Wilful Defaulters: A Further Analysis

[The following post is contributed
by Prachi Narayan of Vinod Kothari
& Company. She can be contacted at prachi@vinodkothari.com.
A previous
post
on the topic discusses SEBI’s recent proposal towards “wilful
defaulters”. This guest post discusses in detail the current regime imposed by
the RBI and also comments briefly on the SEBI proposal as well as relevant case
law on the topic]
The multifarious attempts of the
Reserve Bank of India (RBI) in dealing with wilful defaulters gets further weight
by the Securities and Exchange Board of India (SEBI) proposing to completely
bar such “freeloaders” from tapping
financial markets . 
The RBI has already put in place
plethora of norms, be it with regard to the recovery process or the categorisation
of borrowers as non-cooperative or wilful. SEBI’s move to further ostracize
wilful defaulters makes it clear that the intent is to choke all sources of
funds, close all avenues that may be available and send such defaulters on a
financial exile forever.
This post is an attempt to analyse
the requirement of such stringent norms for recovery of loans and whether
barring such freeloaders from financial markets will help decrease the levels
of non-performing assets (NPAs) in the economy.
RBI Guidelines on Wilful Defaulters
The updated RBI
guidelines of January 7, 2015
(Revised
Guidelines
) now define “wilful default” as the occurrence of any
of the following events:
a.         The
unit has defaulted in meeting its payment / repayment obligations to the lender
even when it has the capacity to honour the said obligations or when the unit
has not utilised the finance for for the specific purposes for which finance
was availed of but has diverted the funds for other purposes.
b.         The
unit 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. It is pertinent to note
here that under the Revised Guidelines transfer of borrowed funds to
subsidiaries /group companies or other body corporates by any modality now
falls within the meaning of siphoning off funds.
c.         The
unit has disposed off or removed the movable fixed assets or immovable property
given by him or it for the purpose of securing a term loan without the
knowledge of the bank/lender.
The penal measures as laid down in
the updated guidelines of the RBI include (i) complete blockage of additional
facilities and debarment of promoter /directors of companies classified
as  wilful defaulters; (ii)  foreclosure
and recovery of dues processes and against wilful defaulters; (iii) change of
management of the wilfully defaulting borrower unit; (iv) non induction on corporate
boards of persons whose names appear in the wilful defaulter list; (v) sharing
the list of wilful defaulter with SEBI to prevent access from capital markets;
(vi) criminal proceedings for cheating, dishonest misappropriation of property,
and criminal breach of trust against wilful defaulters.
Further, the RBI in its Revised
Guidelines has devised an internal process for identification of wilful
defaulters. The identification shall be done on the following basis:
a.  A committee comprising of executive director
and two other senior officers of the rank of GM/DGM, shall examine the
occurrence of wilful default on the part of the borrowing company and its
promoter/whole-time director.
b.  The committee shall issue a show cause notice
to the concerned borrower and the promoter/whole-time director calling for
their submissions and if deem necessary by the committee an opportunity of
personal hearing to the promoter/whole-time director.
c.  After considering the submissions, the
Committee shall issue an order recording the fact of wilful default and the
reasons for the same.
d.  The order of the committee shall be further
reviewed by another committee (Review Committee) headed by the Chairman / CEO
and MD and two independent directors of the bank and the order shall become
final only after it is confirmed by the said Review Committee.
d.  Declaration of a non-promoter/non-whole time
director shall be subject to provisions section 2(60) of the Companies Act,
2013. Therefore, except 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 and that such a
default had taken place with his consent or connivance.
On perusal of the above it seems
that the Revised Guidelines all set to make life of corporates difficult as
companies transferring borrowed funds to its subsidiaries and group companies
will be termed as “siphoning of funds”. It is such an irony that the subsidiary
which in essence looks up to its holding for its business and funds will now
not be able to access them unless they borrow themselves. What if the said
subsidiary is a start-up which largely has to count on its holding company for
source of funding. Surely the intent of such an inclusion could not be to
monitor the end uses of borrowed funds – as the Companies Act, 2013 adequately
takes care of it by envisaging various disclosures under its purview to monitor
movement of funds from holding company to its subsidiaries.
The next blow of the Revised Guidelines
comes by way of debarment of promoters and directors declared as wilful
defaulters to corporate boards. It seems that in eyes of the regulators, the
penal measures as already provided were not enough, that RBI thought fit to
include such a restriction. Assuming a situation where the banks enforce all
the penal measures including criminal proceedings as provided by the guidelines
and the wilful defaulter accordingly completes his term of punishments prescribed.
But what after that? Will he be still presumed to be a freeloader, barred and
restricted from all financial means? Are the regulators trying to envisage an
exile for a life time, irrespective of the fact already much damages, in terms
of civil as well as criminal prosecution has been faced by the defaulter? If the
intent was to lay down a punishment even higher than what criminal law
prescribes, it would have been better traditional courts under criminal
jurisprudence were empowered to adjudicate and declare a defaulter as wilful
defaulter rather than a public authority being empowered to take a decision on
identifying and categorising a defaulter as such. However, the Revised
Guidelines do provide that independent directors and non executive directors unless
connivance proved shall not be deemed to be wilful defaulters under the
guidelines.
Further, with respect to the
