HISTORY AND GERMINATION OF LAW ON WILFUL DEFAULTERS
In the year 1986, Reserve Bank of India ("RBI"), vide its Circular No. 145 dated 20.08.1986, introduced a reporting mechanism in order to introduce financial discipline amongst credit institutions. In order to curb a rapid upsurge in non-performing assets ("NPA") in the 1990s1 stringent measures against 'wilful defaulters' were brought into place and received the necessary impetus when the Central Vigilance Commission ("CVC"), in accordance with the powers and functions vested upon it under Section 8(1)(h) of the CVC Ordinance of 1998, issued instructions on 27.11.1998 on "Improving vigilance administration in Banks" which included directions to the financial institutions ("FIs") to report cases of 'wilful default'. Pursuant to the instructions of the CVC, RBI introduced guidelines by way of a Scheme dated 01.04.1999 requiring banks and FIs to report all cases of 'wilful default' of Rs. 25.00 Lakhs (Rupees Twenty Five Lakhs Only) and above to the RBI on a quarterly basis ("Scheme of 1999"). In the Scheme of 1999, a broad scope was given to the definition of 'wilful default' by expanding the same to cover deliberate non-payment of dues despite adequate cash flow and good net worth, siphoning off of funds to the detriment of the defaulting unit, misrepresentation/falsification of records, disposal/removal of securities without bank's knowledge and fraudulent transactions undertaken by the borrower. RBI had advised credit institutions that prima-facie for a default to be categorized as 'wilful' it must be intentional, deliberate and calculated.
However, the Scheme of1999 was largely ineffective in curbing the menace of wilful defaulters in the financial system. This was reflected in the Eighth Report of the Parliament's Standing Committee on Financial Institutions - Objectives, Performance and Future Prospects, submitted to the Parliament on 20.12.2000. As such, the Committee recommended creation of a database of credit information which would be a comprehensive system and would include details of wilful defaulters and information on promoters and group companies who have mis-utilized the borrowed funds. The Committee also recommended stringent penal measures including filing of criminal cases against such companies as well as denial of access to capital markets to such companies, amongst others. In May 2001, RBI, in consultation with the Government of India, constituted a 'Working Group on Wilful Defaulters'. Based on the recommendation of the said Working Group, various directions and guidelines on 'wilful defaulters' were issued by RBI to the lending institutions by way of Circulars. Further, the Credit Information Bureau (India) Limited ("CIBIL") was also established in the year 2001. Subsequently, the Government of India also notified the Credit Information Companies
(Regulation) Act, 2005 on 23.06.2005. The evolution of the law relating to wilful defaulters in relation to lenders has been shaped, in no small measure, by Courts and Tribunals in India. In one of the earliest indications and measures, in 1998, RBI had received a suggestion from the Hon'ble Supreme Court of India pursuant to its verdict
in the matter of Common Cause (A registered Society) vs. Union of India & Anr. , W.P. (C) No. No.291 of 1998 to expand the scope of definition of 'wilful default'. It is rather surprising that after the Scheme of 1999 provided that disposal/removal of securities without bank's knowledge would be one of the transactions triggering 'wilful default', RBI omitted this parameter when it redefined 'wilful default', in supersession of the Scheme of 1999, in its circular no. DBOD. No.DL(W).BC ./110 /20.16.003(1)/2001 -02 on Wilful defaulters and action thereagainst dated 30.05.2002. Thereafter, in the year 2006, RBI consolidated all instructions and guidelines in respect of 'wilful defaults' at one place in Master Circular on Wilful Defaulters dated 01.07.2006 ("Master Circular, 2006"). However, this parameter also did not appear in definition of 'wilful default' as provided in the Master Circular, 2006. It was only in the year 2008 that RBI issued a statement vide notification number RBI/2007-08/377 UBD.PCB.Cir.No.57/16.74.00/2008-09 dated 24.06.2008 noting that, pursuant to the Hon'ble Supreme Court's order in the Common Cause (A registered Society) vs. Union of India & Anr. (Supra), it had received a suggestion to expand the scope of definition of 'wilful default' to include within its ambit cases where the borrower has also disposed off or removed the movable fixed assets or immovable property given by it for the purpose of securing a term loan without the knowledge of the bank/lender. Subsequently, the definition of 'wilful default' was amended. Over the years, based on recommendations of Working Group on wilful defaulters and various feedbacks received from different stakeholders, the Master Circular, 2006 has been revised time and again.
