Wilful defaulter label: Usage by banks

In the recent past, the declaration of borrowers as wilful defaulters has been an effective tool for prevention and recovery of non-performing assets. Once a borrower is reckoned as a wilful defaulter by a bank or another financial institution, dire consequences follow. Wilful defaulters are barred from obtaining additional financial facilities, promoters of wilful defaulter companies are barred from raising finance to float new ventures, and banks and financial institutions are entitled to initiate penal action against wilful defaulters.

Master circular

The whole process of declaring a borrower as a wilful defaulter and taking necessary actions is solely controlled by banks and financial institutions. Since there is a possibility that banks and financial institutions may misuse their powers while declaring a borrower as a wilful defaulter, the Master Circular on Wilful Defaulters dated 1 July 2014 contains numerous provisions which require banks and financial institutions to put a transparent mechanism in place and take decisions only after careful consideration and due caution.

In cases before certain high courts, it has been contended that a bank’s action in declaring a person as a wilful defaulter was premature. In light of the serious consequences described above, it is imperative that decisions taken under the master circular are prudently taken and are backed by necessary evidence.

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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 1 April 1999. The scheme required banks and financial institutions to report all cases of wilful defaults of ₹2.5 million (US$40,500) and above to the RBI on a quarterly basis. Since implementing the scheme, the RBI issued various instructions regarding wilful defaulters and the master circular consolidates these instructions.

Clarifications issued

A circular issued by the RBI on 9 September 2014 provides a definition of the term “lender” used in the master circular. A lender would include all banks and financial institutions to which any amount is due under a banking transaction. The circular further clarifies that a banking transaction would include off balance sheet transactions such as derivatives, guarantees and letters of credit.

The circular clarifies that a “unit” under the master circular would include individuals, juristic persons and all other forms of incorporated or non-incorporated business enterprises. The circular also provides for reporting the names of individuals who are in charge and responsible for the management of the affairs of such business enterprises. These measures may be intended to complement another provision of the circular, which stipulates that group companies can also be reckoned as wilful defaulters on failure to honour guarantees furnished on behalf of wilfully defaulting units.

The clarification regarding guarantors is one of the major changes brought about by the circular. The circular lays down that guarantors can also be declared as wilful defaulters if they fail to honour their obligations despite having sufficient funds. This provision is applicable only to guarantees provided after the date of the circular. Henceforth, persons or entities willing to provide guarantees will need to be careful as a default could lead to their being classified as a wilful defaulter, post which all the consequences laid down under the master circular would follow.

This clarification is likely to specially affect project financing since in such transactions the borrowers are usually special purpose vehicles and the promoters (guarantors) are effectively the persons on whose credit the loans are extended.

Validity challenged

The master circular’s legality was recently challenged before Gujarat High Court. While holding the master circular legal and valid, the court however held that the provisions as applicable to directors were arbitrary and unreasonable and deserved to be struck down to that extent. In coming to this conclusion, the court observed that all the directors of the company could not be held liable for default in repayment of the loan which might be for reasons beyond the control of the directors.

In light of the above, it seems that the circular is intended to strengthen the provisions governing wilful defaulters. Though there are still grey areas in the guidelines, as may be deduced from the above-mentioned judgment, these steps by the regulator will help ensure that the RBI’s primary intention of curbing non-performing assets by issuing guidelines on wilful defaulters will be achieved.

Guidelines worded in a manner which adequately discourages wilful defaults while ensuring at the same time that no unreasonable restrictions are placed on individuals or entities will go a long way in protecting the interests of banks and other financial institutions.

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Babu Sivaprakasam is a partner, Deep Roy is an associate partner and Megha Agarwal is an associate at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.