As of December 2020, total wilful defaults amounted to INR 2,44,602 crores from 12,917 accounts. This number has grown even bigger in the year 2021. Many of these accounts includes defaulters like Gitanjali Gems, ABG Shipyard, Ruchi Soya Industries Limited, Nakshatra Brands Limited and Coastal Projects Limited, among others. This increasing tally of bad loans amply indicates that this has a significant impact on the growth of India’s financial system and lack of credit availability in the market. However, it also indicates that the banking and finance sector is mindful of the regulatory and legal recourses available to them to timely identify such problematic accounts and have them subjected to the tough and stringent action, including actions meant not only to deter future wilful defaults but also to prevent access of further finance to such defaulters.
The Circular dated 1-7-2013 titled as Master Circular on Wilful Defaulters (RBI Circular, 2013), issued by Reserve Bank of India (RBI) has assumed much significance in this regard. By way of this circular, RBI has sought to put in place a system whereby banks and financial institutions (FIs) attempt to lower the number of wilful defaults by the borrowers and penalise them for defaulting by disseminating the credit information among other banks and FIs to caution them and ensure that further bank finance is denied to the borrowers who have been declared to be a“wilful defaulter”.
In 2015, RBI sought to strengthen the RBI Circular, 2013 by issuing Master Circular of 1-7-2015 (Master Circular, 2015). By way of the Master Circular, 2015, RBI widened the scope and extended the definition of the term “lender” to include all banks and financial institutions to whom any amount is due under a banking transaction. It also clarified that a banking transaction would also include transaction not on the balance sheet such as derivatives, guarantees and letters of credit.This resulted in defaults with respect to such transactions being considered as wilful default and widened the scope thereof.
Master Circular, 2015: Scope
The Master Circular, 2015 defines “wilful defaulter” to mean any “unit” which defaults in meeting payment/repayment obligations to the “lender”, (i)even when it has capacity to honour it; or (ii) has diverted the funds of the lender to things other than for which he has taken up such finance; or (iii) has siphoned off the funds such that the funds are neither utilised for the purpose it was taken for nor it is available in the form of other assets with the unit; or (iv) has disposed of or removed the movable fixed assets or immovable property pledged for securing the loan without the knowledge of the lender.
By defining who can be a “wilful defaulter”, Master Circular, 2015 has delineated the incidents which would amount to a “wilful default”. It further defines the term “unit” to include individuals, juristic persons, and all other forms of business enterprises, whether incorporated or not, and such other persons who have the responsibility of managing the affairs of a business enterprise. This wide definition of “unit” has also enlarged the applicability of the Master Circular, 2015, as detailed below.
Liability of Directors: Defaults by company
From the definition of “unit”, it is evident that a wilful defaulter includes a company and the individuals who are in charge and responsible for managing the affairs of the company which is said to have wilfully defaulted. The Master Circular, 2015 mandates reporting of the names of such individuals, which typically include the promoters and whole-time directors.It further provides that, except in very rare cases, a non-whole-time director should not be considered as a wilful defaulter. It is only when it is conclusively established that such a non-whole-time director 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 or if the wilful default had taken place with his consent or connivance, can such a director be held liable.However, such exception is not applicable in case of a promoter director, even if he or she is not a whole-time director.
Under the Master Circular, 2015, in cases where a company is declared to be a wilful defaulter, there is an automatic presumption that the promoter/whole-time director who is in control of such a company, at the relevant time, is also liable to be declared a wilful defaulter.
However, such presumption is limited to only such promoters/whole-time directors who were/are associated with the company within a period of 90 days prior to the time the company account was classified as non-performing asset. It is because of the reason that the classification of an account as non-performing asset is made after the required repayments in the loan account remain overdue for a continuous period of 90 days. Thus, identifying such officials who were associated with the company at the time when the company committed acts that led to the default is necessary as these officials are responsible for such omissions or commissions of the company.
Procedure for declaring “wilful defaulter”
The Master Circular, 2015 provides a detailed procedure for the banks and FIs to undertake while identifying and reporting instances of wilful defaults. The broad steps under the Master Circular, 2015 are as under:
- Step I: A three-member committee comprising of two senior officers of the rank of General Manager/Deputy General Manager, headed by an Executive Director or equivalent (First Committee/Identification Committee/Screening Committee) is to examine the evidence of wilful default on the part of the borrowing company and its promoter/whole-time director at the relevant time.
- Step 2: If, the First Committee concludes that an event of wilful default has occurred, it shall issue a show-cause notice to the borrower concerned and/or the promoter/whole-time director and call for their submissions/representations as to why they should not be declared a “wilful defaulter”. After considering their submissions, the First Committee may issue an order recording or rejecting the fact of wilful default and the reasons for the same.
