Master Circular on Wilful Defaulters and consequences of being declared a Wilful Defaulter: Overview

Devesh Juvekar and Dikshat Mehra

Guidelines on wilful defaulters were introduced by the Reserve Bank of India (“RBI“) over a decade ago, by way of a scheme which came into effect from April, 1999. The scheme required banks and financial institutions to report all cases of wilful defaults of 25,00,000 lakhs and above to the RBI on a quarterly basis.

The RBI, from time to time, issued a number of circulars to banks and financial institutions, containing instructions on matters relating to wilful defaulters. To enable the banks to have all the existing instructions at one place, a Master Circular dated July 1, 2013, (“2013 Circular“) incorporating all the guidelines issued on cases of wilful default, were issued. 

The purpose was, to put in place a system to disseminate credit information pertaining to wilful defaulters for cautioning banks and other financial institutions so as to ensure that further bank finance is not made available to them.

The 2013 Circular, inter alia provided for submission by banks / financial institutions of data of wilful defaulters to RBI on a quarterly basis and communication thereof to the Securities Exchange Board of India and to Credit Information Bureau (India) Ltd.

When a wilful default would be deemed to have occurred

• The unit has defaulted in meeting its payment / repayment obligations to the lender even when it has the capacity to honour the said obligations;
• The unit has defaulted in meeting its payment / repayment obligations to the lender and has not utilised the finance from the lender for the specific purposes for which finance was availed of but, has diverted the funds for other purposes;
• The unit has defaulted in meeting its payment / repayment obligations to the lender and has siphoned off the funds so that the funds have not been utilised for the specific purpose for which finance was availed of, nor are the funds available with the unit in the form of other assets; and

The unit has defaulted in meeting its payment / repayment obligations to the lender and has also disposed off or removed the movable fixed assets, or immovable property given for the purpose of securing a term loan without the knowledge of the bank / lender.

The Grievance Redressal Mechanism which was adopted by Banks/FIs for identifying and reporting instances of wilful default as under the 2013 Circular 

• Decisions to classify any borrower as wilful defaulter should be entrusted to a Committee of higher functionaries headed by the Executive Director and consisting of two GMs/DGMs as decided by the Board of the concerned bank/FI; such decision taken should be well documented, clearly spelling out the reasons along with the evidence for which the borrower has been declared as wilful defaulter vis a vis RBI guidelines;
• Borrower to be provided reasonable time (say fifteen days) for making representation against such decision, if he so desires, before a Grievance Redressal Committee headed by the Chairman and Managing Director and consisting of two other senior officials; Grievance Redressal Committee should also give a hearing to the borrower if he represent that he has been wrongly classified as wilful defaulter. Final declaration as wilful defaulter should be made after a view is taken by the Committee on such a representation;
• Major changes which were bought by RBI on September 9, 2014 which was then incorporated in Master Circular of July 1, 2015 (“2015 Circular“), was that definition of the term lender would include all banks and financial institutions to which any amount is due under a banking transaction. The 2015 Circular further clarified that a banking transaction would include off balance sheet transactions such as derivatives, guarantees and letters of credit;
• The 2015 Circular also clarified that a unit would include individuals, juristic persons and all other forms of incorporated or non-incorporated business enterprises. The 2015 Circular also provided for reporting the names of individuals who are in charge and responsible for the management of the affairs of such business enterprises. Another aspect which was amended by RBI in September 9, 2014 was a requirement of declaring group companies as wilful defaulters on failure to honour guarantees furnished on behalf of wilfully defaulting units. Guarantors were also to be declared as wilful defaulters, if they fail to honour their obligations despite having sufficient funds. This provision, qua the Guarantors were prospectively applicable i.e. after September 9, 2014; and
• The 2015 Circular also stated that in very rare cases, a non-whole-time director should not be considered as a wilful defaulter, unless it is conclusively established that, he was aware of the fact of wilful default by the borrower by virtue of any proceedings recorded in the minutes of meeting of the Board. The said exception was, however not to be applied to a promoter director even if he was not a whole-time director.

