Five Reasons Why the Recent Demonetisation May Be Legally Unsound

A petition filed in the Supreme Court argues that a decision like demonetisation, pivotal to monetary policy, can't be left to the whims of the Centre.

People queue to deposit or exchange their old high denomination banknotes outside a bank in Allahabad, November 16, 2016. Credit: Reuters/Jitendra Prakash

People queue to deposit or exchange their old high denomination banknotes outside a bank in Allahabad, November 16, 2016. Credit: Reuters/Jitendra Prakash

One of the four petitions challenging the recent demonetisation of high-denomination currency notes, filed in the Supreme Court, invokes at least five significant legal grounds to show why it may not be legally sound.

The petition, filed by Supreme Court advocate V.K. Biju who is known for taking up public interest causes, on behalf of the petitioner Adil Alvi, also an advocate in the Supreme Court, has named the Ministry of Finance and the Reserve bank of India as the respondents. Senior advocate Kapil Sibal appeared and argued for the petitioner on Friday.

The petition, which comes up for hearing again on November 25, claims that since the decision is of wide importance and pivotal to monetary policy in India, it cannot be left to the whims of the central government.

Excessive delegation

First and foremost, it assails the very constitutionality of section 26(2) of the Reserve Bank of India Act, 1934, on the grounds of excessive delegation.

Section 26(2) says that on recommendation of the central board of the RBI, the central government may, by notification in the Gazette of India, declare that with effect from a date specified in the notification, any series of bank notes of any denomination shall cease to be legal tender.

According to the petition, fixing the date from which the demonetisation would come into force is the substratum of power under section 26(2) and constitutes an “essential law making function” which cannot be delegated to be fixed by the central government on its own determination. “It is settled law that essential law making function cannot be delegated,” the petition submits.

The only way to save section 26(2) from being ultra vires the constitution is to regard that the power to fix such a date contemplates a reasonable notice to the people at large, the petition suggests.

No alternative to legislation

Second, the petition argues that the precedent of 1978 – The High Denomination Bank Notes (Demonetisation) Act, 1978 repealing the High Denomination Bank Notes (Demonetisation) Ordinance 1978 – and section 26A of the RBI Act, clearly suggest that demonetisation of this scale with such draconian effect can only be done by a statute of parliament.

Section 26A – inserted in the RBI Act in 1956 by parliament – makes it clear that notwithstanding anything contained in section 26, no bank note of the denominational value of Rs 500, Rs 1,000 or Rs 10,000 issued before January 13, 1946, shall be legal tender in payment or on account.

The point here is that in 1956, the then central government found it imperative to declare the pre-1946 high denomination currency notes as ceasing to be legal tender only through an amendment to the RBI Act and not through a gazette notification as has been done now.

During the arguments in the Supreme Court on November 15, the Attorney General Mukul Rohatgi distinguished demonetisation from the declaration that currency notes of a certain denomination cease to be a legal tender, saying while the former would require amending the RBI Act, the latter could be achieved through a gazette notification.

This is because demonetisation would make even the keeping of a currency note which is not legal tender an offence and therefore, for depriving the freedom of citizens, recourse to law is a must.

Rohatgi told the court that demonetisation would take its legal form once the RBI Act is amended, in due course, after the last date for exchange of old notes is over, so as to make it an offence to keep the illegal tender.

The non-recourse to the amendment of the RBI Act was because of the need to ensure confidentiality till the decision was taken, consistent with its objects – fight corruption, black money and financing of terrorism through counterfeiting of currency notes, he explained.  But the question of why the RBI Act did not envisage the need for confidentiality during demonetisation went unanswered by him.

Citing another precedent, as laid down by the Supreme Court in 1978 (Madan Mohan Pathak v Union of India), the petition suggests that wiping out of a public debt amounts to acquisition, which can be done only by an Act of parliament, according to the Constitution.

Why article 19(6) can’t come to rescue

Third, the petition argues that the November 8 notification was a hasty decision, taken without appreciating all the issues.

