State of Rajasthan vs Shyam Lal

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeals Nos. 884-887 of 1962

Decision Date: 12 March 1964

Coram: K.N. Wanchoo, P.B. Gajendragadkar, J.C. Shah, N. Rajagopala Ayyangar, S.M. Sikri

In this matter the State of Rajasthan instituted proceedings against Shyam Lal, with the judgment rendered on 12 March 1964 by a Bench of the Supreme Court of India consisting of K N Wanchoo, P B Gajendragadkar, J C Shah, N Rajagopala Ayyangar and S M Sikri. The case is reported in 1964 AIR 1495 and 1964 SCR (7) 174, and is cited in later authorities such as R 1964 SC1903 and R 1971 SC 530. The essential question before the Court concerned the liability of the newly formed State of Rajasthan for obligations incurred by the former Dholpur State, particularly under Article 295(2) of the Constitution of India. The factual backdrop began when Dholpur State acceded to the Dominion of India in 1947. Subsequently, Dholpur merged with other princely states to create the Matsya Union on 18 March 1948. The merger agreement stipulated that the existing statutes of the Covenanting States would remain in force until altered or repealed by the successor State, and that all assets and liabilities of the Covenanting States would be transferred to the new authority. Later, the Matsya Union itself merged with the United State of Rajasthan, which had come into being on 7 April 1949, and a comparable provision concerning the recognition of pre‑existing liabilities was incorporated. On 26 January 1950 the Part B State of Rajasthan was constituted, inheriting the legal and fiscal legacy of the antecedent entities.

Within the four appeals that formed the subject of the litigation, the respondents had obtained export permits from the erstwhile Dholpur State for certain commodities and had paid the requisite export duties in advance. Because they were unable to export the full quantities for which the permits were issued, they sought a refund of the surplus duty from the appellant, the State of Rajasthan. The State declined to make any refund, prompting the respondents to file suits seeking the excess duty back together with interest. The State’s defence asserted that, as a new sovereign entity, it was not automatically bound by any liability that might have arisen against the former Dholpur State unless it expressly chose to recognise such obligations, a step it claimed had not been taken in this case. At the trial level one suit was dismissed while the remaining three were decreed in favour of the respondents. The State appealed to the District Judge; those appeals were largely dismissed, although the appeal concerning the first suit was substantially allowed. The State then raised the matter before the High Court, where a full bench referred the issue to a division bench that again dismissed the State’s appeals. After obtaining a certificate of fitness, the appellant approached the Supreme Court, where the sole issue presented was whether the State of Rajasthan, by virtue of Article 295(2), bore liability for the obligations incurred by the former Dholpur State.

In the present case, the Court examined the liability of the State of Rajasthan under Article 295(2) of the Constitution for obligations that originated in the former State of Dholpur and later became part of Rajasthan. The Court dismissed the appeals and held that the new State, by retaining the pre‑existing laws until such laws were expressly repealed or altered, implicitly accepted the same liabilities that the merging State would have borne. The Court observed that during the period of integration, which extended from 1948 to 1950, the newly formed sovereign was required to recognise the rights of the persons living in the former territory and to assume the liabilities of that territory. Consequently, the Court concluded that, pursuant to Article 295(2), Rajasthan was bound to satisfy the liabilities of all the predecessor States that were eventually merged into it. The Court further found that there was no evidence showing that any competent legislation had withdrawn the right to claim a refund of export duty. In support of its reasoning, the Court referred to the decisions in M/s Dalmia Dadri Cement Co. Limited v. The Commissioner of Income‑Tax [1959] S.C.R. 729 and Maharaja Shree Umaid Mill Limited v. Union of India, A.I.R. 1953 S.C. 953.

