CCI's Order in Banks' Prepayment Penalty Case: Of Mistakes and Mis-interpretations!

The Competition Commission of India ("CCI") has issued its first order in a contentious case, Neeraj Malhotra v Deustche Post Bank Home Finance Ltd. & Ors, involving issues of anti-competitive agreements and abuse of dominance by banks while charging prepayment penalty on home loans. (CCI has earlier issued orders in several cases but those were not investigated by Director General (DG) and were disposed by CCI as they did not have merit. This is the first case where CCI has issued its final order after DG has investigated the matter). The majority order of CCI exempts banks from any liability under the Competition Act. However, Mr Parashar and Mr Prasad in their separate dissenting order have found banks violation provisions of Section 3 of the Act. The dissenting orders may be found here and here.

Earlier, I had written on this blog as to why it would be difficult for CCI to make case based on the information I had from media reports. The piece on this blog may be found here. I had pointed that: (i) CCI may not be able to fix the banks under Section 3 as there would be little or no evidence to suggest an agreement given high competitiveness among banks in today's economy; and (ii) proving abuse of dominance would be difficult given the highly fragmented market share of banks. These conclusions were based on the facts available in public domain at that time. However, the investigation of DG reveals that Indian Bank Association ("IBA") had convened a meeting of its members on 28.08.2003 to discuss the issues in relation to charging prepayment penalty ("PPP") and had issued circulars on having a common approach towards PPP. In the light of these facts, it would now be important to analyse the orders (both majority and dissenting) of CCI.

The facts of the case are very simple. The Opposite Parties charge a penalty in the range of 1% to 4% of the entire loan amount or outstanding loan to its customers/borrowers in case the customers choose to prepay their loan ahead of the scheduled time originally agreed. The customers may do so either by switching to another lender (who obviously is offering loan at lower interest rate) or by their own savings. Most the banks charge prepayment penalty ("PPP") in either case while some charge PPP only in the former case. The Informant filed information against four banks/house finance companies ("HFCs"). However, the DG impleaded 12 more banks/HFCs while investigating the matter.

1. Arguments raised by the Informant

The major allegations of the informant may be summed as follows: (i) that by charging PPP on entire loan amount, the opposite parties have agreed to determine sale prices for their services; (ii) that the imposition of PPP also limits the supply/provision of services as the customers are unable to opt for another source of loans; (iii) that the opposite parties have also abused their dominant position in the relevant market by imposing unfair and discriminatory conditions in purchase or provision of services (i.e. loans); and (iii) that the practice of PPP prevents borrowers from switching over to competitors offering lower rate of interest thereby causing existing competitors to drive out from the market.

2. Findings of the DG

The DG in its report to CCI concludes that:
(i) The allegations regarding violation of section 3(1), 3(2) read with Section 4(1), (2)(a)(i) are untrue and that PPP is charged on the outstanding principal and not on the entire loan amount.
(ii) The allegation with regard to violation of section 3(3)(b) is found to be true.
(iii) The levy of PPP makes the exit for a borrower expensive and thus acts as a deterrent for a borrower in availing the best prevailing interest rate of other bank/financial institution.
(iv) levy of PPP violates provisions of Section 19(3) (a), (c) and (d).

3. Analysing the order

At the outset it may be noted that the Chairman of CCI has recused himself from this case, perhaps because he himself is the borrower of home loan from one of the opposite parties. The majority framed five points of determination before (I am not repeating them here; see pg 138-139 of the majority order). The analysis begins with macroeconomic analysis of interest rates over an economy and how it impacts investment and growth. The majority order, on issue of existence and nature of PPP, holds that no uniform can be said have been adopted by banks/HFCs in regard to levy of PPP.

3.1 Limiting the concept of "agreement":

The major upset in the majority order would be seen in its analysis of agreement under section 3 of the Act. While referring to words used in section 3(1) of the Act i.e. production, supply, distribution, storage, acquisition, or control of goods, or provision of services, the majority holds that these terms/activities relate to the supply side of the market. Thus, the majority holds that these terms clearly excluded agreements between a producer and the end consumer because no consumer can be said to be involved in activities such as production, distribution or control of any goods or services. This undoubtedly raises several questions than it answers:
(i) who is an end consumer?
(ii) whether section 3(1) does not apply to section 3(4)?
(iii) If section 3(1) is the genus and section 3(4) a species of the genus, then what happens to tie-in agreement or exclusive supply agreements? Referring specifically to SAIL-JINDAL dispute, whether or not Indian Railway is the end consumer of steel? If Indian Railway is the end consumer, can there be any sustainable case against SAIL-Indian Railway exclusive supply agreement?

