Defaulters at will, and defaulters of size: RBI proposes new Directions

Middle and Upper Layer NBFCs also part of the system

Team Finserv, finserv@vinodkothari.com (updated as on March 30,2024)

Introduction

The Reserve Bank of India on September 21, 2023 has issued the Draft Master Directions on Treatment of Wilful Defaulters and Large Defaulters (‘Proposed Directions’). The Directions, when finalized, will replace the existing Master circulars (referred below). The draft Directions are largely consolidating in nature, with some significant differences. Importantly, NBFCs of middle and upper layer have been brought into the framework, and additionally, as was clear from the recent circular on compromise/settlements, the tag of willful defaulter may be removed if the borrower does a compromise settlement with the lender. However, a mere sale of the loan will not cause removal of the tag, as the tag will pass on to the buyer. The draft Directions also assimilate the provisions about large defaulters, which was earlier a CIC filing requirement, and make it a part of these Directions.

The Draft Directions, issued in September 2023, are yet to be notified. Therefore, in the meantime, the position on wilful defaulters is as follows:

• Banks to identify borrowers as wilful defaulter in accordance with the Master Circular on Wilful Defaulters
• AIFIs to also follow the Master Circular on Wilful Defaulters for identification of wilful defaulters
• HFCs are required to identify and report wilful defaulters as per Annex XVII Guidelines on Wilful Defaulters under the HFC Master Directions
• NBFCs are not covered under the aforesaid Master Circular and hence, cannot classify borrowers as wilful defaulters

Why a stringent framework for wilful defaulters

While a default itself is bad for a lender, where the default is backed by ability, but unwillingness to pay, it assumes a different level of seriousness. Such a borrower, and the entities that such borrower promotes or fosters, should remain deprived of further assistance from the financial system.

Note that fraudulent defaulters are even a further level of seriousness, as a fraud is clearly a criminal offence. A fraudulent borrower is also a Wilful Defaulter, but vice versa need not be true. Fraudulent defaulters are covered by Master Directions on Frauds.

The concept of Wilful Defaulter can be traced back to 1999 when it introduced a scheme to address Wilful Defaulters. Currently, the Master Circular dated July 01, 2015 (‘Current Circular’) is the governing framework for classifying an account as Wilful Defaulter.

Wilful defaulter: Meaning

There is a new ground proposed to be added in the definition of Wilful Defaulter – failure to infuse committed equity, even while having sufficient resources. Additionally, the proposed definition includes guarantors who, despite being able to meet guarantee obligations, do not do so. This part is there in the existing Master Circular as well.

Notably, even where the principal debtor is not a Wilful Defaulter, a guarantor, upon invocation of the guarantee, failing to pay while being able to pay, will still be construed to be a Wilful Defaulter. That is to say, it is not that only guarantors for Wilful Defaulters are willful defaulters themselves.

Earlier Definition	Proposed Definition	Remarks
Wilful Default: A ‘wilful default’ would be deemed to have occurred if any of the following events is noted: The unit has defaulted in meeting its payment / repayment obligations to the lender even when it has the capacity to honour the said obligation unit has defaulted in meeting its payment / repayment obligations to the lender and has not utilised the finance from the lender for the specific purposes for which finance was availed of but has diverted the funds for other purposes. 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 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. 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.	“Wilful Default” (i) by a borrower shall be deemed to have occurred when the borrower defaults in meeting payment/ repayment obligations to the lender and any one or more of the following features are noticed: the borrower has the capacity to honour the said obligations; the borrower has diverted the funds availed under the credit facility from lender; the borrower has siphoned off the funds availed under the credit facility from lender; the borrower has disposed of immovable or movable assets given for the purpose of securing the credit facility without the knowledge of the lender; The borrower has failed in its commitment to the lender to infuse equity despite having the ability to infuse the equity, although the lender has provided loans or certain concessions to the borrower based on this commitment and other covenants and conditions; (ii) by a guarantor shall be deemed to have occurred if the guarantor does not honour the guarantee when invoked by the lender, despite having sufficient means to make payment of the dues	As mentioned in the Proposed Directions, the scope of the term Wilful Default has been widened so as to include circumstances wherein the borrower has defaulted in its commitment to infuse equity despite having the ability to infuse equity. This particular circumstance is understood to be  drawn towards promoter driven funding wherein commitment of infusing equity is quite common.

NBFCs get right to tag defaulters as wilful

NBFCs are covered by the proposed framework.