The matter before the Court was a civil appellate jurisdiction involving Civil Appeals Nos. 884‑887 of 1962, which were filed against a judgment and decree dated 2 May 1960 rendered by the Rajasthan High Court in Civil Second Appeals Nos. 268 of 1954, 203 of 1955, 4 of 1954 and 27 of 1954. Counsel for the appellant, appearing in all the appeals, were represented by legal practitioners, while counsel for the respondents appeared in appeal No. 887 of 1962. The judgment was delivered on 12 March 1964 by Justice Wanchoo. The four appeals arose from certificates granted by the High Court of Rajasthan and presented a common legal issue, prompting the Court to set out the facts of appeal No. 887, noting that the remaining appeals shared similar factual circumstances apart from the specific commodity and the amount in dispute. The suit that gave rise to appeal No. 887 had been instituted by the respondent against the State of Rajasthan. The respondent, a resident of the former Dholpur State, asserted that the dispute concerned events that occurred before the merger of Dholpur into the Matsya Union. According to the respondent, in 1947 certain goods, including a textile called chuni, could be exported from Dholpur only on export permits issued by the Dholpur customs department, and the prevailing practice required payment of export duty in advance. In June 1947, the respondent applied for and obtained a permit to export 15,000 maunds of chuni, and deposited Rs 30,000 as export duty. The permit, dated 28 June 1947, remained valid until 2 December 1947, but the respondent was unable to export the entire quantity within that period.

In the present case the respondent was authorized by a permit dated 28 June 1947 to export fifteen thousand maunds of chuni. He succeeded in exporting only four thousand five hundred seventy‑two maunds and twenty seers before the permit expired on 2 December 1947, after which the permit was not extended. The respondent explained that the failure to export the full quantity was caused by unfavourable market conditions and by the inability to obtain an allocation of railway wagons. Because export duty of two rupees per maund had been deposited in advance for the entire fifteen thousand maunds, the respondent asserted that he was entitled to a refund of the duty proportionate to the unexported quantity of ten thousand four hundred twenty‑seven maunds and twenty seers. He further stated that repeated requests for refund were ignored by the State.

Subsequent to the date of the permit, constitutional developments altered the political landscape. After the independence of India on 15 August 1947, the former State of Dholpur merged into the Matsya Union on 17 March 1948. By 15 May 1949 the United State of Rajasthan had been formed, incorporating the Matsya Union, and on 26 January 1950, when the Constitution of India came into force, the United State of Rajasthan became the Part B State of Rajasthan. The respondent filed a suit in January 1952, seeking a refund of Rs 20,855 together with interest and costs. The State of Rajasthan opposed the suit on several grounds, but the Court focused on a single ground that the State claimed: that the newly formed State of Rajasthan was not bound by any liability that might have arisen against the former State of Dholpur, because a new sovereign was not automatically bound by obligations of a predecessor unless it expressly chose to recognise them. The State argued that the United State of Rajasthan had never recognised the obligations of the former Dholpur State and therefore owed no refund.

In response, the respondent relied upon Article 295(2) of the Constitution and on other provisions enacted during the period of mergers after 15 August 1947. He contended that Article 295(2) made the State of Rajasthan bound by the obligations of the former State of Dholpur. Before examining the relevant case law, the Court found it useful to set out the admitted factual background concerning the inclusion of the former Dholpur State into the Part B State of Rajasthan on 26 January 1950, a development that would place the State of Rajasthan within the ambit of Article 295(2).

By virtue of Article 295(2) of the Constitution, the former Dholpur State remained a distinct entity until 17 March 1948, although it had already acceded to the Dominion of India on 15 August 1947 with respect to the three subjects of communications, defence and external affairs. In the year 1948 the process of merger in Rajasthan commenced, and the first consolidation involved the former States of Alwar, Bharatpur, Dholpur and Karauli. These four erstwhile States were united to form the Matsya Union, effective from 18 March 1948, under a covenant that had been executed on 28 February 1948. The covenant expressly provided that the statutes and regulations of each covenanting State would continue to operate in the new Union until such time as they were altered or repealed by the authority of the Matsya Union. Moreover, the covenant stipulated that all assets and liabilities of the four merging States would be transferred to and become the assets and liabilities of the newly constituted Matsya Union. This arrangement was not contested by any party.