3.2 Raising the threshold to prove agreement more than intended by the Act itself:

The majority states that an agreement is a conscious and congruous act that has to be associated to a point in time. With this reasoning, it holds that there is nothing to prove that the opposite parties have formed any internal and discrete association for charging PPP. The majority stressed on the point that there is no concerted action among banks as not all of them started charging PPP at one point of time. While it may be true that HDFC and LIC started charging PPP much before the said meeting of IBA members in 2003, however the majority does not provide any reasoning why other members, who started charging PPP only after the said meeting, could not have been charged of having entered into an agreement towards a common approach for levy of PPP. It would be pertinent, here, to quote the extract of the minutes of the meeting of IBA members on 28.08.2203:

"...[W]hile discussing the issue members had expressed divergent views on the subject. While one view was that commitment charges on non-availment of committed line of credit would improve the fee-based income of banks. Suggestions were made that we should also think of uniform norms for pre-payment charges when a borrower chooses to pre-pay the loan availed. With the interest spread narrowing under intense market competition, it was felt that banks should look for other avenues for earnings. It was therefore suggested that IBA could suggest to reintroduce commitment charges on unutilized portion of working capital limits and decide on levy of pre-payment charges with the decision as to the extent of charges to be levied being left to the banks..."

Further, IBA issued a circular to its members after the said meeting on 10.09.2003 stating in part as follows:

"On the whole, members were of the view that levy of commitment charges and pre-payment charges would help not only in terms of asset liability management, but also in augmenting fee based income of the banks. The latter was seen as significant consideration in today’s competitive market with pressures on interest spread. While members felt that charges in the range of .5%-1% would be reasonable, the view was that a decision in this regard should be left to the banks to decide …"

Yet, the majority held that there was no congruence of action which is an integral part of any agreement. The majority seems to be guided by the fact that different banks/HFCs charge different rates of PPP. It further notes that mere fact that the IBA issued a circular dated 10.09.2003 mentioning concern of some of member banks could not in itself be said to form a basis for or evidence of an agreement between banks.

In contrast to the above, Mr Parashar, in his minority order, has presented a richer analysis of facts and legal position on agreements. Mr Parashar has very meticulously analysed the action of each of the opposite parties pursuant to the meeting of IBA members and to show that how the common approach deliberated in the meetings of IBA was actually effected by most of the opposite parties. The internal circulars of the some of the opposite parties (for example, Punjab National Bank and Vijaya Bank) clearly show that the asset liability management ("ALM") was no reason for adopting PPP. The circulars of these banks prove that the main purpose to introduce PPP was to dissuade the borrowers from shifting to other banks. Further, internal circulars of some other banks also clearly suggested that their action was in pursuant to the meeting of IBA dated 28.08.2003.

Given this factual background, the majority order has clearly undermined the statutory intent of giving 'agreement' a very wide meaning. The position in Europe and UK is clear, as has been rightly referred by Mr Parashar in his minority order, that "People who combine together to keep up prices do not shout it from the house tops. They keep it quiet. They make their own arrangements in the cellar, where no one can see. They will not put anything into writing nor even into words. A nod or wink will do. Parliament as well is aware of this. So it included not only an “agreement” properly so called but any “arrangement”, however informal". The minority order is also laudable, in another aspect, for clearly stating that temporal coincidence is not necessary for proving an agreement. Mr Parashar has rightly noted that a 'decision' to be covered within the provisions of section 3(3) of the Act need not necessarily be simultaneous or taken at the same point of time by all parties (at para 73 of his order). The majority order, it seems, has ignored the dynamics of steadily changing competition law jurisprudence in other jurisdictions. CCI has in effect imposed a higher threshold for itself and also for informants for all future cases of alleged cartels which in themselves are toughest of the cases to crack.