RBI CIRCULARS ON WILFUL DEFAULT AND EVOLUTION THEREOF
In the year 2015, with the objective of consolidating the aforesaid recommendations of various committees and stakeholders and for giving directions to banks/FIs on identifying and dealing with 'wilful defaulters', RBI issued the Master Circular on Wilful Defaulters bearing reference number RBI/2015-16/100 DBR.No.CID.BC.22/20.16.003/2015-16 dated 01.07.2015, ("Master Circular"). RBI has also proposed setting-up of a Public Credit Registry2 ("PCR") for capturing all details of borrowers and wilful defaulters. The PCR is meant to include data from entities like Securities and Exchange Board of India ("SEBI"), the Ministry of Corporate Affairs ("MCA"), the Goods and Services Tax Network and the Insolvency and Bankruptcy Board of India to enable banks and FIs to get a complete profile of the existing, as well as prospective, borrowers on a real-time basis.
The RBI guidelines dealing with the subject of wilful default are loaded in favour of lending institutions, while at the same time perhaps not being as apparently flawed as, say, the guidelines of declaration of 'Fraud'. In view of the fact the power to declare a borrower as a 'wilful defaulter' lies in the hands of its lender, as such, there is always potential for abuse of powers. Unfortunately, in some cases, with the adverse consequences that emanate from the Master Circular, lenders use the threat of declaration as a 'wilful defaulter' as a tool to hasten recovery. Lenders thereby endeavour to impart a criminal colour to a purely civil dispute under the garb of adhering to the provisions of the Master Circular. The Master Circular is extremely broad in the sense that it does not take into consideration any extraneous circumstances such as reasons beyond the control of the promoters that have led to a default. Such extraneous circumstances which can often lead to default have been recognized by RBI in the Master Circular - Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances dated July 01, 2015 ("IRAC Norms"). As per paragraph 4.2.4 of the IRAC Norms, RBI has advised banks to not downgrade the asset classification of borrowers to NPA, where their accounts face temporary deficiencies which can be rectified. However, owing to the onerous conditions laid out in the Master Circular, with the object to hasten recovery, a bona fide defaulter can also be categorized as 'wilful defaulter' at the behest of creditors. A careful balancing of equities is, therefore, the need of the hour in order to prevent such abuse. In a society like ours where reactive lawmaking is (almost) the norm, considerable time and thought ought to be given before declaring a borrower as a 'wilful defaulter'.
The Hon'ble Supreme Court of India has also been walking on a tight rope, struck between balancing the interests of the creditors as against the principles of natural justice. Taking into account various equities and other relevant factors, in the landmark case of State Bank of India vs. Jah Developers Pvt. Ltd., (2019) 6 SCC 787, the Court recognized that harsh consequences, having a direct and immediate impact on rights of the borrowers enshrined under Article 19(1)(g) of the Constitution of India, are attracted the moment a person is sought to be declared a 'wilful defaulter'. So, the Hon'ble Supreme Court, inter-alia, directed/declared:
- Incorporation of a second opportunity of representation/hearing to the borrower (which was also present in the Circular on Wilful Default issued by RBI on 01.07.2013 but was reduced to a single opportunity in the Master Circular). The Court also directed that the orders of the both the committees shall be served upon the borrower (Paragraph 24 of the judgment)3; and
- The committees are neither a tribunal, nor are vested with any kind of judicial powers nor can they call for evidence while making a decision. Their powers are only administrative in nature. Their duty is to only gather facts and then arrive at a result. Such committees formed are not legally authorized to take evidence under any statute, or subordinate legislation. Hence, no lawyer would have any right to appear before such committees (Paragraph 11 to 14 of the judgment, now reflected in Paragraph 3(b) & 3(c) of the Master Circular); and
- Oral hearings are not mandatory. A just result can be arrived at after considering the written
representations given by parties also (Paragraph 15 of the judgment, now reflected in Paragraph 3
of the Master Circular).
As a (somewhat) related point, it may be noted that if an enquiry is made as to the list of wilful defaulters, RBI may not be able to withhold such information in view of the decision of the Hon'ble Supreme Court in Reserve Bank of India vs. Jayantilal N. Mistry, 2016 (3) SCC 525 wherein the following was held:
- The provisions of Right to Information Act, 2005 ("RTI Act") are applicable to RBI, and RBI is duty-bound to disclose the information sought, but with certain exceptions;
- There is no fiduciary relationship between RBI and banks/FIs;
- RBI has a statutory duty to uphold interests of the public-at-large, the depositors, the economy of the nation and the banking sector;
- Exceptions (paragraph 77 of the judgment): RBI is permitted to conceal only such information which could be a threat to the economy of the nation or national security. Otherwise, being the chief regulator of banks and sentinel/custodian of the economy, it is under duty to discharge its obligations with utmost transparency.