Subsequent to the creation of the Matsya Union, another amalgamation occurred in March 1948 when a group of Rulers in Rajasthan united under the leadership of the Ruler of Udaipur, thereby forming the entity later known as the Former State of Rajasthan. In March 1949 a further covenant was executed by fourteen Rulers of Rajasthan, including those who had previously formed the Former State of Rajasthan. This covenant established the United State of Rajasthan, which came into existence on 7 April 1949. The covenant for the United State likewise provided for the continuance of all existing laws until they were specifically repealed or amended by the new government, and it transferred the assets and liabilities of the covenanting States to the United State. In May 1949 the Matsya Union merged into the United State of Rajasthan, causing the former Dholpur State, through its earlier inclusion in Matsya, to become part of the United State of Rajasthan. At the time of this merger it was undisputed that the extant laws of the Matsya Union remained in force until altered by the United State, and that the assets and liabilities of Matsya were assumed by the United State. Finally, after the inclusion of the State of Sirohi, the United State of Rajasthan was transformed into the Part B State of Rajasthan on 26 January 1950. At that juncture Article 372 of the Constitution preserved the existing laws subject to their amendment or repeal by the new State, while Article 295(2) declared that, as of the commencement of the Constitution, the government of each Part B State would succeed the government of the corresponding Indian State in respect of all property, assets, rights, liabilities and obligations, except those expressly excluded in clause (1) and subject to any agreement between the Government of India and the State concerned.

Clause (1) stipulated that the provision was subject to any agreement entered into for that purpose by the Government of India with the Government of the State concerned, and this completed the description of the political changes that had occurred up to the coming into force of the Constitution on 26 January 1950. The Court noted that several defences had been raised on behalf of the State of Rajasthan, and that the trial court had negatived those defences in three separate suits. In one of those suits, from which appeal number 886 subsequently arose, the trial court had dismissed the suit. The State of Rajasthan then appealed the decisions in two of the suits before the District Judge, and it appealed a third suit—corresponding to appeal number 887—directly to the High Court on the basis of valuation considerations. In a fourth suit, the plaintiff filed an appeal before the District Judge. The District Judge substantially dismissed the State’s appeals, while it substantially allowed the plaintiff’s appeal in the fourth suit. After those determinations, the State of Rajasthan filed three further appeals before the High Court, which were classified as second appeals. Those three second appeals were heard together with the first appeal that was before the High Court. During the High Court proceedings, for the first time a point was raised that the liability of the former Dholpur State did not automatically attach to the State of Rajasthan when the latter came into existence on 26 January 1950. The High Court allowed that point to be raised, holding that it presented a pure question of law. The appeals then proceeded before a Division Bench of the High Court. The two learned Judges constituting the Division Bench disagreed on whether the State of Rajasthan bore liability under Article 295(2) of the Constitution for the obligations of the former State of Dholpur. Consequently, the matter was referred to a Full Bench for clarification of the liability issue. The Full Bench framed the question as follows: “Whether the expression ‘Government of the corresponding State’ used in Article 295(2) of the Constitution with reference to Rajasthan properly denotes only the Government of the United State of Rajasthan, which was the sole Indian State in existence at the commencement of the Constitution, or whether it also includes the Government of any of the covenanting States that had merged into the United State before the Constitution came into operation.” The three learned Judges hearing the reference unanimously held that the expression ‘Government of the corresponding State’ in Article 295(2) as applied to Rajasthan meant not merely the Government of the United State of Rajasthan, but also the United State of Rajasthan together with its component units. After the Full Bench’s opinion, the matter returned to the Division Bench. The Division Bench dismissed the three second appeals filed by the State. It also dismissed the first appeal from which appeal number 887 had arisen, with the modification that no interest would be awarded up to the date of the decree and that the monetary award would be reduced to the actual amount of excess export duty that had been deposited in advance and was ordered to be refunded.