3.3. On cartels and burden of proof: Is there a per se rule?

The majority order is completely silent on how the burden of proof works under section 3(3) of the Act. It is here again that the minority order of Mr Parashar is partially of worth. I say partially as Mr Parashar has confused the legal practitioners on the "per se-rule of reason dichotomy". Mr Parashar provides a detailed analysis of evolution of per se rule under the US antitrust law and concludes that agreements under section 3(3) of the Act is covered within the per se rule. He begins stating that ". . . cartels and similar horizontal agreements are placed in a special category and are subject to the adverse presumption of being anti-competitive. This is also known as per se." There is inherent contradiction in these two statements. If something is subject to adverse presumption, how can it be "per se" as evolved under US antitrust law. Under US antitrust law, there are certain agreements which because of their pernicious effects on competition and lack of any redeeming virtue are conclusively presumed to be unreasonable and, therefore are considered to be illegal without any further elaborate enquiry [Northern Pacific Rilaway Co. v United States; 356 US 1 (1958)]. Interestingly, Mr Parashar refers to this decision and yet finds the agreements under section 3(3) to be covered under per se rule. While interpreting the term "shall presume" appearing under section 3(3), Mr Parashar refers to decisions of Supreme Court where it has held that the phrase lays down a rebuttable presumption in respect of matters with reference to which they are used . . . and not laying down a rule of conclusive proof. In spite of this Mr Parashar, again at paragraph 100, holds that the agreement reached among opposite parties is covered within the per se rule contained in section 3(3) of the Act. This, in my opinion, is not correct as there is no per se rule under the Indian competition law as it has been known and evolved in US antitrust jurisprudence.

However, Mr Parashar's attempt to clearly bring out the onus of proof in cases of allegations under section 3(3) is laudable. Where the majority is conspicuously silent on the burden of proff, Mr Parashar has convincingly conveyed that once the existence of agreement among opposite parties is proved, the onus to prove that it does not have appreciable adverse effect on competition lies on the opposite parties. The majority is of the view that housing finance market has seen immense growth during 2004-2009 and thus levy of PPP has in no way undermined competition in home loan market. However, Mr Parashar has taken more rule-based or technical approach holding that banks have not been able to conclusively show that how PPP helps in maintaining asset-liability balance. He emphasizes that neither the asset is defined and quantified at relevant stages nor the liability is worked out and specified on the basis of cost transactions. Thus, he rejects the entire plea of ALM on grounds of lack of facts and evidence. Here again, Mr Parashar has successfully implemented the intent of legislature by casting stringer test for successfully pleading pro-competitive effects under section 19(3).

3.4. On abuse of dominance

Both majority and minority orders do not find any violation of section 4 given the highly fragmented market share of banks/HFCs in home loan market. But, here again, it may be argued that CCI has escaped the responsibility of a deeper and technical analysis of geographic markets. Given the huge disparity in economic growth among parts of country, there are areas (geographic markets) in this country which have not experienced the mushrooming of banks/HFCs unlike more developed tier-I cities. In such less developed markets, it may be certainly possible that a bank or two to three banks command the entire market for home loans. Could it be said that levy of PPP by such dominant banks in segregated smaller geographic markets results in abusive practice? That is separate question which, I believe, requires complex number crunching, deeper and technical analysis.

4. Final remarks

It is disheartening that the informant Mr Neeraj Malhotra did not provide his comments on the DG report. However, this does not mean that the order of CCI cannot be appealed before the Appellate Tribunal. Section 53B of the Act vests the right to appeal in any person aggrieved by the order of CCI. It would be desirable that the order of CCI is appealed before the Tribunal for a better interpretation of law.

Note: My earlier piece on prepayment penalty was based on the limited facts avaiable in public domain. With IBA meeting and its circular, the issue as to the existence of an agreement among opposite parrties (except HDFC and LIC)is contentious.

Prepayment Penalty: Does CCI has a Case?

If the speculation in print media is to be believed, it seems the Competition Commission of India (CCI) has made its mind to penalise banks that impose “pre-payment penalty” clauses on their borrowers while lending loans. One of the defending banks, State Bank of India, has already suffered the brunt of National Consumer Disputes Redressal Commission (NCDRC) in Usha Vaid v Sate Bank of India [RP No.2466/2007]. In Usha Vaid case, the NCDRC categorically held that the levy of pre-payment penalty amounts to unfair and restrictive trade practice. On appeal, the Supreme Court refused to grant leave to hear the matter. Nonetheless, in my view, it would be difficult for CCI to bring the practice of pre-payment penalty within the four corners of the prohibited actions as laid out in Sections 3 and/or 4 of the Competition Act.

Typically, a pre-payment penalty is a clause in a mortgage/loan contract that says if the mortgage/loan is prepaid within a certain time period, a penalty will be assessed. The penalty is usually based on percentage of the remaining mortgage balance or a certain number of months worth of interest. In India, banks usually charge this penalty at the rate of 2% to 3% of the remaining principal amount.

