In the year 1999, pursuant to the instructions of the Central Vigilance Commission coupledwith an objective of arresting the increasing menace of Non-Performing Assets of the banks, and to caution the banks and FIs against the borrowers who had defaulted in their dues to other lending institutions and to make public the name of the defaulting borrowers the RBI introduced a scheme under which banks and notified Financial Institutions were required to submit to the RBI, on quarterly basis, the details of willful defaulters with outstanding of ` 25 Lac and above.
The Master Circular on Willful defaulters issued by RBI under Sections 21 and 35A of the Banking Regulation Act, 1949 and is mandatory and binding on the banks and it prescribes the measures required to be adopted by the banks and FIs in identifying and reporting the instances of willful default. It further stipulates that the decision to identify a borrower as wilful defaulter should be entrusted to a committee of higher functionaries of the bank/FI concerned headed by the Executive Director or equivalent and consisting of two GMs/DGMs as decided by the Board of the Bank/FI. Further, the decision taken on classification of the willful defaulters should be well documented and supported by requisite evidence and should clearly spell out the reasons for which the borrower has been declared as willful defaulter in terms of the guidelines issued by the Bank. The bank/FI is also required to advise the borrower concerned about the proposal to classify him as wilful defaulter along with the reasons there-for. The bank/FI is also required to provide a reasonable time to the borrower for making their submissions followed by a personal hearing, if deemed necessary. The order of the Committee shall be reviewed by another committee headed by the Chairman and Managing Director or Managing Directors/ CEO of the bank/FI concerned along with two independent/non executive directors of the bank/FI and the order identifying a borrower as `Willful Defaulter’ shall attain finality only after confirmation from the review Committee.
The underlying intent is to put a completely transparent mechanism in place for the entire process so that the provisions of the Master Circular are not misused and the scope of the discretionary powers conferred upon the banks and FIs are kept to the barest minimum. The Master Circular also requires the banks and FIs to ensure that identification of the willful default should be made keeping in view the track record of the borrowers and should not be decided on the basis of isolated transactions / incidents for imposing any penalty on the willful defaulters. The default to be categorized as willful must be intentional, deliberate and calculated.
The Master Circular dated 01.07.2015 on Willful Defaulters issued by the RBI lays down the various parameters for adjudging a borrower as a `Willful Defaulter’ which broadly cover deliberate non-payment of the dues despite adequate cash flow and good net worth; Siphoning off funds to the detriment of the defaulting unit, Assets financed by the lenders either not purchased or been sold and proceeds mis utilized; Misrepresentation/Falsification of records; Disposal/removal of securities without bank’s knowledge; Fraudulent transactions by the borrower.
The tag of a `Willful Defaulter has serious consequences which include bar on extension of any additional credit facilities by any bank / FI; such companies (including their entrepreneurs/promoters) shall be debarred from institutional finance from the scheduled commercial banks, Financial Institutions, NBFCs, for floating new ventures for a period of 5 years from the date of removal of their name from the list of willful defaulters as published/disseminated by RBI/CICs; Expeditiously initiation of legal proceedings against the borrowers / guarantors, including initiation of criminal proceedings against willful defaulters, wherever necessary; it may also lead to initiation of a change in management; removal of a `willful defaulter’ from the Board of a Company.
In terms of Section 128 of the Indian Contract Act, 1872, the liability of the surety is co-extensive with that of the principal debtor unless it is otherwise provided by the contract. Therefore, in cases where guarantees furnished by the Group companies on behalf of the defaulting units are not honored, when invoked, such Group companies will also be reckoned as willful defaulters.
Similar treatment shall be accorded to non group and individual guarantors who refuse to comply with the demand made by the creditor / banker, despite having sufficient means to make payment of the dues. This treatment of non-group corporate and individual guarantors was made applicable with effect from September 9, 2014 and not to cases where guarantees were taken prior to this date.
The ramifications of a person being labelled as a willful defaulter are draconian. Such declaration sounds the commercial death knell of the borrower in the sense that credit facilities would no longer be available to such borrower. Not only would such a borrower be deprived of credit facilities from banks and financial institutions but is likely to be also deprived of credit from any other person with whom it may be having financial / commercial dealings. The suppliers of goods and raw materials to such borrowers would stop supplying goods and raw materials on credit and would insist upon delivery against payment. Not only so, such declaration as a willful defaulter, which is put in public domain, is also injurious to commercial goodwill and reputation of the borrower, likely to make anyone weary of dealing with the borrower. All this is likely to lead to cessation of the business of such a borrower.
The circular confers rampant and unfettered power upon the banks to decide the future of any borrower and makes the bank a judge in its own cause and also the decision whether the other banks should lend money to the borrower declared as a willful defaulter which is strictly against the principle of natural justice that no one can judge a case in which they have an interest.