The applicability of the proposed framework to NBFCs may be understood by the following:

Particulars	Upper and Middle layer	Base Layer
The ability to declare a borrower as Wilful Defaulter	Yes	No
The obligation to identify a Wilful Default, have a review and reporting process	Yes	No
The obligation to refrain from taking any new or additional exposure on a Wilful Defaulter, or associated entities	Yes	Yes

Do ML and UL NBFCs have the option of declaring a borrower as wilful, or is it an obligation?

It is important to highlight that the tagging of a person as a Wilful Defaulter is not merely for the purpose of casting pressure on the borrower; it is also for the purpose of saving the financial system from being hurt by a person who is not a defaulter by chance, but defaulter by design. Therefore, NBFCs who are covered as “lenders” under the Directions, are mandatorily required to adhere to the entire Directions.

The major obligations of NBFCs include:

• Identification of an NPA as to whether it may fall into the category of Wilful Defaulter
• Having an Identification Committee, Review Committee, etc. for the process of declaration
• Formulating guidelines, based on their board-approved policy, for nominating authorized officers who would issue show cause notices and serve written order on behalf of the Identification Committee and Review Committee respectively.
• Post declaration, appropriate filing with Credit Information Companies(CICs)
• Internal audit system to be developed so as to specifically look into adherence to instructions for classifying a borrower as a Wilful Defaulter. 
• Review of status of Wilful Defaulters by the audit committee
• Inclusion of a covenant in lending to all companies that the company shall not induct on its board a person who has been a director of a Wilful Defaulter
• Determining a limit/threshold in the board approved policy for the commissioning of forensic audit
• To complete the investigation from a Wilful Default angle in every case before transferring the credit facility
• Reporting of Wilful Defaulters in the List of Wilful Defaulters with CICs before transferring the credit facility
• Loan agreement may be amended so as to incorporate a covenant for certification by auditors with regard to the diversion/siphoning of funds
• Reporting of auditors with National Financial Reporting Authority/ Institute of Chartered Accountants of India in cases they are found to be negligent or deficient in conducting the audit.
• Reporting the details of third parties to Indian Banks Association in cases where they are found to be negligent or deficient in their work.

Composition of the Identification Committee and Review Committee

A lender shall have an Identification Committee or Committees; however, it seems that the Review Committee is a central committee, and is a Board-level committee.

A brief comparison of the two is as follows:

Criteria	Identification Committee	Review Committee
Task	Fact finding. To consider the evidence from the borrower’s financials or otherwise as to whether the indications of Wilful Default exist. To consider the borrower’s response, and escalate the matter, if thought appropriate, to the Review Committee	To review the findings of the Identification Committee, borrower’s response, give opportunity of hearing to the borrower, and carefully, and with reasoning, give its ultimate decision on tagging the borrower as wilful
Seniority	May consist of one WTD and other senior officers not below two ranks of the chairperson of the committee	May consist of a WTD and independent directors as members. The chairperson shall be an independent director if the credit facility has been sanctioned by the CEO
Multiplicity	May be more than one	Seems like a central committee
Finality of decision	Internal committee; decisions are subject to review by the Review Committee	Final, as far as the lender is concerned.

Process of Wilful Defaulter declaration

As in case of the existing Master Circular, the size of current outstanding for a Wilful Defaulter is Rs 25 lacs or above.

Thus, if it is an NPA with a current outstanding of Rs 25 lacs or above, the lender should do a check on whether the borrower is a Wilful Defaulter. The entire process shall have to be completed within a period of 6 months from the date of the accounting turning into an NPA, which translates into a maximum time period of 9 months from the date of first default by the borrower.

The various steps in the process are as follows:

• Examination of Evidence by Identification Committee
  • Recovery team or similar teams to examine the borrower’s financial statements, security cover, etc to detect any indications of Wilful Default, and to place the same before the Identification Committee.
  • Identification Committee to consider the same and it may decide to send notice
• Issuing of Show Cause Notice
  • Time period to be given should be reasonable. No specific timeline laid in the Directions, but one may take 14-15 days as reasonable   
• Consideration of the Submissions from the borrower
• Post Consideration, the Identification Committee shall make a proposal for classification of Wilful Defaulter to the Review Committee with reasons in writing. Simultaneously, this proposal shall also be communicated to the guarantor/ persons who are responsible for managing the affairs of the said entity. Review Committee, after consideration of the findings of the Identification Committee, may give notice to the borrower, along with an opportunity of personal hearing, with a reasonable time, say, 15 days.
• Representation and personal hearing of the borrower
• Reasoned decision of Review Committee
• Once established, the lenders shall report such Wilful Defaulters at monthly intervals in Annex II to all CICs.