internal identification process, the Revised Guidelines provide that the
Committee, if it deems fit, shall provide the defaulter with an opportunity of
hearing. It is pertinent to note here that this is very much against the
principles of natural justice. The essence of any jurisprudence is that the
accused should always be provided with an opportunity of hearing to put forth
his case. A mere show cause notice can never serve as substitute for personal
hearing. The Revised Guidelines first seem to make the bank a judge of its own
cause, second do not provide the defaulter with a mandatory hearing opportunity
and then finally declare a defaulter as wilful defaulter for life. Such a life
time punishment without adjudication is not only arbitrary but also against
moral principles.
SEBI’s take on Wilful Defaulters
While RBI was not enough, SEBI also
seems to have joined the crusade against wilful defaulters. SEBI on January 7,
2015 to tighten noose on wilful defaulters proposed to debar a wilful defaulter
from completely accessing equity and debt markets. SEBI’s discussion paper says
wilful defaulters cannot sell shares, debt securities and non-convertible
instruments to the public. Such companies can, however, raise funds through a
rights issue or private placement to qualified institutional investors but with
full disclosure. The paper also provides that wilful defaulters cannot take
control of another listed entity, however, they be allowed to participate in
counter offers in case of hostile bids for taking control of a firm.
While SEBI in its discussion paper
admits that such a restriction is not very healthy for company’s shareholders’as
this may negatively impact the operations of the company thereby negatively
impacting its share price. Such a measure may not be in the interest of the
shareholders of listed company. Theoretically, it’s the shareholders who should
infuse funds if the company is in trouble. Shutting down finance even from its
own shareholders is unreasonable and irrational.
Some recent rulings
In case of Ionic Metalliks v. Union of India,[1]
the Gujarat High Court of Gujarat opined that RBI Master Circular relating to
‘Wilful defaulters’ is ultra vires and
violative of Article 19 of  Constitution
in so far as made applicable to all directors of company. All directors cannot
be held liable for the default in repayment of the loan which might be for
reasons beyond the control of such directors. This provision in the circular
shatters the concept of a company being a separate legal identity distinct from
its directors. The circular paints all directors with the same brush. An
element of arbitrariness is found in such policy decision. To this limited
extent the court held that the Master Circular is violative of Article 19(1)(g)
of the Constitution of India.
In Kotak Mahindra Bank Ltd. v.Hindustan National Glass & Ind. Ltd,[2]
the Bombay High Court held Master Circular covered default by a party in
complying with the payment obligations under derivative transactions and
observed that it will be open to the Grievance Redressal Committee to pass
fresh orders in accordance with law after complying with the principles of
natural justice.
Recently, the Calcutta High Court
observed that the banks identification committee on wilful defaulters was
comprised of four members, which was one more than prescribed in regulation
3(i) of the master circular on wilful defaulters.
Conclusion
All the above cases, in one way or
the other have upheld the principles of natural justice. The principles of natural
justice are two fold; (1) audi alteram
partem
, i.e, a right of being heard
(2) nemo judex in causa sua, i.e, no
one should be the judge of its own cause.
Even the Revised Guidelines confers
unbridled power on committee identifying borrowers as wilful defaulter, to give
an opportunity of personal hearings only in cases which the committee deems
necessary, while principles of natural justice illustrate a hearing opportunity
in all cases.
The approach to `wilful default’
involves a bank (which is not a judicial or a quasi judicial authority) to
determine that a default is `wilful’. Once done, the subordinated legislation
forces all banks to proceed with penal measures. But what about the formal
processes of adjudication and judicial review? The Revised Guidelines tries to
bestow untrammeled powers of judicial review on the banks that surely lack
judicial skills of adjudication. RBI’s regulation gives banks the ability to
wield their coercive power of the judiciary, without adequate checks and
balances.
Debt in essence is a contract, and
debt default is a violation of the contractual obligations as agreed between
the parties. Even in such situations of debt default, whether the intent of the
person who violates a contract is wilful or not is something which is
impossible to assess. This further is irrelevant for the purpose of contractual
enforcement as what matters in such cases is that violation has taken place.
For such cases of violation there can maximum be a reasonable prohibition on
the right of a person to contract but surely not a banishment for life. It is
agreed that there may be cases where a borrower 
wilfully defaults and stonewalls the efforts of a lender to recover
funds, but there also has to prevail a sense in empowering financial
institutions with power of adjudication when penal measures sought to be
imposed are of a lifetime magnitude.
The Revised Guidelines seems to
confer uncanalised and unfettered power upon the banks to decide the future of
any borrower and to further decide whether the other banks should lend money to
such a borrower. It does not end here: borrowers are  now left to the mercy of the banks that would
further decide whether such borrower should have access to capital markets or
not. Once a wilful defaulter will always be a wilful defaulter and there is
exile from financial markets for lifetime. This is not only strangulating such
defaulters but also vindictive of the rights of wilful defaulters to practice
any profession, or occupation or to trade and do business which otherwise is
guaranteed by Article 19 of the Constitution.
Prachi Narayan



[1] 2014] 49 taxmann.com 222 (Gujarat)/[2014] 128 SCL 316 (Gujarat)
[2] http://judis.nic.in/supremecourt/imgs1.aspx?filename=39808

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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