Mechanism for identification of Wilful Defaulters under the 2015 Circular

• The evidence of wilful default on the part of the borrowing company and its promoter / whole-time director at the relevant time would have to be examined by a Committee headed by an Executive Director, or equivalent and consisting of two other senior officers of the rank of GM / DGM;
• If the Committee concludes that an event of wilful default has occurred, it shall issue a Show Cause Notice to the concerned borrower and the promoter / whole-time director and call for their submissions and after considering their submissions issue an order recording the fact of wilful default and the reasons for the same. An opportunity should be given to the borrower and the promoter / whole-time director for a personal hearing, if the Committee feels such an opportunity is necessary; and
• The order of the Committee should then be reviewed by another Committee headed by the Chairman / Chairman & Managing Director, or the Managing Director & Chief Executive Officer / CEOs and consisting, in addition, to two independent directors / non-executive directors of the bank and the Order shall become final only after it is confirmed by the said Review Committee.

Major Consequences of Being Declared as A Wilful Defaulter

• No additional facilities should be granted by any bank / FI to the wilful defaulters. In addition, the entrepreneurs /promoters of companies where banks/FIs have identified siphoning / diversion of funds, misrepresentation, falsification of accounts and fraudulent transactions would be debarred from institutional finance from the scheduled commercial banks, etc and  floating new ventures for a period of five years from the date the name of the wilful defaulter is published in the list of wilful defaulters by the RBI; 
• The lenders may initiate criminal proceedings against wilful defaulters, wherever necessary. Banks and FIs should adopt a proactive approach for a change of management of the wilfully defaulting borrower unit, wherever possible and
• Under section 29A of the Insolvency and Bankruptcy Code, 2016, a wilful defaulter cannot be a resolution applicant.

Incorporation of certain guidelines by SC in their verdict of State Bank of India (SBI) v. Jah Developers Pvt Ltd, qua circular dated July 2015, w.r.t the in-house committee procedure and personal hearing

The Apex Court in Jah Developers had an opportunity to deal with the much-debated issue as to whether, a person who is to be declared as a wilful defaulter under the RBI guidelines/circulars is entitled to be represented by a lawyer of his choice before such a declaration is made? The SLP had arisen from a Delhi High Court’s order

The Apex Court held that in-house Committees are neither a tribunal, nor are vested with any judicial powers. Their powers are only administrative in nature. The duty of such in house-committees is to only gather facts and then arrive at a result. The Apex Court further held that since, such Committees formed are also not persons legally authorised to take evidence by statute, or subordinate legislation, no lawyer would have any right to appear before such committees.

Under the 2013 Circular, the borrower was given two opportunities to present his case. One, when Committee informs the borrower the proposal to classify him as a wilful defaulter, when borrower would be given fifteen days to make his defence. This reply would then be submitted before a Grievance Redressal Committee. Second instance was when the Grievance Redressal Committee was also required to give the borrower an opportunity to be heard before declaring a wilful defaulter.

The 2015 Circular, however deviated from the 2013 Circular and only entitled the borrower to one opportunity to present his case before the First Committee which would issue him a show cause notice, if they proposed to declare him a wilful defaulter. The borrower may then make his submissions upon such notice being served and had no right thereafter to be appear and/or make submissions.

The Apex Court in Jah Developers felt that, since harsh consequences that follow declaration of a borrower as a wilful defaulter, and the fact that Article 19(1)(g) was attracted in facts of the case, the moment a person is sought to be declared as a wilful defaulter, the fundamental right to carry on business is direct and immediate, the Court held that 2015 Circular must be construed reasonably and directed the incorporation of certain features of the 2013 Circular, qua the Grievance Redressal Mechanism (in-house proceedings) so that a borrower can defend himself before he is declared a wilful defaulter.

The Court has further gone ahead and held that once the First in-house Committee, declares a borrower a wilful defaulter it shall serve a copy of such an order to the borrower. Thereafter, borrower must be given an opportunity to make his representation within fifteen days before the Review Committee, after which the Committee is expected to pass a reasoned order with evidence relied upon in the matter. This reasoned order of the Review committee must also be then served on the borrower.

Impact of a lawyer’s appointment in such a case and how it could affect the in-house proceedings positively or negatively

The events of wilful default consist of borrower’s version of facts; hence a lawyer was not necessarily required at such hearings as no complicated questions of law were to be presented before the in-house Committees. One of the possible objections the banks had over the years were that with lawyers appearing it may unnecessarily delay the process of declaration of a borrower as a wilful defaulter with their prolonging arguments. By the Apex Courts’ verdict now in Jah Developers, one can now positively expect a fast track in-house proceeding initiated by banks, or financial institutions to declare a person as a wilful defaulter. 

About the authors: The authors are lawyers working at Rajani Associates. Devesh Juvekar is a Partner at the firm, whereas Dikshat Mehra is a Senior Associate with the firm’s Dispute Resolution Team.

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