An opportunity may be given to the borrower and/or the promoter/whole-time director for a personal hearing if the First Committee feels such an opportunity is necessary. However, such opportunity does not confer a right to the borrower and the promoter/whole-time director to be represented by a lawyer before the First Committee as it is not judicial but an in-house proceeding.
- Step 3: The order of the First Committee, in case wilful default is recorded, should be reviewed by a Second Committee headed by the Chairman/Chairman & Managing Director or the Managing Director & Chief Executive Officer/CEOs and consisting, in addition, two independent directors/non-executive directors of the bank (Review Committee).The order passed by the First Committee shall become final only after it is confirmed by the said Review Committee.
Additional checks and balances to prevent arbitrary exercise of powers
While the aforesaid procedure is robust, one could argue it had scope for abuse. The Supreme Courtconsidering the severe implications of such a declaration, has added some additional checks and balances to further bolster the fairness of this process. The Supreme Court has incorporated following in this regard:
- the First Committee must supply a copy of its order to the borrower as soon as it is made;
- the borrower must be given an opportunity to represent against such an order of the First Committee within a period of 15 days to the Review Committee;
- the Review Committee, at the time of passing its reasoned order, must take into consideration the representation made by the borrower/its director(s); and
- once the aforesaid procedure is properly followed, the order of the Review Committee must be communicated to the borrower and its director(s).
The aforesaid procedure laid down by the RBI in the Master Circular, 2015, and later supplemented by the Supreme Court, ensures that the principles of natural justice are not violated while making declaration of “wilful default”. It ensures that prior to any borrower being classified as a wilful defaulter, adequate opportunity is provided to such borrower to make representations against such declaration before the Review Committee, comprising of high-ranking officials of the Bank.
Challenges by borrowers to declaration of “wilful defaulter”
Since, declaration of a wilful defaulter has far-reaching civil and criminal consequences,it is only natural that there is substantial litigation surrounding it. In the absence of grievance redressal mechanism under the Master Circular, 2015, invocation of writ jurisdiction of a High Court is the only option available for an aggrieved person. The common grounds of challenge in such petitions are usually as below:
Challenge at the stage of issuance of show-cause notice
- The constitution of the First Committee issuing the show-cause notice is not in knowledge of the person declared as “wilful defaulter”, or that the First Committee is not formed as per the terms of the Master Circular, 2015.
- The show-cause notice is not signed or issued by all the members of the First Committee.
- The First Committee did not apply its mind to the case, and instead delegated the work to another agency instead of forming its own opinion by conducting its own independent enquiry.
- The proposal classifying a person as wilful defaulter is not substantiated with documents constituting event of “wilful default”.
Challenge to the decision of the First Committee/Review Committee
- The First Committee/Review Committee premeditated and concluded that the events of default have been committed by the defaulter.
- The precise facts to conclude that an event of wilful default has occurred is not provided and/or that the relevant documents have not been supplied to the borrower, therefore, there is a violation of principles of natural justice.
- The opportunity to represent before the First Committee/Review Committee is not provided or the representations/submissions of the alleged defaulter is not considered by the First Committee/Review Committee while passing an order of wilful default Therefore, such an order is not a reasoned order.
- Review Committee did not apply its own mind while assessing the correctness of the opinion of the Identification Committee.
- The order of the First Committee declaring the borrower a “wilful defaulter” is not supplied to the borrower.
- The director cannot be made liable without classifying the company as wilful defaulter.
- The Director was not a person associated with the company in default during the relevant period.
- That the moratorium under Insolvency and Bankruptcy Code, 2016 is imposed on the debts and defaults of the company; or that the company stands absolved of the debt.
With increasing challenges to the declaration of “wilful default”, the judicial position on these aspects is further developing day by day. For instance, in most of these cases involving challenge to the show-cause notice, courts have adopted a uniform approach to reject such challenge on the preliminary ground of it being premature as no actions has yet been taken making the borrower aggrieved.
Earlier the position of law, however, was not uniform across various High Courts in this regard. For instance, the Calcutta High Court in Atlantic Projects Ltd. v. Allahabad Bankhad held that Master Circular, 2015 does not envisage that the First Committee can even delegate the ministerial task of issuance of show-cause notice to a subordinate, on the ground that the Master Circular, 2015 requires it to apply its own mind to even the task of issuance of show-cause notice. On the other hand, the Delhi High Court in Sanjay Singal v. SBIand the Division Bench of the Calcutta High Court in Union Bank of India v. Sudhir Kumar Patodiahad set aside similar challenge and held that it is the First Committee which examined the conduct of the borrower and the utilisation of credit facilities before proposing classification of the account as wilful default, and it was only the mere act of communicating such proposal vide issuance of show-cause notice which has been delegated.
