The Revised Guidelines of RBI give untrammelled powers of judicial review on the banks that surely lack judicial skills
Regulators have been attempting to deal strongly with wilful defaulters. Reserve Bank of India’s (RBI) efforts in this direction got gets support from the Securities and Exchange Board of India (SEBI) proposing to completely bar such “freeloaders” from tapping financial markets.
RBI has already put in place a plethora of norms be it with regard to the recovery process or categorisation of borrowers as non-cooperative or wilful. SEBI’s move to further ostracise wilful defaulters makes it clear that the intent is to choke off all sources of funds, close all avenues that may be available and send him on a financial exile forever.
This article 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 on 7 January 2015 (Revised Guidelines
) now define "wilful default" if any of the following events occur:
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 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 includes…
(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, 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 general manager/ deputy general manager (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, chief executive (CEO) and managing director (MD) and two independent directors of the bank and the order shall become final only after it is confirmed by the said Review Committee.
e. 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 are all set to make life of corporates difficult. 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 for sources? 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 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 lifetime, irrespective of the fact already much damages, in terms of civil as well as criminal prosecution has been faced by the defaulter. If so, was the intent to lay down a punishment even higher than what criminal law prescribes? It would have been better if 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 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 it do not provide the defaulter with a mandatory hearing opportunity and then finally declare a defaulter as wilful defaulter for life. Such a lifetime 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, to tighten noose on wilful defaulters, on 7 January 2015, proposed to debar a wilful defaulter from 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 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 is 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 ( 49 taxmann.com 222 (Gujarat)/ 128 SCL 316 (Gujarat))- the Gujarat High Court opined that RBI Master Circular relating to 'Wilful defaulters' is ultra vires and violative of Article 19 of the 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
, the Bombay High Court held that the RBI Master Circular covered default by a party in complying with the payment obligations under derivative transactions. The HC observed that it would 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.
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 untrammelled 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 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 is also vindicative 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.