Citing absence of recital to “public interest”, the petition faults the notification for causing prejudice and inconvenience to the public at large.

This is an important ground of challenge, because the notification suffers from its inherent potential to violate the fundamental right (under article 19(1)(g)) to practice any profession or to carry on any occupation, trade or business, because of the suddenness of its timing and its resultant consequences. It cannot be claimed even by the government that only those with black money, fake currency notes or an intent to aid terrorism are bound to suffer because of the notification.

The government, of course, would rely on article 19(6), which says that nothing in article 19(1)(g) shall affect the operation of any existing law in so far as it prevents the state from making any law imposing, in the interests of the general public, reasonable restrictions on the exercise of the rights conferred by the sub-clause.

Alvi’s petition, therefore, argues that the exception of article 19(6) is not available to the central government as the notification is beyond “police powers”.  The grounds cited cannot justify the adoption of extreme measures like invalidating 86% of printed currency in circulation overnight, the petition contends.

The petition argues that issuing Rs 2000 currency notes clearly shows that it has no rational nexus with the object, sought to be achieved by the demonetisation.

Arguing that public inconvenience itself is a ground to set aside the notification, the petition alleges that the central government has not considered the current rate of inflation and the low minimum wage, which “affects everyone most severely”.

The RBI and the central government

The fourth contention of the petition is that the central board of the RBI did not give a recommendation independently after detailed consideration of all the issues, although the same was elicited by the central government. The RBI Act, the petition says, uses the phrase “recommendation” and not “consultation”, and therefore a recommendation from the RBI cannot emanate from the central government itself, Alvi’s petition has argued.

Alvi’s petition also raises the larger issue of the relationship between the central government and the RBI, which it says ought to have been maintained at an “arm’s distance”. By implication, it would mean that the central government must not just “consult” the RBI, but give it sufficient scope to deliberate and offer its independent views through a well-reasoned recommendation, initiated by itself rather than by prompting. To discharge its role as a central bank in a financial system, the RBI is assumed to be insulated from executive and political influences and is required to act independently, the petition submits.

The petition says that the RBI is under an obligation, before making such a recommendation, to consult the public and the stakeholders on the issue. The doctrine of “legitimate expectations” in a modern democracy would require the RBI to adopt such a course, the petition suggests. While the RBI can work like parens patriae, it cannot function like a patriarch, the petition comments.

The petition, therefore, requests the court to call for the complete record of the consultation before the central board of the RBI and consider whether in fact there has been effective consultation in the manner contemplated under the law.

Section 26 of the RBI Act, it argues, clearly contemplates a distinction between the central board of the RBI and the central government, and implies that the decision making process of the RBI has to be independent. The petition thus wonders whether the central board has considered all the relevant materials and the likely consequences before it made its recommendation to the central government.

Another interesting legal question the petition has raised is whether the government can withdraw, alter or restrict the promise made by the RBI governor on the bank notes to the effect, “I promise to pay the bearer the sum of five hundred/one thousand rupees”, thereby seeking to go back on the guarantee.

The central government and the RBI have an obligation to bring on record the minutes of the meetings leading to recommendation from the very inception for scrutiny by the Supreme Court, the petition has submitted. The central government cannot prevent judicial review by hiding behind the cloak of a policy decision, it argues.

Test of reasonableness

Fifth, the petition points to an interesting correlation between reasonableness of a legislation or an executive decision and its immediate effect, as held by the Supreme Court in a judgment rendered by the constitution bench in 1954. (Saghir Ahmad v State of Uttar Pradesh.)

Although the Supreme Court’s judgment pointing to such correlation was rendered in the context of a legislation, the petition argues that “the test that applies to legislation would apply more vigorously to executive decisions within the precincts of a statute”.

As examples of the immediate effects, the petition cites the central government’s failure to grant exemption to essential services such as all hospitals (including private), doctors, lawyers, court houses and so on from the demonetisation, and claims that impacts the exercise of the fundamental right to health and access to justice.

The government’s and RBI’s responses to each of these five legal contentions will be of wide interest.