All You Want To Know About Law On Willful Defaulters

The RBI, on 1.07.2015 (Revised) issued a Master Circular which consolidated instructions on how all the commercial banks and notified financial institutions are to deal with willful defaulters. The circular provides cut off limits, the mechanism for identification of willful defaulters, diversion and siphoning of funds, penal measures, etc.

• CONCEPT OF WILLFUL DEFAULTER

When a "unit", fails to repay the loaned amount, it is termed as a defaulter. When this defaulter siphons off/diverse away the funds or tries to dispose of/remove the loaned security or doesn't pay the loaned amount back despite its ability to repay it, the unit is termed as a willful defaulter.

The Reserve Bank of India has list down the following four events, the occurrence of which would result in willful default:

1. The unit has defaulted in meeting its payment/repayment obligations to the lender even when it has the capacity to honor the said obligations.
2. The unit has defaulted in meeting its payment/repayment obligations to the lender and has not utilized the finance from the lender for the specific purposes for which finance was availed of but has diverted the funds for other purposes.
3. The unit has defaulted in meeting its payment/repayment obligations to the lender and has siphoned off the funds so that the funds have not been utilized for the specific purpose for which finance was availed of, nor are the funds available with the unit in the form of other assets.
4. The unit has defaulted in meeting its payment/repayment obligations to the lender and has also disposed off or removed the movable fixed assets or immovable property given for the purpose of securing a term loan without the knowledge of the bank/lender.[i]

It is important to understand the meaning of the terms "diversion and siphoning of funds" before moving ahead with the mechanism for the identification of wilful defaulters.

• SIPHONING OFF FUNDS

'Siphon off funds' is draining off of money from business without having legitimate authority. Conversely, if the transfer of funds is duly recorded in the books of accounts with legitimate narration and that narration is a rightful explanation which is not found to be fabricated or untruthful then no court of law shall hold such legitimate transfer of money as illicit siphoning of funds. [ii]

The siphoning off funds refers to a situation wherein a "unit" fails to meet its payment/repayment commitments to the lender bank or utilizes the funds for a purpose different from what it was supposed to use it for. Furthermore, the unit fails to show that the financed funds are available in any other form of assets with the unit.

The Calcutta High Court in the case of Indranil Mukherjee. v. Jayeeta Mukherjee (Nee Bhattacherjee) & Ors.[iii] passed an injunction order and thereby restrained the defendants from withdrawing and/or siphoning any amount of money lying in the various deposits of different descriptions either in the joint name of the plaintiff and his wife or from withdrawing any money lying in the fixed deposit or savings bank account in the name of the defendant alone.

MEANING OF SIPHONING AS PER RBI

"Siphoning off funds should be construed to occur if any funds borrowed from banks / FIs are utilized for purposes unrelated to the operations of the borrower, to the detriment of the financial health of the entity or of the lender. The decision as to whether a particular instance amounts to siphoning of funds would have to be a judgment of the lenders based on objective facts and circumstances of the case. The identification of the wilful 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. The default to be categorized as wilful must be intentional, deliberate and calculated."[iv]

• DIVERSION OF FUNDS

The Supreme Court in the recent case of Bikram Chatterji v. U.O.I[v] has termed diversion of funds as a serious fraud.

Diversion of funds implies utilization of funds for a purpose for which it was originally not sanctioned. Following occurrences construe diversion of funds as per RBI:

• When the unit employs short term working capital funds for long term goals, which is not in conformity with the sanctioned terms.
• When the unit deploys borrowed funds for purposes antithetical to the sanctioned ones.
• When the unit assigns borrowed funds to its subsidiaries or group companies or other corporates.
• When the unit routes funds through a bank other than the lender bank or members of consortium without its consent.
• When the unit makes an investment in other companies by way of acquiring equities or debt instruments without the consent of the lenders.
• When the unit fails to account for the difference in the utilization of funds to the amount released.[vi]

MECHANISM FOR IDENTIFICATION OF WILLFUL DEFAULTER

• EXAMINATION BY IDENTIFICATION COMMITTEE: A committee headed by the Executive Director or equivalent and consisting of two other senior officers of the rank of GM/DGM shall look into the evidence of willful default on the part of the borrowing company and its promoter/whole-time director.
• ISSUANCE OF SHOW CAUSE NOTICE(SCN): If the Committee comes to the conclusion that the borrower company has committed a willful default, then in that event it shall issue an SCN to the borrower company and its promoter/whole-time director and call for their submissions. The Committee shall then issue an order recording the fact of willful default and the reasons for the same.

The opportunity for personal hearing may be provided to the borrower company and the promoter/full-time director if found necessary by the Committee.

• REVIEW COMMITTEE: The Review Committee shall be headed by the Chairman / Chairman & Managing Director or the Managing Director & Chief Executive Officer / CEOs and consist of two independent directors / non-executive directors of the bank.

The Order of the Identification Committee shall become final only when it is reviewed by the Review Committee.[vii]

1. CAN THE IDENTIFICATION COMMITTEE ACTING UNDER THE MASTER CIRCULAR 01.07.15 FOR THE WILLFUL DEFAULTER, DELEGATE ITS POWER TO ISSUE A SHOW CAUSE NOTICE?

