Saradha chit fund scam: Can lottery laws apply to chit funds such as Saradha?

The multi-thousand crore chit fund scam in West Bengal involving the Saradha group of companies and top state politicians, businessmen etc. predictably triggered a strong response from the judiciary and masses. The West Bengal government and top leaders were accused of complicity in the scam which looted thousands of innocent citizens of hard-earned savings. After the scam, the West Bengal government has attempted to regulate fraudulent investment companies by way of special laws. Though the subject of regulating chit fund companies does not really fall within the ambit of gaming or lottery laws; there is a slight intersection of both these fields as drawing of lots for declaring the winner of the pool of amount is also an element involved in lotteries.

In this post (at the expense of slightly digressing from the main subject of this website), I shall analyse the laws relating to chit funds and their regulation in India along with its interface with the prohibition of lotteries prescribed in the IPC/state legislations.

What are chit funds?

A chit is defined by Section 2(b) of the Central Chit Funds Act, 1982 as follows:

 (b) “chit” means a transaction whether called chit, chit fund, chitty, kuri or by any other name by or under which a person enters into an agreement with a specified number of persons that every one of them shall subscribe a certain sum of money (or a certain quantity of grain instead) by way of periodical installments over a definite period and that each such subscriber shall, in his turn, as determined by lot or by auction or by tender or in such other manner as may be specified in the chit agreement, be entitled to the prize amount.

Explanation.- A transaction is not a chit within the meaning of this clause, if in such transaction,
(i) some alone, but not all, of the subscribers get the prize amount without any liability to pay future subscriptions; or
(ii) all the subscribers get the chit amount by turns with a liability to pay future subscriptions.

However, a prize chit has been defined under Section 2(e) of the Prize Chits and Money Circulation (Banning) Act, 1979 as follows:

(e) “prize chit” includes any transaction or arrangement by whatever name called under which a person collects whether as a promoter, foreman, agent or in any other capacity, monies in one lump sum or in instalments by way of contributions or subscriptions or by sale of units, certificates or other instruments or in any other manner or as membership fees or admission fees or service charges to or in respect of any savings, mutual benefits, thrift, or any other scheme or arrangement by whatever name called, and utilizes the monies so collected or any part thereof or the income accruing from investment or other use of such monies for all or any of the following purposes, namely:–

(i) giving or awarding periodically or otherwise to a specified number of subscribers as determined by lot, draw or in any other manner, prizes or gifts in cash or in kind, whether or not the recipient of the prize of gift is under a liability to make any further payment in respect of such scheme or arrangement;

(ii) refunding to the subscribers or such or them as have not won any prize or gift, the whole or part of the subscriptions, contributions or other monies collected, with or without any bonus, premium, interest or other advantage by whatever name called, on the termination of the scheme or arrangement or on or after the expiry of the period stipulated therein, but does not include a conventional chit.

Thus, a distinction has been made between ordinary chit funds and prize chits and two central legislations operating in different spheres operate for these two kinds of funds.

Chit funds are said to be an indigenous method of savings specially in rural areas and many self-help groups are formed for the purpose of allowing members of the group a lump-sum amount of money either through a bidding process or through draw of lots in times of their need such as marriage, medical emergencies etc.

As per the Chit Funds Act, such funds constituted are not entirely illegal and are merely regulated by law; requiring registration, regulation (publication such as accounts and details of the company to the government), publication of chit fund agreement, transparency in the drawing of lots etc.

In contrast, prize chit funds are schemes used by companies to lure citizens to invest and the money collected is used to award gifts by draw of lots or other means. All such prize chits are illegal and punishable with up to three years imprisonment and fine as per Section 4 of the Act.

The question of constitutional validity of the Chit Funds Act was answered by the Karnataka High Court in Sri Visalarn Chit Fund Ltd. v. Union of India (AIR 1989 Kant 125) where the Court stated that the Act was not ultra vires the Constitution and the regulations stipulated in the Act did not violated the Constitutional right to carry on trade and commerce guaranteed under Article 19(1)(g).

Similarly the Supreme Court has also upheld the validity of both these Acts in Srinivasa Enterprises v. Union of India (AIR 1981 SC 504) [Prize Chits banning Act] and M/s Shriram Chits & Investment v. Union of India (AIR 1993 SC 2063) [Chit Funds Act].  Further courts have clarified that such activities can be regulated by the Parliament under Entry 7 of List III of Schedule VII (Constitution of India) and they do not strictly fall within the ambit of lotteries or gambling (Entry 34, List II) and consequently state or central governments can make laws on the subject (while gambling falls exclusively within the domain of state governments). [For a comprehensive discussion on chit funds, prize chits and legislative intent behind the Acts see Reserve Bank of India v. Peerless Finance, 1987 SCR (2) 1].

Sudipta Sen- Kingpin of Saradha chit fund scam

Chit funds and Section 294-A of the Indian Penal Code

Section 294-A of the Indian Penal Code makes keeping of a lottery office without prior permission from the government is illegal and punishable with up to six months imprisonment and/or fine. Certain states such as Maharashtra, Gujarat, Andhra Pradesh etc. have repealed this provision and replaced it with state legislations such as Bombay Lotteries (Control and Tax) and Prize Competitions (Tax) Act, 1958 (applicable to the state of Maharashtra and Gujarat) prescribing punishment for holding lotteries without appropriate license. However the question that arises is whether chit funds owners offering such high rate of returns can be termed as lotteries and thus their owners/promoters be exposed to criminal liability?

The Gujarat High Court had an occasion to examine this question [State of Gujarat v. Mohandas Manumal, (1979) 1 GLR 226] where the issue was whether subscription schemes available to a closed group of members wherein monthly contributions were expected of subscribers and monthly winners who would win prizes could opt out of the process of contributing their further monthly subscriptions and other non-winners would get certain loans would amount to a lottery.

The Court while referring to Halsbury’s law of England and other authorities reasoned that for an activity to constitute a lottery there has to be some stake, risk of loss (as opposed to gratuitous offering of prizes) and drawing of lots. Thus, when a prize is offered to the detriment of others, despite the fact that there may be certain benefits to the non-winners and they may be given interest and their deposits, this activity would constitute an illegal lottery.

Thus, promoters of such chit fund companies have to be careful while offering prizes to depositors (to the detriment of others) through draw of lots or otherwise. Such allurements of prizes or gifts to select subscribers would not only fall foul of the Prize Chits Banning Act but possibly even of Section 294-A of the IPC or local lottery laws (though these provisions seem to be scarcely used in relation to prize chit funds).

However, it has to be noted that this provision would only be applied when prizes are being given to subscribers through draw of lots and not on systematic use of chit funds where equal amounts is given to all members in turn or in cases where companies offer a high rate of return to all subscribers. In these situations investigations by SEBI, RBI, Enforcement Directorate, police and other authorities on violation of Chit Funds Act, criminal and securities laws would be the options available.