Banks And Financial Institutions Should Pass Reasoned Orders While Declaring Entity/Person Wilful Defaulter: Bombay High Court

The Bombay High Court has emphasized that the banks and financial institutions must provide reasoned orders before labeling an individual or entity as a wilful defaulter under the Reserve Bank of India's Master Circular.

The Court observed that being branded as a wilful defaulter bars one from accessing the financial sector. Consequently, the discretion granted to banks by the circular must be wielded judiciously, in line with the RBI's directives.

In a ruling dated March 4, a division bench comprising Justices B P Colabawalla and Somasekhar Sundaresan underscored, “Banks and financial institutions that seek to invoke the Master Circular to declare occurrence of wilful default, must share the reasoned orders passed by its Identification Committee and Review Committee.”

The Court was hearing a petition lodged by Milind Patel, former joint managing director of IL&FS Financial Services Limited (IFIN), contesting an order issued by the Union Bank of India in February 2023, which pronounced the firm and its promoters as wilful defaulters under the 2015 Master Circular issued by the RBI.

As per the RBI's circular, banks and financial institutions are mandated to furnish data on wilful defaulters quarterly, a requirement also communicated to the Securities and Exchange Board of India (SEBI).

As per the plea, in July 2022, the Union Bank issued a show cause notice to IFIN and Patel, indicating that it had preliminarily concluded that they should be designated as wilful defaulters.

Subsequently, in February 2023, the bank's review committee issued an order officially designating the firm and its promoters as wilful defaulters.

In February 2023, the bank's review committee issued a decree designating the firm and its promoters as wilful defaulters.

According to the high court, once a final order of declaring an entity or firm as wilful defaulter is passed, numerous severe penalties ensue.

The High Court stated, “In a nutshell, the wilful defaulters are ostracised from access to the financial sector. No additional facilities can be granted to such a person by any bank or financial institution. Bodies corporate declared to be wilful defaulters, and their promoters and directors, would be debarred from access to institutional finance from scheduled commercial banks, financial institutions and non-banking financial companies for a period of five years after the date on which their names are eventually removed from the list of wilful defaulters.”

“So also, wherever warranted, civil recovery proceedings and criminal proceedings are to be initiated against such persons. We are not setting out other implications under other legislations that fasten on to wilful defaulters once such a declaration is made, and are restricting ourselves to the consequences set out in the Master Circular,” the high court added.

The high court noted that the RBI's circular also requires banks to assess evidence of wilful default.

The Court further noted, “The discretion conferred on these commercial banking entities to inflict penal consequences was meant to be kept to the bare minimum, which only underlines that the exercise of discretion has to be reasonable and not arbitrary. The absence of transparency with the reasons would render the exercise of discretion to be arbitrary. In this light, various petitions have been dealt with by writ courts including the Hon'ble Supreme Court of India and multiple benches of this very High Court, in connection with declaration of borrowers as wilful defaulters. However, for purposes of these proceedings, and in the interest of brevity, we highlight just a few of them.”

The high court emphasized that it is not only necessary to provide information that is referenced and relied upon in the Show Cause Notice (SCN), but also information that could potentially discredit the allegations mentioned in the SCN. This is essential to ensure that all pertinent information required to ascertain the truth is available to both parties involved.

Furthermore, the court clarified that the purpose of the proceedings initiated through the issuance of an SCN is not solely to establish the guilt of the noticee based on the allegations presented. Rather, the objective is to uncover the truth regarding whether or not an individual should face "penal" consequences, as described by the RBI.

In line with this, the Court added that if a bank has conducted a forensic investigation into suspected diversion and misappropriation of funds, and if the investigation reveals specific roles played by certain individuals, there could be instances where the investigation indicates that certain individuals may not have been involved in the diversion and misappropriation. In such cases, the information supporting this plausible inference would undermine the allegations made.

“Therefore, fair and transparent symmetrical access to information, as stipulated by the Hon'ble Supreme Court in Takano would mean providing access to not only incriminating material but also exculpatory material, since all such information would be relevant for arriving at the truth. Therefore, access to the record is a vital element of complying with principles of natural justice,” the Court said.

The Union Bank ultimately relented on its previous directives against Patel. Following the Court's decision, the bank was granted the freedom to initiate new proceedings starting from the issuance of a show cause notice, ensuring Patel's access to pertinent material.

Assuring the Court, the bank pledged to provide Patel with complete access to all relevant documents on record. The Court duly noted this commitment in its judgment before concluding the petition.

Case Title: Milind Patel v. Union Bank of India & Ors.