Riddhi Paritosh Vyas*

RBI recently issued the finalized Master Direction on Treatment of Wilful Defaulters and Large Defaulters, offering an opportunity to delve into the revised provisions, challenges, and future implications. With that in mind, this article offers a comparative analysis of the finalized Master Direction with the previously issued Draft Directions (2023). It highlights the notable changes that can be seen through provisions such as inclusion of guarantors, expanded definitions, and revised procedural frameworks. This article further examines the persisting concerns, such as the denial of legal representation and the lack of clear guidelines for removal of a borrower’s name from the List of Wilful Defaulters, underscoring the need for greater transparency and procedural fairness in India’s evolving financial regulatory framework.

A. INTRODUCTION

India is one of the few countries in the world that discerns between ‘wilful’ defaulters and other defaulters. A wilful default is said to have occurred in the event a borrower deliberately and intentionally fails to repay a loan, despite having the capacity to do so.

This concept exists in other jurisdictions too. For instance, in the United States of America, the term ‘strategic default’ is used, particularly in association with residential and commercial mortgages, where a homeowner intentionally stops making payments on a mortgage, despite having the financial means to do so. This was rampant in 2006-07 and was followed by the subprime mortgage crisis in 2008 and the great recession. However, the laws governing strategic default are less formalized in USA as compared to the stringent regulations surrounding the treatment of wilful defaulters in India – making the concept of wilful default distinctive to the Indian financial landscape.

The issue of wilful default has been discussed in India since the late 1980s. It becomes crucial to understand how the concept of wilful default has evolved in India – from the structural reforms nudged by the balance of payment crisis in 1990, to the issuance of the Draft Reserve Bank of India (RBI) (Treatment of Wilful Defaulters and Large Defaulters) Directions, 2023 (Draft Directions), wherein all instructions on treatment of wilful defaulters, as issued by RBI from time to time, were consolidated. Recently, in July 2024, after seeking comments from stakeholders and public at large, the RBI finalized the RBI (Treatment of Wilful Defaulters and Large Defaulters) Directions, 2024 (Master Direction), which will be coming into effect shortly.

Considering the severe consequences that attach to a borrower being declared a wilful defaulter, it becomes important to study the ongoing developments on laws dealing with the treatment of wilful defaulters in India. This article seeks to highlight the changes brought about by the Master Direction, in comparison to the Draft Direction and further examine the judicial development on this issue, to reveal the interplay between judicial decisions and regulatory guidelines. This article further seeks to underscore the ongoing challenges and issues in regulating wilful default in India.

B. MAIN CHANGES IN THE MASTER DIRECTION

Basis the feedback received, changes have been made to the Master Direction, as it stands today. These changes reflect a mixed impact. On one hand, financial discipline may be strengthened by expanding the definition of wilful defaulter to include guarantors and by outlining necessary sanctions on the same. On the other hand, lack of legal representation during in-house committee proceedings may raise fairness concerns, which has always been a sore point through the regime. While the changes do address stakeholder feedback, they also run the danger of establishing more levels of bureaucracy, that could hinder quick decision making. The changes have been highlighted below:

– Addition of ‘Guarantor’– First, the definition of ‘wilful defaulter’, now includes a guarantor (in addition to a borrower), who has committed wilful default in terms of Direction 3(1)(u) of the Master Direction. Second, circumstances for wilful default by a guarantor have been added to the definition of ‘wilful default’, under Direction 3(1)(t) of the Master Direction.

– Widening the scope of ‘credit facility’ – Under Direction 3(1)(d) of the Master Direction, the definition of ‘credit facility’, has been amended to include off-balance sheet items such as derivatives, guarantees, and letters of credit. While some of this was covered even in the earlier regime, a specific inclusion brings about the much-needed clarity.

– Changes in the composition of the Identification Committee (IC) and the Review Committee (RC) – Composition of the IC and RC now features entity specific classifications for commercial banks, foreign banks, Urban Co-operative Banks (UCBs), Non-Banking Financial Companies (NBFCs), and Regional Rural Banks (RRBs), leading to variations in composition in each category. Further, commercial banks can now form multiple ICs and RCs under Directions 3(1)(j) and 3(1)(r) of the Master Direction.

– Timeline for response to show-cause notice issued by IC – Under the mechanism for identifying and classifying wilful defaulters, Direction 4(1)(a)(ii) of the Master Direction sets a timeline of 21 days to call for submissions from the borrower/ guarantor/ promoter, after the IC examines the evidence pertaining to wilful default, to respond to the show-cause notice issued by the IC.

– No right of representation by a lawyer – Under Direction 4(1)(a)(viii) of the Master Direction, the proceedings before the IC and RC have been classified as in-house proceedings and the borrower/ guarantor/ promoter/ directors do not have the right to be represented by a lawyer in such proceedings.

– Penal measures against wilful defaulters: The penal measures under Direction 5(3)(a)(iv) of the Master Direction now include a provision that does not permit the wilful defaulter and its associated entities to restructure the credit facility. This further halts the enforcement of penal measures on associated entities once they are no longer linked to the wilful defaulters, under Explanation (C) to Direction 5(3)(a)(iv) of the Master Direction.

– Review by Internal Audit Committee: Under Direction 7(2) of the Master Direction, the review of the audit committee shall focus on identifying the root cause of wilful default and shall address deficiencies in the wilful defaulter classification adopted by the lender.