In Girish Mittal vs. Parvati V. Sundaram & Anr., Contempt Petition (C) No. 928 of 2016 in Transfer Case (C) No. 95 of 2015 (decided on 26 April, 2019), the Hon'ble Supreme Court directed that RBI disclose its annual inspection reports on banks, along with the list of wilful defaulters and information related to them under the RTI Act. In response to an application filed under the Act in May 2019, RBI released a list of 30 major wilful defaulters. As per the information received in response to the RTI, total funded advances outstanding to these 30 companies, along with the amount that the banks have written off so far, add up to over Rs 50,000 Crore. Further, as of December 2018, over 11,000 companies had wilfully defaulted on amounts worth over Rs 1.61 lakh Crore as per the data collated by TransUnion Cibil4.
Despite periodic amendments and interpretations by various courts, many contentious issues remain with the Master Circular, basis which it becomes amenable to challenge. The same have been laid out in the third part of this notebook. Our analysis of the Master Circular, therefore, is split into 3 (three) Parts as follows:
- Part A Summary of key provisions of the Master Circular;
- Part B Summary of judicial precedents on various aspects ofthe Master Circular; and
- Part C Potential challenges and undecided issues with respect to the Master Circular.
PART A - SUMMARY OF KEY PROVISIONS OF THE MASTER CIRCULAR
|Proposition||Reference in Master
Circular & Other
|Cross Reference||GL Observation|
|Scope and Applicability||Page 2 of the Master Circular||
||Yes||Part B (1) of this Notebook||
The Master Circular is amply clear as regards its applicability. However, the Hon'ble Telangana High Court5, while interpreting Section 45M of the Reserve Bank of India Act, 1934 ("RBI Act"), has erroneously made the same applicable to Non-Banking Financial Institutions ("NBFCs").
Please refer Part B (1) of this Notebook for the same.
|Definition of Wilful Default||Paragraph 2.1.3 of the Master Circular (Please refer to paragraph 2.2 of the Master Circular for definition of terms 'diversion of funds' and 'siphoning of funds'.)||
||Yes||Part B (2) of this Notebook||
The Master Circular's scope has been expanded to cover in its ambit 'default' in meeting payment obligations under bank guarantees.
Please refer Part B (2) of this Notebook for the same.
Recognition of Wilful defaulters under SEBI guidelines:
Points of Difference between SEBI andRBI norms:
Common threads between RBI and SEBI definitions on wilful default:
SEBI has, while incorporating the definition of'wilful defaulter' under relevant regulations, deferred to RBI by making reference to the Master Circular in such regulations.
|Companies Act, 2013 ("Companies Act")||
||Yes||Part B (3) of this Notebook|
|Liability of External Agencies||Paragraph 2.7 of the Master Circular||
||Yes||Part B (4) and Part C (1) of this Notebook||
In the absence of any statutory backing, RBI has, in effect, conferred ICAI and IBA with adjudicatory powers to sit, mull over and decide complaints against auditors. A defacto statutory/adjudicatory status has been conferred upon IBA as RBI guidelines can be construed as providing legal force to IBA guidelines by making banks follow them.
Please refer Part B (4) and Part C (1) of this Notebook.
|Right to Representati on||Paragraph 3 of the Master Circular||
||Yes||Part B (5) of the Notebook||
Despite severe implications on Fundamental Rights like denial of additional finance, bar from institutional finance, issuance of Look Out Circulars ("LOC") against the promoters/directors of borrowers, etc., the Hon'ble Supreme Court has erroneously gone so far as to propound that no lis is being adjudicated upon by these committees. As such, the Court has denied representation of a borrower through a lawyer before these committees. Lawyers would obviously be more adept in handling matters wherein (atleast effectively, even if not theoretically) a lis is being adjudicated upon.
Please refer Part B (5) and GL Note 4 of this Notebook.
|Authority of GMs/DGMs||Paragraph 3 of the Master Circular||
Section 7 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970: The general superintendence, direction and management of the affairs and business of any bank vests in its Board of Directors, which is entitled to exercise all such powers and do all such acts as the bank is authorized to do.