The Court noted that the amount in question had been deposited in advance and that an order had been made directing its refund. The sole issue that the appellant sought to raise before the Court concerned whether the State of Rajasthan bore any liability under Article 295‑2 of the Constitution for obligations that had originally pertained to the former State of Dholpur, a territory that had become part of Rajasthan as a result of the political changes previously described. To support this contention, the appellant relied heavily on the precedent set by this Court in the case of M/s. Dalmia Dadri Cement Co. Ltd. v. The Commissioner of Income Tax. That earlier decision examined the Covenant that created the State of Pepsu, particularly Article VI of that Covenant, and observed that the covenant in Pepsu was substantially similar in substance to the Covenant that formed the United State of Rajasthan. The Court in that case reviewed several authorities dealing with the acquisition of territory either by cession or by conquest and held that it made no legal difference whether a new territory was acquired by an existing State through conquest, by cession, or whether a new State was formed by agreement out of territories previously belonging to other States. In each circumstance, the Court held that a new sovereignty over the concerned territory was established, and that the establishment of such sovereignty constituted an act of State. Consequently, the Court further held that the Covenant which brought the State of Pepsu into existence was, in its entirety, an act of State, and that Article VI of that Covenant could not be invoked to confer any right on a private company against the newly formed State. The principle, as the Court explained, is well settled: clauses in treaties entered into by sovereigns of independent States, wherein sovereignty over territory passes from one sovereign to another and the treaty provides for the new sovereign’s recognition of the existing rights of the residents, must be regarded as having the character of an act of State, and no claim based on such provisions may be enforced in a court of law. The Court also rejected the argument advanced in that case that any part of the Covenant might be treated as an interim Constitution, reaffirming that the Covenant, whether in whole or in part, was an act of State and could not be construed as an interim constitutional document. The appellant placed strong reliance on this decision to argue that, even assuming that the former State of Dholpur had any liability to refund tax that had been collected in advance where no export had taken place, such liability did not transfer to the Part B State of Rajasthan under Article 295‑2 because the new State had never recognised the liability at any time. The appellant therefore claimed that the present matter was directly on all fours with the earlier decision. After setting out these principles, the Court indicated that it proceeded, in the earlier case, to examine the specific point that had been raised – namely a clause contained in an

In the earlier dispute, the Court examined an agreement entered into between the ruler of the former Jind State and the Dalmia Dadri Cement Company concerning income‑tax obligations and certain concessions granted to the company. The central issue was whether the newly constituted sovereign authority had ever recognised those concessions. After reviewing the relevant statutes, the Court observed that Pepsu Ordinance No 1 of 1948, dated 20 August 1948, contained a clause (section 3) which expressly repealed all laws existing in every Covenanting State and substituted the laws of the State of Patiala, to be applied mutatis mutandis throughout the entire territory of the new State. This Ordinance was subsequently repealed and replaced by Ordinance XVI of Samvat 2006, which came into force on 5 February 1949 and incorporated an identical provision. The Court therefore concluded that if the agreement between the former ruler and the company was to be treated as a special law, it would necessarily have been repealed by section 3 of Ordinance No 1. Moreover, the Court held that the wholesale repeal of all statutes of the Covenanting States, except those of Patiala, and the substitution of Patiala law across the whole territory, demonstrated unequivocally that the new sovereign did not recognise any rights of the subjects of the former Covenanting States that might have arisen under any post‑Covenant legislation. Consequently, the Court determined that the concessions contained in the agreement ceased to have any effect at the moment Ordinance No 1 was enacted, because they were never recognised by the new sovereign and therefore could not be claimed by the company. It was further noted that the decision regarding non‑recognition of rights in states other than Patiala rested on the factual premise that Ordinance No 1 had repealed every law of those states and imposed Patiala law throughout the new territory. While the Court also addressed the status of Article VI of the Covenant, it observed that, although citizens could not directly enforce Article VI against the new sovereign because the Covenant represented an act of State, the provision could nevertheless serve as valuable evidence from which one might infer an affirmation of the rights mentioned therein, provided such inference related to the conduct of the new State after its formation. However, in the facts before it, the Court declined to treat Article VI as admissible evidence, noting that no equivocal acts of the new State indicated an intention to assume the liabilities claimed.

The Court observed that the first act of the new sovereign had been to apply the Patiala State statutes, including the Patiala Income‑tax Act, to the territories of Jind, thereby negating the rights asserted in the earlier case. The Court noted, however, that beyond the specific ruling in that case, the analysis had to be based on the broader principle articulated therein concerning the legal effect of the creation of a new State, as exemplified by the manner in which the State of Pepsu and the United State of Rajasthan were formed after the execution of their respective Covenants. The Court therefore turned its attention to this general aspect of the matter. In examining the historical development that eventually led to the formation of the Part B State of Rajasthan following the commencement of the Constitution, the Court identified two recurring features throughout the merger process. The first feature was that, each time a merger occurred, the Covenant contained a provision whereby the new State assumed the assets and liabilities of the merging States.