– Reporting and dissemination of credit information on wilful defaulters: Direction 10(5) of the Master Direction states that, in cases where a NBFC/ a non-scheduled UCB has been reclassified into the middle/higher layer, from tier 3 or 4 (as per the scale-based regulation criteria for NBFCs/ revised regulatory framework for UCBs), such institutions shall not be eligible to classify their borrowers as wilful defaulters. Yet, they must continue to provide updates on the historical data that they have previously submitted to the Credit Information Companies (CICs).

C. CHALLENGES IN THE CURRENT MASTER DIRECTION

Following the decision of the Hon’ble Supreme Court of India (SC) in State Bank of India v. Jah Developers (Jah Developers) [(2019) 6 SCC 787],  a division bench of the Hon’ble High Court of Bombay in Milind Patel v. Union Bank of India [2024 (3) ABR 295], emphasized on due compliance with principles of natural justice,  in allowing borrowers to access all relevant investigation material (whether incriminating or exculpatory) before designating them as “wilful defaulters”. In line with the evolving jurisprudence on the issue, I have two challenges. First, on the effect that the Direction has on the principles of natural justice and second, on the lack of a transparent procedure for the removal of names from the List of Wilful Defaulters (LWD).

No right of legal representation to the borrower

The current Master Direction denies the borrowers the right to legal representation before the in-house committees, when facing potential classification as wilful defaulters.

In Punjab National Bank v. Kingfisher Airlines & Ors. [2016 (154) DRJ 164], the Hon’ble Delhi High Court ruled to the contrary. With the understanding that being declared a wilful defaulter has far-reaching consequences (both civil and criminal), and emphasizing on principles of natural justice, the Court granted borrowers the right of being represented by advocates, in hearings before the Grievance Redressal Committee (GRC), which was held to function as a Tribunal vested with State’s judicial power. This was overruled by the SC in Jah developers which held that the borrower had no unconditional right to be represented by an advocate before the GRC.

The absence of the right to legal representation may raise many concerns regarding the efficiency with which borrowers may be able to represent themselves before such committees and may thus be problematic considering the purpose of such hearing. A novel way to address this issue may be an assessment whether the absence of an advocate would defeat the purpose of such hearing.

Setting out the procedure for removal of name of a borrower from the LWD

The Master Direction does not lay down the procedure for removal of name of a borrower from LWD. This carries various legal implications and makes it important to understand the process undertaken for such removal to ensure prompt reporting to the CICs.

The removal of the account of a borrower (declared a wilful defaulter) from the LWD can happen in the following three ways under the Master Direction: First, after payment of the full compromise amount by the borrower (in case of compromise settlements) [Direction 11(1) of the Master Direction]; second, when the remaining defaulted amount is below the threshold of INR 25 lakhs (in case of defaulted loans sold to other lenders/ ARCs) [Direction 12(5) of the Master Direction]; and third, after successful resolution resulting in change of management and control of the entity (under the Insolvency & Bankruptcy Code, 2016 in case of accounts where resolution is done under IBC or the RBI Prudential Framework for Resolution of Stressed Assets, 2019) [Direction 10(2) of the Master Direction].

This may attract legal implications, for instance, the Master Direction, under Direction 5(3)(a)(iii), states that no credit facility shall be granted for floating new ventures by any lender to a wilful defaulter (or any associated entity) for a period of five years after the removal of the wilful defaulter’s name from the LWD, by the lender. A lack of clarity on the removal of defaulters from the LWD could hamper their ability to access such credit facilities.

Further, where the Master Direction talks about reporting and dissemination of credit information on wilful defaulters, it mandates the lenders/ARCs (to which the account of a particular wilful defaulter has been transferred) to submit LWD for suited and non-suited filed accounts & the lenders/ARCs must further inform the CICs, about such removal, within 30 days. Thus, the procedure for removal has important implications on the LWD received by the CICs.

It is crucial to understand the process undertaken for the removal of the name of a wilful defaulter from the LWD to ensure transparency, accountability, and accuracy in reporting of such changes by lenders/ARCs. Prompt reporting to CICs is not only essential to maintain up-to-date credit information but also ensures that borrowers who have rectified their defaulter status are no longer wrongfully penalized.

D. CONCLUSION

The current Master Direction is a significant step forward in streamlining regulations and enhancing accountability in the Indian financial system. Notably, the interplay between judicial pronouncements by various courts and the Master Direction, in bringing out procedural clarity and importance of the principles of natural justice is now embedded in the finalised Master Direction.  However, few concerns remain, particularly around the right to legal representation before the in-house committees and the lack of clear procedures for removal from the LWD, continue to exist.

Going forward, further refining of these directions is vital to address these gaps and ensure a balanced approach that protects both lenders and borrowers. One way in which this could happen is by strengthening transparency and procedural fairness, thereby fostering trust and mastering the efficiency needed in addressing issues pertaining to wilful default in India. The upcoming legal issues and judicial pronouncements in this field will pave the way for better law on treatment of wilful defaulters in India.

*Riddhi Paritosh Vyas is a Research Fellow working with the Policy Research Group of Shardul Amarchand Mangaldas & Co., New Delhi. Her main areas of focus are banking & finance, insolvency, and dispute resolution.

[The Author would like to thank Ms. Veena Sivaramakrishnan (Partner), Mr. Prashant Saran (Senior Consultant), Mr. Gopalkrishna Hegde (Senior Consultant), Mr. Sudarshan Sen (Senior Consultant) and Mr. Pratik Datta (Associate Director, Research) – Shardul Amarchand Mangaldas & Co., for the meaningful discussions.]