India: RBI Overhauls Wilful Defaulter Guidelines: More Onus On Bankers?

Introduction

Reserve Bank of India has introduced RBI (Treatment of Wilful Defaulters and Large Defaulters) Directions, 2023 ("Wilful Defaulters Directions") to overhaul the process of declaration of wilful defaulters. Earlier, wilful defaulters were classified in terms of the Master Circular on Wilful Defaulters dated 1 July 2014 ("Existing Wilful Defaulters Circular"). The Wilful Defaulters Directions will replace the Existing Wilful Defaulters Circular.

Recently, classification of wilful defaulters under the Existing Wilful Defaulters Circular has come under scrutiny from several High Courts and even the Supreme Court of India. The key concern of the courts has been on the principles of natural justice. The Supreme Court in State Bank of India v. Jah Developers Private Limited and Ors. ruled that the implication of classifying a person as a wilful defaulter is enormous and thus this invites principles of nature justice in the decision making. The court also ruled that the wilful defaulter committee (formed in accordance with the Existing Wilful Defaulters Circular) of a bank must pass a reasoned order. The Delhi High Court in Frost International Limited v. Punjab National Bank¹ observed that the order of the wilful defaulter committee did not provide adequate reasons for its decision and consequently, fails to be a reasoned order. Courts have also routinely dismissed wilful defaulter orders on the ground that sufficient opportunity of representation was not provided before taking the decision.

The Wilful Defaulters Directions, among others, attempts at addressing the concerns of several courts regarding the principles of natural justice. This article summarizes the key changes in the process suggested by the Wilful Defaulters Directions.

Key Changes

Lenders

At present, only scheduled commercial banks (and all India notified financial institutions) can classify a borrower or guarantor as a wilful defaulter. Now, the onus to investigate and classify wilful defaulters is extended to all banks (including all commercial banks, regional rural banks, local area banks), NBFCs (only NBFC Middle-Layer and above layers classified under RBI Scale Based Regulation (SBR): A Revised Regulatory Framework for NBFCs dated 22 October 2021), and the All-India Financial Institution (AIFI), which includes EXIM Bank, National Housing Bank, SIDBI and others.

Wilful Default

The definition of "wilful default" remains largely the same except for one interesting addition. Now, if relying on the assurance of the borrower to infuse equity the lender provides loan or grants concessions to the borrower, but the borrower fails to infuse equity (despite having the ability to do so), then this is a "wilful default". Whether this will restrict banks from seeking infusion of equity in negotiations, will be something to watch for.

Principles of Natural Justice

The Wilful Defaulters Directions seek to address key concerns of courts. First, sufficient representation to borrowers and guarantors before classifying them as "wilful defaulters". The identification committee (it was an informal nomenclature earlier, now, defined in the directions) if satisfied that a "wilful default" has occurred must: (a) issue a show cause notice to the borrower or guarantor or promoter or any person in charge or responsible for the management of the borrower; and (b) make a proposal to the review committee for classification of such person as "wilful defaulter". The borrower (or any person, as the case may be) will be given 15 days' time to make "written representation" to the review committee. The review committee must also provide an opportunity of "personal hearing" before classifying any person as a "wilful defaulter". But if any person chooses to not appear before the review committee, then the committee can take a decision based on documents and materials available. The Wilful Defaulters Directions mandate that the review committee must pass a reasoned order.

The Wilful Defaulters Directions is unclear on the number of opportunities of "personal hearing" that must be given to a borrower. This should have been specified to avoid unnecessary litigation by borrowers and promoters. It is also unclear whether the lenders are required to provide all documents relied on by them to the concerned borrower. This has been a contentious issue in the past. Also the RBI should have specified the basic contents of a "reasoned order". This is because the bankers cannot be expected to be aware of the basic requirements of a "reasoned order" and this can be a ground for conflict.

Treatment of Defaulted Loans

The Wilful Defaulters Directions mandate that before transferring a facility to any transferee, the lender must complete the investigation from a "wilful default" angle. Once the account is transferred, the "wilful default" classification will continue. Completion of "wilful default" investigation before transferring a loan can create delay, more so, when NARCL, the bad bank, is trying to acquire defaulted loans.

Use of Funds and Role of Statutory Auditors

The directions place immense importance on monitoring use of funds. The loan documents now must include measures to ensure the end use of funds such as scrutiny of quarterly progress reports and books of account, periodic stock audit. In the case of falsification of accounts by a borrower, if the auditors are found negligent or deficient in conducting the audit, then the lender can complain to the National Financial Reporting Authority or Institute of Chartered Accountants of India. The complaints are also required to be sent to RBI and IBA, so that others are cautioned against those auditors. Lenders can also engage independent auditors to verify use of funds or present diversion of funds, in addition to relying on the borrower's auditors. This is a good aspect as this will bring more accountability to the role of the auditors.

Stick for Wilful Defaulters

No "wilful defaulter" can be given additional credit facility, and even after the classification is removed, there is a bar on additional lending for 1 year. A borrower can shake off the "wilful defaulter" tag by entering a compromise settlement with banks, but critically, the classification as such, is removed only after the compromise amount is paid. This avoids borrowers entering into agreements and delaying payment of amounts due. Lenders (and all entities regulated by RBI) have been mandated to submit a list of large defaulters to all Credit Information Companies monthly. The list of suit-filed on accounts of large defaulters must be displayed on the Credit Information Companies website.

Conclusion

On several accounts, the Wilful Defaulters Directions is a positive step in streamlining the process of identification and classification of "wilful defaulters". On the flip side, it appears that the RBI wants bankers to be more accountable and enhance their legal knowledge. The lenders will need increased support from their legal and secretarial teams to comply with the directions.

Footnotes

1 2021 SCC OnLine Del 3683

The above is a generic analysis and should not be regarded as a substitute for specific advice based on the facts of a client's objectives and specific commercial agreements reached. Please do reach out to us at mail@zba.co.in for any queries.