The Petitioners in the case of Atlanta Projects Ltd v. Allahabad Bank[viii] challenged the show-cause notice issued by the Deputy General on the pretext of it not being issued by the Identification Committee.

The High Court of Calcutta did not answer this question in affirmative.

It held that all administrative functions cannot be delegated. Where law requires an identified administrative authority to decide on a particular issue or subject, such administrative authority cannot delegate its power to decide.

"The words used in Clause 3(b) of the Master Circular on Willful Default dated July 1, 2015 are such that, they do not allow the Identification Committee to delegate any of their functions to any other authority. If the functions noted above cannot be delegated, then the requirement of issuance of the show-cause notice cannot also be delegated. That requirement, must be discharged by the Identification Committee."

• CONSEQUENCES OF BEING DECLARED AS A WILLFUL DEFAULTER

Following are the consequences which flow after a unit has been classified as a willful defaulter:

(a) No additional facilities to be granted by any bank/financial institution.

(b) Entrepreneurs/Promoters would be barred from institutional finance for a period of 5 years.

(c) Any legal proceedings can be initiated, including criminal complaints.

(d) Banks and financial institutions to adopt proactive approach in changing the management of the wilful defaulter.

(e) Promoter/Director of wilful defaulter shall not be inducted by another borrowing company.

(f) As per section 29A of the Insolvency and Bankruptcy Code, 2016, a wilful defaulter cannot be a resolution applicant.[ix]

1. WHETHER THE BORROWER CAN, GIVEN THE CONSEQUENCES OF BEING DECLARED A WILLFUL DEFAULTER, BE SAID TO HAVE A RIGHT TO BE REPRESENTED BY A LAWYER?

The Supreme Court in the case of State Bank of India v. Jah Developers Pvt. Ltd. and Others[x] has held that there is no right to be represented by a lawyer in the in-house proceedings contained in Clause 3 of the Revised Circular dated 01.07.2015, as it is clear that the events of willful default as mentioned in paragraph 2.1.3 would only relate to the individual facts of each case.

It also stated the following:

• The right to be represented by a lawyer is not an unconditional right under the Indian Legal System.
• This right is not a part of Principles of Natural Justice as held in the case of J.K. Aggarwal v. Haryana Seeds Development Corporation Ltd.[xi]

1. WHETHER A LAWYER OUGHT TO BE ALLOWED TO REPRESENT THE BORROWER BEFORE THE FIRST COMMITTEE AND/OR REVIEW COMMITTEE UNDER THE REVISED CIRCULAR DATED 01.07.2015?

The Supreme Court in the case of State Bank of India v. Jah Developers Pvt. Ltd. and Others[xii] held that no lawyer has a right under Section 30, Advocates Act,1961 to represent the borrower before the above mentioned Committees.

It reasoned its decision by discussing the ambit of the term "tribunal" with regards to the nature of the above mentioned committees.

"Before a body can be said to be a "tribunal", it must be invested with the judicial power of the State to decide a lis which arises before it. This would necessarily mean that all "tribunals" must be legally authorized to take evidence by statute or subordinate legislation or otherwise, the judicial power of the State vesting in such tribunal."

The earlier Master Circular dated 01.07.2013 granted a hearing before the Grievance Redressal Committee and also provided that the borrower should be provided 15 days' time for making a representation against the preliminary decision of the First Committee, this situation does not now obtain.

Under Clause 3 of the Revised Circular dated 01.07.2015, a borrower may be given a personal hearing at the preliminary stage if the Identification Committee thinks it is necessary to provide one. It is left with the discretion to provide or not provide a personal hearing.

The Review Committee is completely in-house. This Committee reviews the Order passed by the Identification Committee with no involvement of the borrower. Thereby leading to the conclusion that no representation is required against the Orders of either of the Committees.

"First and foremost, the State's judicial power, is the power to decide a lis between the parties after gathering evidence and applying the law, as a result of which, a binding decision is then reached. This is far from the present case as the in-house committees are not vested with any judicial power at all, their powers being administrative powers given to in-house committees to gather facts and then arrive at a result.

Secondly, it cannot be said that the Circulars in any manner vests the State's judicial power in such in-house committees. On this ground, therefore, the view of Delhi High Court is not correct, and no lawyer has any right under Section 30 of the Advocates Act to appear before the in-house committees so mentioned. Further, the said committees are also not persons legally authorized to take evidence by statute or subordinate legislation, and on this score also, no lawyer would have any right under Section 30 of the Advocates Act to appear before the same."

1. IS THE RESERVE BANK OF INDIA DUTY BOUND TO DISCLOSE THE LIST OF WILLFUL DEFAULTER UNDER THE RIGHT TO INFORMATION ACT, 2005?

The Supreme Court in the recent case of Girish Mittal v. Parvati V Sundaram[xiii] has held that the RBI is duty bound to disclose the list of the willful defaulters sought under the RTI. It also held that its non-disclosure policy was in violation of the judgment pronounced in 2015 by this Court in the case of Reserve Bank of India v. Jayantilal N. Mistry [xiv] and thereby ordered it withdrawn.

(Authors are Third Year law students at Amity Law School, Delhi, affiliated to Guru Gobind Singh Indraprastha University. Views are personal)