The Court further explained that, according to the decisions in Dalmia Dadri Cement Co.’s case(1), a Covenant—whether in whole or in part—constituted an act of State and therefore could not be invoked directly by the subjects of the new State. Nonetheless, the Court held that the continued presence of such a clause throughout the Covenant served as persuasive evidence that the new State intended to assume the liabilities of the merging State whenever the new State’s actions were ambiguous. From the historical narrative already set out, the Court found that each occasion of merger and the creation of a new State was accompanied by a rule that the pre‑existing laws would remain in force until the new State expressly repealed, amended, or altered them. The Court expressed the view that when a new State maintains the old laws until such modification, and when each Covenant expressly provides that the assets and liabilities of the merging States become those of the Union, the new State must have intended to honor all rights derived from the continued laws and to accept all liabilities that arose from those laws. The Court remarked that it would be illogical to preserve the old statutes without intending to bear the accompanying obligations and liabilities, unless a specific provision—similar to that found in the Pepsu case—had been inserted to repeal all the old laws except those of Patiala, thereby limiting the rights to those recognized or conferred by the Patiala statutes.

In the case before the Court, the statutes that existed in the merging States were declared to remain in force until such time as they were either repealed, altered, or otherwise modified. From that premise, the Court concluded that the rights which arose under those pre‑existing statutes for the citizens of the merging States would persist, and those citizens would retain the same entitlements against the newly formed State as they had previously enjoyed against the former States. Consequently, by electing to preserve the old statutes pending any alteration, the new State effectively assumed the responsibility for any liabilities that might arise by virtue of the continued operation of those statutes. Even if some uncertainty existed regarding whether the new State expressly undertook the liabilities of the predecessor States by permitting the old statutes to continue, the Court found that the decision in Daltia Dadri Cement Co.’s case (1959) S.C.R. 729 provided guidance. Referring to Article VI of the Covenant, the Court determined that the continuation of the old statutes indicated the new State’s intention to uphold the rights of the individuals and to accept any liability that would have attached to the merging State.

The Court distinguished the present matter from the Dalmia Dadri Cement Company case, noting that in the latter the old statutes were wholly repealed in all territories except Patiala, thereby repudiating those laws. In contrast, the present case involved the explicit continuation of the old statutes until such statutes were altered or repealed. Because of this fundamental difference, the Court considered it appropriate to invoke Article VI of the Covenant, together with analogous provisions that were consistently incorporated throughout the process of merging the various territories into Rajasthan. Those provisions, the Court held, served as evidence that the new State, by maintaining the old statutes without amendment, recognized that it would be liable in the same manner as the merging State would have been, should any liability arise.

The Court emphasized, however, that this assumed liability remained subject to any later legislation enacted by the new State that lawfully repealed the old statutes and thereby altered the liability landscape, provided that such legislation fell within the new State’s legislative competence and did not violate the constitutional limits that became applicable after the Constitution commenced. Accordingly, the Court concluded that the new sovereign throughout the integration process had consistently recognized the rights of the subjects and had, by virtue of preserving the old statutes, undertaken the corresponding liabilities of the former States, subject only to any valid, constitutionally permissible statutory changes made thereafter.

In the period of integration that extended from 1948 to 1950, the process was deemed to have recognised the rights of the subjects of the former States and to have assumed any liability that might have been attached to those States. Consequently, the Court held that the State of Rajasthan became liable under Art. 295(2) of the Constitution to satisfy the liabilities of all the earlier States that were eventually merged into it. This liability was subject to the condition that, should the newly formed State enact any legislation that repealed the earlier law and thereby affected the liability, the new legislation would prevail, and the liability could cease, provided that such legislation was within the competence of the State legislature and did not violate constitutional limitations after the Constitution came into force. The Court therefore expressed the opinion that the new State continuously recognised the liability throughout the integration process, and on that basis the suit was maintainable against the Part B State of Rajasthan pursuant to Art. 295(2). The Court further observed that it was unnecessary to decide whether the specific wording of Art. 295(2) refers only to the United State of Rajasthan as it existed immediately before 26 January 1950 or also to the former States that were merged into it, because the historical record demonstrated that the new State consistently acknowledged its liability with respect to the merging States. Any doubt on this point, the Court noted, was resolved by the existence of Art. VI or comparable provisions that prevailed throughout the political transitions. The Court also referred to section 3 of the Rajasthan Administration Ordinance No. 1 of 1949, which preserved the existing laws of the former States until they were altered by a competent legislature or other authority in the new State. Section 3 further provided that references in those laws to the Ruler or Government of a former State were to be construed as references to the Rajpramukh or, as appropriate, to the Government of Rajasthan. These provisions indicated that any right or obligation enforceable against the Ruler or Government of a merging State could likewise be enforced against the Rajpramukh or the Government of the new State. This reinforced the conclusion that the new State recognised the rights of the subjects derived from the old laws and was prepared to assume any liability arising therefrom. Accordingly, the Court agreed with the Full Bench that the liability lay upon the State of Rajasthan because of this recognition of liability, consistent with the principles previously articulated.

