A lot of investors do not prefer to do fixed deposits citing interest rate of 7% to 7.5% as too low. They find equity investing in mutual funds also risky which can give them returns of 12% and above, instead they lend to friends and family or outsiders at interest rate of 12% to 15%. Now we all know the credit risk involved in this where the capital does not come back and many investors have burned their hands in this yet it remains a popular practice.
To minimize the risk, investors think of giving the loan through bank transfer only so that there is proof of lending the money if they go to courts to recover the money. To add a layer of security they also take post dated cheques from the borrower so that if the borrower does not repay the loan, the cheques can be deposited and if they bounce, the recourse is under Section 138 of Negotiable instruments act.
With a bank transfer and post dated cheques in hand, investors think they have made a full proof arrangement and other than the borrower going bankrupt he would have to pay up if he has the funds. Unfortunately it is not that simple!
Under the moneylending act, a lender can recover money from the borrower through a legal recourse only if he has a moneylending license. If it is a one off case where money has been loaned to a borrower then there may be a legal recourse, but if an investor is regularly giving money on loan to different parties then this is the equivalent of carrying a moneylending activity without having a license in place.
Here investors surely think they can use the post dated cheques to try and enforce the debt if the cheques bounce. However; under the negotiable instruments act, a cheque is enforceable only if there is legally enforceable debt or liability. In this case if a lender does not have money lending license then the debt or liability is not enforceable and hence recourse may not be available through Section 138 also. There are also judgements in various states who have given recourse to lenders without having a money lending license, but that differs from case to case and state-wise.
Hence, it is not just important for investors to do due diligence on the credit worthiness of the party they are lending to, but also understand law in their state relating to money lending.
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