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.
Recently, the Ministry of Agriculture released a draft Model Contract Farming Act, 2018. The draft Model Act seeks to create a regulatory and policy framework for contract farming. Based on this draft Model Act, legislatures of states can enact a law on contract farming as contracts fall under the Concurrent List of the Constitution. In this context, we discuss contract farming, issues related to it, and progress so far.
What is contract farming?
Under contract farming, agricultural production (including livestock and poultry) can be carried out based on a pre-harvest agreement between buyers (such as food processing units and exporters), and producers (farmers or farmer organisations). The producer can sell the agricultural produce at a specific price in the future to the buyer as per the agreement. Under contract farming, the producer can reduce the risk of fluctuating market price and demand. The buyer can reduce the risk of non-availability of quality produce.
Under the draft Model Act, the producer can get support from the buyer for improving production through inputs (such as technology, pre-harvest and post-harvest infrastructure) as per the agreement. However, the buyer cannot raise a permanent structure on the producer’s land. Rights or title ownership of the producer’s land cannot be transferred to the buyer.
What is the existing regulatory structure?
Currently, contract farming requires registration with the Agricultural Produce Marketing Committee (APMC) in few states. This means that contractual agreements are recorded with the APMCs which can also resolve disputes arising out of these contracts. Further, market fees and levies are paid to the APMC to undertake contract farming. The Model APMC Act, 2003 provided for contract farming and was released to the states for them to use this as reference while enacting their respective laws. Consequently, 20 states have amended their APMC Acts to provide for contract farming, while Punjab has a separate law on contract farming. However, only 14 states notified rules related to contract farming, as of October 2016.
What are the issues with the current structure, and how does the draft Model Act seek to address them?
Over the years, expert bodies have identified issues related to the implementation of contract farming. These include: (i) role of APMCs which are designated as an authority for registration and dispute settlement in most states, (ii) provisions of stockholding limits on produce under contract farming, and (iii) poor publicity of contract farming among the farmers about its benefits.
Role of Agricultural Produce Marketing Committees/Marketing Boards
The NITI Aayog observed that market fees and other levies are paid to the APMC for contract framing when no services such as market facilities and infrastructure are rendered by them. In this context, the Committee of State Ministers on Agricultural Reforms recommended that contract farming should be out of the ambit of APMCs. Instead, an independent regulatory authority must be brought in to disengage contract farming stakeholders from the existing APMCs.
In this regard, as per the draft Model Act, contract farming will be outside the ambit of the state APMCs. This implies that buyers need not pay market fee and commission charges to these APMCs to undertake contract farming. Further, the draft Model Act provides for establishing a state-level Contract Farming (Promotion and Facilitation) Authority to ensure implementation of the draft Model Act. Functions of the Authority include (i) levying and collecting facilitation fees, (ii) disposing appeals related to disputes under the draft Model Act, and (iii) publicising contract farming. Further, the sale and purchase of contracted produce is out of the ambit of regulation of the respective state/UT Agricultural Marketing Act.
Registration and agreement recording
The Model APMC Act, 2003 released to the states provides for the registration of contract farming agreements by an APMC. This was done to safeguard the interests of the producer and the buyerthrough legal support, including dispute resolution. The procedures for registration and recording of agreements vary across states. Currently, registration for contract farming has been provided with the APMC in few states, and with a state-level nodal agency in others. Further, market fee on purchases under contract agreements is completely exempted in few states and partially exempted in others. The Committee of State Ministers on Agricultural Reforms recommended that a instead of a APMC, district-level authorities can be set-up for registration of contract farming agreements. Further, any registering authority should verify the details such as the financial status of the buyer.
Under the draft Model Act, every agreement should be registered with a Registering and Agreement Recording Committee, which will be set up consisting of officials from departments such as agriculture, animal husbandry, marketing, and rural development. Such a Committee can be set up at the district, taluka or block levels.
Disputes between the producer and the buyer
The Ministry of Agriculture and Farmers Welfare observed certain risks related to upholding the contract farming agreement. For example, producers may sell their produce to a buyer other than the one with whom they hold a contract. On the other side, a buyer may fail to buy products at the agreed prices or in the agreed quantities, or arbitrarily downgrade produce quality. The Committee of State Ministers on Agricultural Reforms recommended that dispute redressal mechanism should be at block, district or regional-level state authorities and not with an APMC.
Under the draft Model Act, in case of disputes between a producer and a buyer, they can: (i) reach a mutually acceptable solution through negotiation or conciliation, (ii) refer the dispute to a dispute settlement officer designated by the state government, and (iii) appeal to the Contract Farming (Promotion and Facilitation) Authority (to be established in each state) in case they are not satisfied by the decision of the dispute settlement officer.
Stockholdings limits on contracted produce
Stockholding limits are imposed through control orders as per the Essential Commodities Act, 1955. Such provisions of stockholding limits can be restrictive and discourage buyers to enter into contracts. It was recommended that the buyers can be exempted from stock limits up to six months of their requirement in the interest of trade. Under the draft Model Act, limits of stockholding of agricultural produce will not be applicable on produce purchased under contract farming.
Other recommendations
While contract farming seeks to provide alternative marketing channels and better price realisation to farmers, several other marketing reforms have been suggested by experts in this regard. These include: (i) allowing direct sale of produce by farmers, (ii) removing fruits and vegetables out of the ambit of APMCs, and (iii) setting-up of farmer-consumer markets, (iv) electronic trading, and (v) joining electronic National Agricultural Market for the sale of produce.