The Court observed that the earlier decision in the Dalmia Dadri Cement Company case was not required to be addressed further. Consequently, the Court stated that it would not express any opinion on whether the phrase “Government of the corresponding Indian State” appearing in Article 295(2) of the Constitution should be interpreted as referring solely to the United State of Rajasthan as it existed on January 26, 1950, or whether it should also encompass all the former states that were merged into the United State of Rajasthan on that same date. The Court then turned its attention to another precedent, namely the decision of this Court in Maharaja Shree Umaid Mill Limited v. Union of India. In that earlier case, an agreement had been executed between the ruler of the former State of Jodhpur and Maharaja Shree Umaid Mills Limited, under which certain exemptions from both income tax and excise duty were granted to the mills.

The Court noted that the earlier case presented two principal questions for determination. The first question asked whether excise duty could lawfully be imposed on cloth manufactured by the mills, while the second question concerned whether income tax could be imposed on the mills’ income, given the existence of the exemption agreement with the former ruler of Jodhpur. The Court further explained that the initial issue in that case was whether the agreement itself constituted law. Relying on the authorities cited as (1) [1959] S.C.R. 729 and (2) A.I.R. 1963 S.C. 953, the Court held that the agreement was not a law. The present appeals, however, did not require consideration of that particular aspect.

The subsequent issue in the earlier case was whether the new sovereign – the State of Rajasthan – had recognized the agreement. Arguments were made that the continuity of laws and Article VI of the Covenant supported recognition, and it was also contended that, in view of Article 295 of the Constitution, the exemption contained in the agreement should continue to operate. The Court identified a material distinction in that case: although the old laws remained in force temporarily under Rajasthan Ordinance No. 1 of 1949, the newly formed State later enacted the Rajasthan Excise Duties Ordinance of 1949. That Ordinance expressly applied to the mills and was enacted within the State’s competence. Consequently, the Court observed that the exemption provided by the agreement was not affirmed by the new State of Rajasthan.

Because the facts of the earlier case differed from those of the present matter, the Court emphasized that a competent law had been enacted which expressly negated recognition of the agreement and imposed excise duties. Regarding income tax, the Court pointed out that it had been imposed from April 1, 1950, after the Constitution came into force, through a statute passed by Parliament that did not violate any constitutional limitation. The Court therefore concluded that such a statute must prevail, and in the presence of that statute there could be no question of the Union recognizing any right to exemption based on the agreement with the former ruler of Jodhpur. Accordingly, the Court held that both of the claims raised in the present appeals could not succeed.

In the earlier case referred to, the Court observed that a specific statute expressly applied to the mills, and consequently it held that the newly constituted sovereign authority did not recognise any exemption that might have existed under the previous arrangement. By contrast, in the present matter the only legislative framework that continues to operate consists of the pre‑existing statutes that were in force before the accession, and the Court may rely upon the evidentiary value of Article VI of the Covenant, which was incorporated into the legal relationship between the parties. The Court examined the legislative record and found no amendment, repeal or new enactment that withdrew the right to seek a refund, and therefore concluded that no competent legislation has been shown to extinguish that right. It further noted that, in the absence of a statute expressly repealing the covenant’s provisions, the covenant retains its evidentiary effect and supports the continuation of the old legal regime. Accordingly, the Court is of the view that the appellant cannot draw any benefit or legal support from the decision reported in Maharaja Shree Umaid Mills, A.I.R. 1963 S.C. 953, because the factual and legal circumstances are different. For these reasons the appeals are dismissed in their entirety. The respondent in Appeal No. 887 is awarded costs against the appellant, and both appeals are thereby dismissed.