To begin our analysis, let us assume that pre-payment penalty amounts to anti-competitive practice so far as it restricts a consumer to avail banking services of another firm which is ready to offer the loan at lower interest rates. Yet, it would be difficult for CCI to pin down the practice as result of some sort of collusion among banks or abuse of dominance. The CCI would have two options to target the banks:

i. Firstly, it may try to establish that the defending banks entered into an agreement among themselves to fix the rate of pre-payment penalty and had limited or controlled the supply of banking services (home loans and such other loans being the relevant product market) within India (relevant geographic market), [Section 3(3) Claim] or;

ii. CCI may claim that the defending banks possess “collective dominance” in the relevant product market and thus have abused this dominance by limiting or restricting the provision of services or market therefor. It is important to note that CCI may not be able to claim that any one of the defending banks individually enjoys a “dominant position” in the relevant product market. The reason being, Indian retail banking sector, over the time, has seen fierce competition with gradual introduction of new entrants. According to RBI's 'Quarterly Statistics on Deposits and Credit of Scheduled Commercial Banks: September 2009', nationalised banks, as a group, accounted for 50.5 per cent of the aggregate deposits, while State Bank of India (SBI) and its associates accounted for 23.8 per cent. The share of other scheduled commercial banks, foreign banks and regional rural banks in aggregate deposits were 17.8 per cent, 5.6 per cent and 3.0 per cent, respectively. Given the market shares of different commercial banks, the only way in which CCI may put forward its claim is through the application of "collective dominance".

Having identified the two viable options available to CCI, it would be interesting to examine whether there may be a successful claim against the defending banks. Coming to the first option, it would be certainly an uphill task for CCI to prove the elements of Section 3(3) claim. CCI would have no evidence to suggest that the defending banks entered into any agreement, arrangement or understanding, whether formal or informal, to implement pre-payment penalty clauses in their loan contracts. The practice of pre-payment penalty by banks is matter of commercial policy and prudence practiced all throughout the world. Therefore, existence of an agreement is a matter of remote possibility or rather impossible. This brings us to the question of fixation of rate of pre-payment penalty. The impediments of proving agreement apply here too. Added to the hurdle is the question as to whether rate of pre-payment penalty may be categorized as “purchase or sale price” under clause (a) of Section 3(3). The banks may safely argue that “pre-payment penalty” does not form part of the interest rate (which is the real source of revenue in any loan contract) applied to loan while selling their services. The penalty clause is mere insurance against the untimely loss of a customer, being entirely independent of the interest rate. Hence, an overall analysis of the practice of prepayment penalty clearly suggests that the CCI is unlikely to rely on the first option to prove its claim.

This leaves us with the claim of “collective dominance” and abuse thereof i.e. Option 2 [Section 4 Claim]. CCI’s task would have been much easier has there been only one bank with large market share. But, the adoption of pre-payment penalty clauses by almost all known commercial banks together brings the issue of “collective dominance” − a concept alien to the Indian Competition Act. Unlike European Commission, where it was much easier for Commission and Courts to read the concept of ‘collective dominance” under Article 82 of EC Treaty, the CCI would not enjoy the same privilege. This is because the difference in while couching the opening words of Article 82 of EC Treaty and Section 4 of the Competition Act. Article 82 begins with the phrase “any abuse by one or more undertakings of a dominant position” and it was this phrase “one or more undertakings” which was used by Court of First Instance in Italian Flat Glass case to hold that “there is nothing in principle to prevent two or more independent economic entities from being, on a specific market, united by such economic links that, by virtue of that fact, together they hold a dominant position vis-à-vis the other operators on the same market.” This marked the birth of the concept of “collective dominance” in Europe.

However, Section 4 of the Competition Act aims at “an enterprise” or “group”. Section 4(1) reads: “No enterprise or group shall abuse its dominant position”. There is nothing in the definition of enterprise under Section 2(h) or in the provisions of Section 4 to suggest that two or more independent entities can be clubbed together to constitute collective dominance. Again the term ‘group’ borrows its definition from Explanation to Section 5 which applies to related entities.

Even assuming that the concept of “collective dominance” may be forcibly read into Section 4 by applying provisions from General Clauses Act (Section 13), yet it would bring little respite to CCI. The concept was evolved to tackle the abuse of dominance by two or more undertakings in an oligopolistic market. Most cases in EC where the doctrine of collective dominance has been applied invloved two to three entities having significant market share in the relevant market. Given the present market structure in banking sector (supra), it would be difficult to prove that the relevant product market is oligopolistic one. Hence, in my view, should the CCI find the banks guilty, it has a bleak chance to prove its case before the Appellate Tribunal. This note has not addressed on the issue of pro and anti-competitive effects of penalty clause. I would bring my perspectives on the same soon!