Section 21 of BRA, 1949 empowers the RBI to make and determine the policy in relation to the advances and section 21(2) specifies the scope of such policy. There is no specified scope which empowers the RBI to make policy in relation to the borrowers and their conduct which otherwise can be taken care of under the provisions of various statutes or Acts involving civil as well as criminal liability which can be resorted to by the Banks and FIs.
Similarly, Section 35A of the Banking Regulation Act empowers the Reserve Bank of India to make policy so as to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company; or to secure the proper management of any banking company. Therefore, to prescribe a particular conduct by a borrower as a “willful default”, to impose the penalty for such a “willful default” and to prescribe a procedure for adjudication of the lis regarding the “willful default” are beyond the scope and ambit of Section 35(A) of the Banking Regulation Act, 1949.The willful default, if any of the borrowers of a bank or FI is the outcome of the conduct of the borrower and the RBI is not empowered to make guidelines in relation to the conduct of the borrower.
That none of the provisions of the Reserve Bank of India Act or the Banking Regulation Act, 1949 confers any power upon the Reserve Bank of India to impose any penalty relating to a particular conduct of a borrower.
The circular has the effect of almost blacklisting the borrowers from obtaining any new loan from any other bank or financial institution and it attaches a social stigma on the Directors who may not be concerned in any manner as regards the day-to-day affairs and management of the company.
It does not differentiate between the promoter Directors and the other set of Directors such as Independent Director, Nominee Directors etc which fact has also been observed by the Hon’ble Gujarat High Court in the case of IONIC METALLIKS Versus UNION OF INDIA, wherein the court has observed that restrictions of all such directors is a violation of their constitutional right to do business as such they cannot be restricted to avail bank finances for their new ventures.
The provisions of the circular violate the doctrine of “due process” and the concept of a “just, fair and reasonable law”. The Circular pre-supposes a default, without the same having been adjudicated in accordance with law before a competent judicial forum. The circular intends to delegate the function of making a judicial inquiry to a non-judicial authority like a private bank or even a nationalized bank and arrive at a conclusion regarding the conduct of a borrower to be identified as a “wilful defaulter”.
Although it is a settled principle that the liability of a guarantor is co-extensive of the principal debtor and that the banker can proceed against the guarantor/surety in the case of a default by the principal debtor even without exhausting the remedies against latter however, categorization of the guarantors as `Willful Defaulters’ along with the principal debtor is not judicious.
The daily affairs and banking transactions of the principal debtors are done at the back of the guarantor whereas the Banks are a party to those transactions and every transaction relating to the business of the borrower is known to the banks who can easily verify the end use of the funds. Further, willful act of the borrower in committing a default prima facie contains an element of criminality which may include fraud perpetrated by the borrower and/or in connivance with or with the knowledge of the lenders’ officers. The Hon’ble Supreme Court and High Courts of India have unambiguously held in catena of judgments that the guarantors, under the contract of guarantee are bound to pay the guaranteed amount immediately upon invocation of the agreement of Guarantee by the beneficiaries/lenders, however, there are two exceptions to this rule – the first is when there is a clear fraud of which the Bank has notice and a fraud of the beneficiary from which it seeks to benefit. The second exception to the general rule of non-intervention is when there are `special equities’ in favor of injunction, such as when `irretrievable injury’ or `irretrievable injustice’ would occur if such an injunction were not granted. Therefore, whenever a willful default is committed by the borrower, the criminal act of fraud has to be first investigated and adjudicated which can only be done by a judicial forum and not by the banks or other lenders, and the decision to categorize the guarantor as a `wilful defaulter’ should be based on the outcome of the adjudication. As such cataloging the Guarantors with the tag of ‘Willful Defaulter’ along with the principal debtor, would entail gross injustice and irretrievable injury to the guarantors. Further, the classification of Guarantors as `Willful Defaulters’ is not in sync with the underlying spirit of the circular that identification of the willful default should be made keeping in view the track record of the borrower and should not be decided on the basis of isolated transactions/incidents. The Banks/FIs have no mechanism in place to ascertain the track record of a guarantor.
Therefore, the provisions of declaration of guarantors as Willful Defaulters provided in the RBI Circular on Willful Default are unjust and require reconsideration.
Although the Hon’ble courts have dealt with the various legal issues discussed above and also upheld the constitutional validity of the RBIs circular however, it still appears that the provisions of the circular are relatively harsh on the genuine borrowers who have defaulted in meeting their obligations due to external exigencies and circumstances beyond their control. Putting the entire brunt on the borrower and that too by a non judicial body which itself a privy to all the financial transactions of the defaulting borrower is something which needs to be thought about as it leaves very little room for a non biased process. The Banks must take a more pragmatic approach in strengthening their recovery processes to be able to bring the money back into the system and even more than this the need of the hour is concentrate more on strengthening their in-house capabilities for an effective credit appraisal system and subsequent more efficient monitoring capabilities which should be able to raise a red flag upon observing signs of delinquency in any borrower account and as such the problem may be addressed at the nascent stage without waiting for it to assume huge proportions.
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