It can therefore be said that the law on this subject is still in a nascent stage and/or remains an enigma for both the lenders and the borrowers as all the possible issues and disputes arising out of the Master Circular, 2015 are yet to be conclusively addressed or settled. However, there is no doubt that, in the current economic scenario, the Master Circular, 2015 remains an important ammunition in the lender’s arsenal, provided the procedure envisaged thereunder is followed in letter and spirits.
*Partner, Cyril Amarchand Mangaldas and “Top Individual Lawyer”, Forbes Legal Powerlist 2021.
**Principal Associate Designate, Cyril Amarchand Mangaldas.
***Senior Associate, Cyril Amarchand Mangaldas.
 George Mathew and Khushboo Narayan, Amid Covid Effect, Bank Steps, Wilful Defaults Rise Rs 38,976 crores, Indian Express, 11-5-2021, available at https://indianexpress.com/article/business/amid-covid-effect-bank-steps-wilful-defaults-rise-rs-38976-crore-7309969/.
 Nachiket Kelkar, 2,426 Wilful Defaulters Owe Rs 1.47 Lakh Crores to State-owned Banks, Reveals Bank Union, The Week, 18-7-2020, available at <https://www.theweek.in/news/biz-tech/2020/07/18/2426-wilful-defaulters-owe-rs-147-lakh-crore-to-state-owned-banks-reveals-bank-union.html>.
Rise by over INR 38,976 Crores from the Default as of December 2019. See George Mathew and Khushboo Narayan, Amid Covid Effect, Bank Steps, Wilful Defaults Rise Rs 38,976 Crores, Indian Express, 11-5-2021, available at https://indianexpress.com/article/business/amid-covid-effect-bank-steps-wilful-defaults-rise-rs-38976-crore-7309969/.
- A borrower who is a wilful defaulter can otherwise go to different banks or financial institution and obtain loans. Past conduct of wilful default by way of diversion and siphoning off funds, etc. is always a relevant consideration for deciding whether or not additional funds/facilities should be granted. Past conduct as a wilful defaulter should be in the knowledge of bank/financial institutions advancing the money. The Master Circular obviously has a laudatory purpose behind it and cannot be rejected.
Guidelines on Wilful Defaulters— Clarification regarding Guarantor, Lender and Unit, accessed at <http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=9224&Mode=0>.
Master Circular, 2015, Para 2.1.3(a).
 Master Circular, 2015, Para 2.1.3(b).
Master Circular, 2015, Para 2.1.3(c).
Master Circular, 2015, Para 2.1.3(d).
Master Circular, 2015, Regn. 3.
Master Circular, 2015, Regn. 3(d).
Master Circular, 2015, Regn. 3(a).
Master Circular, 2015, Regn. 3(b).
 It may be noted that the First Committee and the Review Committee are constituted with different officials to ensure a process of impartiality and objectivity to the final decision of the Bank.
- 24. … given the fact that Para3 of the Master Circular dated 1-7-2013 permitted the borrower to make a representation within 15 days of the preliminary decision of the First Committee, we are of the view that first and foremost, the Committee comprising of the Executive Director and two other senior officials, being the First Committee, after following Para3(b) of the Revised Circular dated 1-7-2015, must give its order to the borrower as soon as it is made….Given the fact that the earlier Master Circular dated 1-7-2013 itself considered such steps to be reasonable, we incorporate all these steps into the Revised Circular dated 1-7-2015.
See also, Sudarshan Overseas Ltd. v. RBI, 2009 SCC OnLine Del 1656 : (2009) 160 DLT 77. In this case, challenge was made to Master Circular dated 2-7-2007 on wilful defaulters. The Delhi High Court held that the circular lays guidelines for banks and FIs, which they have to necessarily adhere to, and enough safeguards are provided for the protection of the borrowers, and in case of violations, complaints can be made as the action to declare borrower as wilful defaulter is an internal action of the bank and such declaration can only be made after hearing the representation and giving right to hearing. Thus, the circular was held to have enough safeguards as to differentiate between wilful defaulter and genuine borrowers.
 The consequences of being declared a wilful defaulter includes:
- no additional facilities to be granted by any bank/financial institution [Master Circular, 2015, Para 2.5(a)];
- entrepreneurs/promoters would be barred from institutional finance for a period of 5 years [Master Circular, 2015, Para 2.5(a)];
- any legal proceedings can be initiated, including criminal complaints [Master Circular, 2015, Para 2.5(a)];
- banks and financial institutions to adopt proactive approach in changing the management of the wilful defaulter [Master Circular, 2015, Para 2.5(c)];
- promoter/Director of wilful defaulter shall not be inducted by another borrowing company [Master Circular, 2015, Para 2.5(d)]; and
- as per 29-A of the Insolvency and Bankruptcy Code, 2016, a wilful defaulter cannot be a resolution applicant.