Bill and the position as per the Standing Committee’s recommendations:
| Right of recourse - The Bill gives operators a right to recourse under three conditions: (a) if there is a clear contract; (b) if the damage is caused by someone with intent to cause damage; (c) against suppliers if damage is caused by their wilful act or negligence. | In the Bill the three conditions are separated by a semi-colon. The Committee recommended that the semi-colon in clause 17(a) should be replaced by “and”. | This might imply that all three conditions mentioned need to exist for an operator to have recourse. |
| Right to recourse against suppliers exists in cases of “willful act or gross negligence on the part of the supplier”. (Clause 17) | The Committee felt that the right of recourse against suppliers is vague. It recommended that recourse against the supplier should be strengthened. The supplier is liable if an incident has occurred due to (i) defects, or (ii) sub-standard material, or (iii) gross negligence of the supplier of the material, equipment or services. | The variance with the Convention continues to exist. |