Wilful Defaulter declaration is serious business

There have been various instances in rulings that highlight the banks’ casual conduct in designating borrowers as ‘willful’ and ‘fraudulent’. These include not providing the borrower with supporting documents, not making reasoned orders, and at times not even communicating their decisions to the borrower. In the matter of State Bank of India Vs. Jah Developers Private Limited and Others([2019] 6 SCC 787), the Supreme Court highlighted the need for the due process to be followed; in Kanchan Motors and Others Vs. Bank of India & Ors. (2018 SCC OnLine Bom 1761) the need for clarity in the SCN and the importance of providing reasoned orders was emphasised; the fact that the penal measures being quite substantial and severe, the principles of natural justice and fair play with recorded reasons would be imperative was discussed in the matter of Narendra Seoomal Sabnani & Others Vs. State Bank of India & Others (2021 SCC OnLine Bom.4604). (Read more about ‘Implications of being labelled as wilful defaulter’ in our article here)

In March 2024 case of Milind Patel Vs. Union Bank of India, the Bombay High Court has again highlighted the need for prudence and due process to be followed for the classification of a borrower as a ‘wilful defaulter’. The Order has emphasized the following:

1. Banks and financial institutions that seek to invoke the Master Circular and or Proposed Directions to declare the occurrence of wilful default, must identify the members of the Identification Committee and the members of the Review Committee, and share the reasoned orders passed by such committees.
2. The borrower must be allowed to be heard before passing any order to declare the borrower as a ‘wilful defaulter’. Banks and FIs must establish a transparent mechanism for the entire process. This will prevent the misuse of penal provisions and ensure that discretionary powers are kept to a minimum. It should also be ensured that a solitary or isolated instance is not made the basis for imposing the penal action.
3. Not only must information that is referred to and relied upon by the lender be supplied but also information that may undermine the allegations contained in the SCN must be supplied – only to ensure that everything relevant to arrive at the truth is available to both parties. There should be fair and transparent symmetrical access to information since all such information would be relevant for arriving at the truth. Access to the record is essential to uphold the principles of natural justice, as held by the Supreme Court in the matter of T.Takano Vs Securities and Exchange Board of India & Anr. [(2022) 8 SCC 162].
4. RBI must ensure that banks wield their conferred discretion responsibly and in compliance with its guidelines, particularly regarding transparency.

Board approved policy for Wilful Defaulters: Contents

The Proposed Direction mandates the Lender to have a non discriminatory board approved policy inter alia providing for the following aspects:

• Transparent mechanism for identification of Wilful Defaulters
• Criteria of publishing photographs of persons classified as Wilful Defaulter;
• Terms of the compromise and settlement to be executed with the Wilful Defaulter;
• Threshold for commissioning a forensic audit against Wilful Defaulter;
• Determination of the periodicity for review of the willful defaulter status, if not found at Wilful Defaulter during the first examination
• Guidelines for nominating authorized officers who would issue show cause notice on behalf of Identification and review Committee.

Role of audit committee and independent directors

• As per the Proposed Directions, the Audit Committee will periodically review the cases of Wilful Default and recommend steps for prevention and early detection.
• It is notable that the Review Committee consists of independent directors being in majority. Therefore,  independent directors have a crucial role in this Committee.

Action against Wilful Defaulters

Once identified as a Wilful Defaulter, the lender has the following recourses available:

1. Initiation of criminal action or legal action if warranted
2. Publishing of photographs as per the Circular Dated September 29, 2016.
3. Initiating penal actions in the form of  debarring the borrower or any its associated entities from availing any additional credit facility.
   1. The restriction in availing additional facility has been further extended to related parties of the borrower as well, that is to say in the event the Wilful Defaulter is an individual/natural person the debarment of availing additional credit facility is extended to all the entities wherein the said individual was associated as a promoter or a director or as one in charge and responsible for the management of the affairs. Whereas , if a company is declared as a Wilful Defaulter, then the promoter/holding of the said entity will also be debarred from accessing any credit facility despite not being classified as a Wilful Defaulter.
   2. This bar shall be effective upto a period of one year after the name of the Wilful Defaulter has been removed from the list of Wilful Defaulters (LWD). However it shall be noted that additional funding, by either the wilful defaulter or the above mentioned related parties, for the purposes of  floating any ventures will be restricted for a period of 5 years after the name of Wilful Defaulter has been removed from the LWD. Impact resonates throughout the industry even though classification is at an entity level
4. At the board level, any person classified as a Wilful Defaulter shall not be eligible for holding any position on the board of any company.
   1. With respect to existing such  persons holding a position in the board, a time period of 90 days has been proposed for undertaking effective steps for removal of such person.
5. Lastly the Wilful Defaulter would not be eligible for restructuring

Therefore, declaration of WD is limited (as per definition), but debarment on raising finance is wider as it extends to related entities as well.