Indian Bank (Officers') Service Regulations, 1979 ("IBOS Regulations"): GM/DGM belong to top executive grade; delegation of powers decided by the Board of Directors; powers revised periodically, depending upon Government/RBI guidelines; sanctioning of loan is absolute discretion of the sanctioning authority in a bank; specific to every bank, there are manuals ofinstructions, classified circulars, scheme of delegation of powers, proceedings of the board etc.
|No||Part C (2) of this Notebook||
The creditors have been elevated to the position of judges in declaring borrowers as 'wilful defaulters', a declaration which has severe implications on the Fundamental Rights of such borrowers. Not only there is apprehension of bias, the procedure also lacks transparency, which ought to be of utmost significance considering public interest is at stake.
Please refer Part C (2) of this Notebook.
|Criminal action by banks/FI under Indian Penal Code 1860("IPC")||Paragraph 4(ii) of the Master Circular||Criminal action can be initiated against 'wilful defaulters' under Sections 403 and 415 of the IPC.||Yes||Part B (6) of this Notebook||Please refer Part B (6) of this Notebook.|
GL Note 1
Most of the above provisions have been interpreted by various High Courts and Hon'ble Supreme Court of India in a few cases, on this subject, that have come up before them. The table below summarizes the legal positions that have emerged based on interpretation of the substantive provisions of the Master Circular.
PART B - SUMMARY OF JUDICIAL PRECEDENTS ON VARIOUS ASPECTS OF THE MASTER CIRCULAR
|S. No.||Proposition||Legal Position (Based on Interpretation of Substantive Laws in Force through Judicial Precedents)||Relevant Case Law|
|1.||Applicability of Master Circular on financial institutions other than banks and AIFIs||
Powers of NBFCs to classify a borrower as 'wilful defaulter'
|Mr. Dumpala Madhusudhana Reddy vs. M/S. REC Ltd., W.P. (C) Nos. 1420, 1421 & 1428 of 2019, Telangana High Court|
|2.||Definition of Wilful Default||
||Kotak Mahindra Bank Ltd vs. Hindustan National Glass & Industries Limited & Ors., (2013) 7 SCC 369|
Wider interpretation of 'wilful default' taken by the Court to hold:
|Revati Cements Pvt. Ltd. & Anr. vs. State Bank of India & Ors. , W.P. No.27421/2018, Madhya Pradesh High Court|
|3.||Classification of a person as a 'wilful defaulter' outside the purview of RBI/SEBI guidelines||
|Siddharth Chauhan vs. Serious Fraud Investigation Office, CRM-M No. 38296 of 2019, order dated 13.11.2019, Punjab and Haryana High Court (please refer page 86 to 88 of the order as available on website of the Hon'ble High Court)|
GL Note 3
Although various issues have seemingly been settled with respect to the Master Circular, there are a host of potential grounds for challenging the Master Circular. A judgment is authority only for what it holds and not for something that may be logically deduced. The law of precedent is based upon what the common law describes as the ratio decidendi of a judgment. This reason alone has to be followed. The law on this issue has been laid down in the case of Union of India vs. Dhanwanti Devi, (1996) 6 SCC 44 in the following words:
"It is not everything said by a Judge who giving judgment that constitutes a precedent. The only thing in a Judge's decision binding a party is the principle upon which the case is decided and for this reason it is important to analyse a decision and isolate from it the ratio decidendi. A decision is only an authority for what it actually decides. What is of the essence in decision is its ratio and not every observation found therein not what logically follows from the various observations made in the judgment. Every judgment must be read as applicable to the particular facts proved, since the generality of the expressions which may be found there is not intended to be exposition of the whole law, but governed and qualified by the particular facts of the case in which such expressions are to be found. It would, therefore, be not profitable to extract a sentence here and there from the judgment and to build upon it because the essence of the decision is its ratio and not every observation found therein.
Therefore, in order to understand and appreciate the binding force of a decision, it is always necessary to see what the facts were in the case in which the decision was given and what was the point which had to be decided. No judgment can be read as if it is a statute. A word or a clause or a sentence in the judgment cannot be regarded as a full exposition of law. Law cannot afford to be static and therefore, Judges are to employ an intelligent in the use of precedents."
MANY QUESTIONS LEFT UNANSWERED
Despite the aforesaid issues having been agitated before many high courts, there are still many fundamental issues within the Master Circular. For instance:
Excessive Delegation of powers to institutions such as ICAI and IBA: There is no bar upon banks to arrive at a consensus (either through resolutions passed at IBA or of their own accord) against availing services of auditors against whom complaint with ICAI has been filed. Without fair and proper inquiry or providing any hearing to the auditors before a court of law (empowered by law to conduct such trial/inquiry), mere filing of complaint with ICAI can lead to impairment of their right to practice of such auditors NOTEBOOK ON WILFUL DEFAULT GRAVITAS LEGAL 13 | P a g e
De-facto statutory status to IBA: RBI circulars (carrying statutory force) often take cognizance of IBA and have directed banks to follow IBA guidelines, thereby providing legal force/legislative backing to the IBA circulars, without any statutory backing to IBA circulars; without express provision for continuation in service of auditors (against whom complaint before ICAI is pending) until the allegation against them is adjudicated upon by ICAI internally, mere filing of complaint can lead to impairment ofthe right to practice of such auditors, impacting their right to livelihood.
Adjudicatory powers to banks: Despite providing opportunities of hearing to the borrowers, it is still a fundamental flaw within the Master Circular that a borrower is pronounced a 'wilful defaulter' and suffers from reputational and penal consequences at the determination of the banks that are 'interested parties'. As such, banks are empowered by the Master Circular to exercise powers ofa criminal court and effectively sit over and decide constitutional rights of borrowers.
As already stated above, a judgment is authority for what it holds and nothing more, therefore, room for challenging the Master Circular is still available. It is pertinent to mention here that the constitutional validity of the Master Circular was agitated before the Hon'ble High Court of Gujarat. In the absence of the Hon'ble Supreme Court's decision on such contentious issues impairing the fundamental rights of borrowers, room to challenge the Master Circular before any other High Court of India and escalate the same before the Hon'ble Supreme Court still remains for the fact that the judgment of one High Court is not a binding precedent for another High Court and at best carries a persuasive value (State of Gujarat vs. Gordhandas Keshavji Gandhi and Ors., AIR 1962 Guj 128, Gujarat High Court; M/S. Ambica Industries vs. Commissioner Of Central Excise, (Civil Appeal No. 2749 of 2007) Supreme Court). Thus, these issues agitated before the Hon'ble Gujarat High Court are yet to attain finality in the strict sense. The table below contains a brief description of such issues.
GL Note 4
In addition to the points of challenge referred to above, there are many other arguments which may not directly impact or pose challenge to the Master Circular. For instance, in Dynametic Overseas Private Limited & Anr. vs. State Bank of India & Ors. , AIR 2016 Cal 303, the Hon'ble Calcutta High Court held that proceedings under the Master Circular do not involve any lis being decided. Subsequently, in State Bank of India vs. Jah Developers Pvt. Ltd., (Supra), the Hon'ble Supreme Court of India held that the in-house committees are neither a tribunal, nor are vested with any kind of judicial powers and also cannot call for evidence while making a decision. Their powers are only administrative in nature. The duty of such in house-committee is to only gather facts and then arrive at a result. Such committees formed are also not legally authorized to take evidence under any statute, or subordinate legislation. Hence, considering the above, no lawyer would have any right to appear before such committees. What is even more ironic is the fact that the Hon'ble Supreme itself, in paragraph 9 of the judgment of State Bank of India vs. Jah Developers Pvt. Ltd. (Supra) has categorically recognized that declaration of any borrower as a 'wilful defaulter' has a direct bearing upon the fundamental rights of such borrower. Moreover, as per section 29A ofthe Insolvency and Bankruptcy Code, 2016, a wilful defaulter cannot be a resolution applicant.
In addition to the above, Office Memorandum ("O.M.") No. 25016/31/2017-Imm. on issuance of LOC in respect of Indian citizens and foreigners dated 27.10.2010 issued by the Ministry of Home Affairs ("MHA"), as amended by O.M. dated 12.10.2018 when read with Press Release dated 24.07.2019 (directions issued by the Government to deal with fraud, wilful bank loan defaulters or fugitive economic offenders ("FEO")), issued by MHA, empowers Chairmen/Managing Directors/Chief Executive Officers of public sector banks to request issuance of the LOC against FEO/wilful defaulters/fraudsters. In cases of 'wilful default', there is no pre-requisite of a pending criminal investigation or enquiry or complaint or FIR and public sector banks can request for issuance of LOC against any person accused of 'wilful default', casting serious aspersions upon the Fundamental Rights of borrowers. The law on LOC has been dealt in detail in the next Part of our Pocket Notebook. The Hon'ble Courts, to the contrary, however, observed that the decision of the committees do not involve any lis being decided and that these committees do not possess any judicial or quasi-judicial powers. Such observation is erroneous in light of the aforesaid severe implications on rights under Article 19(1)(g) and 21 of the borrowers accused of 'wilful default'.