Large Defaulters

Large defaulters were earlier covered by reporting requirements vide Notification dated June 27, 2014. Now, these defaulters are also sought to be covered by these Directions.

Classification of a borrower as a large defaulter:

• Is not affected by classification as wilful. That is, even if not wilful, a large defaulter is still a large defaulter if the other conditions are satisfied.
• While a Wilful Defaulter faces a bar on raising finance, etc., there is no similar bar proposed on a large defaulter.
• Large defaulter is based on two conditions:
  • Size of the default: Rs 1 crore of outstanding
  • Vintage of the default: Should have been classified as doubtful or loss by the lender

The applicability of this new framework has been proposed to be quite wide in terms of including even those lenders which do not fall within the definition of ‘Lender’ provided in this  Proposed Directions. The obligations arising out of this new framework includes monthly filing of large defaulters to all CICs as per Annex I of this Proposed Directions. Further, the CICs shall be required to provide access to Credit Institutions^[1] regarding all non-suit filed accounts of large defaulters. Whereas in respect to suit filed accounts of large defaulters, the CICs have been mandated to display their names on their websites.

Comparison of Wilful Defaulters vs Large Defaulters

Criteria	Wilful Defaulter Framework	Large Defaulter Framework
Minimum Defaulted exposure	Rs 25 lacs	Rs 1 crore
Vintage of default	Should be an NPA, and the default should be a ‘Wilful default’	The debt should have been classified as doubtful or loss
Applicability	Applicable to only the “lenders” identified in terms of the Proposed Directions	Applicable to all lenders irrespective of whether they are identified in the Proposed Directions.
Committees	Requirement to constitute an Identification Committee and Review Committee to identify a Wilful defaulter	No requirement of formation of separate committees
Reporting Requirement	The manner of reporting under this framework has been prescribed in Annex II of the Proposed Directions	The manner of reporting under this framework has been prescribed in Annex I of the Proposed Directions.
Bar on additional lending by the lender or any other lender	Exists	Does not exist

Compromise and settlement

The Proposed Directions states that ..Wilful Defaulters shall not be eligible for restructuring of credit facility.”

And in the RBI circular dated June 8, 2023 it is mentioned that- REs may undertake compromise settlements or technical write-offs in respect of accounts categorised as Wilful Defaulters or fraud without prejudice to the criminal proceeding underway against such debtors.

So restructuring cannot be done but the lender may enter into compromise settlement

For further understanding of what constitutes compromise and settlement you may refer to our earlier write up.

When does a Wilful Defaulter come off the tag

Once classified as a Wilful Defaulter, the tag can only be removed if the defaulting borrower undertakes either of the following:

• The defaulting borrower clears his dues
• The defaulting borrower enters into a compromise settlement with the lender, and the entire settlement consideration is cleared
• The defaulting borrower clears so much of his dues as to bring the outstanding amount to less than Rs 25 lacs 
• The defaulting borrower undergoes a CIRP which is implemented; however, the promoters of the defaulter will continue to be classified as Wilful Defaulter

It may be noted that the sale of the Wilful Defaulters account to the other lenders/ARCs shall not be construed as recovery and therefore the tag of Wilful Default shall continue.

Action against auditors

The implications of these Proposed Directions have been further extended to Auditors as well, similar to the Current Circular,  in the cases where the lender finds the auditor negligent and deficient in conducting the audit. Such lack of diligence by the auditors is proposed to be reported to National Financial Reporting Authority /Institute of Chartered Accountants of India in the form of formal complaint.  Further such complaints shall also be forwarded to the Reserve Bank (Department of Supervision, Central Office) and Indian Banks’ Association (IBA) which shall eventually prepare a caution list of such auditors that shall be considered by lenders before assigning any kind of work to them.

Action against loan sourcing partners/third parties

Similar to the above requirement in the event the classification of Wilful Default is on account of some negligence or deficiency by the third parties engaged by the lender or loan sourcing partners, the lender shall forward the details of such third parties to the  Indian Banks’ Association (IBA) for records who shall eventually publish a caution list that shall be circulated amongst the lenders. The lenders shall thereafter consider this list before assigning any kind of work to third parties.

Other consequences of Wilful Defaulters

Apart from the above-mentioned actions against the Wilful Defaulters, such defaulting borrowers are also subject to the following further consequences in terms of other applicable provisions of law:

• Restriction to file an application under Section 29A of the Insolvency & Bankruptcy Code 2016
• Prohibition under Regulation 5 of SEBI( Issue of Capital & Disclosure Requirements) Regulations 2018 from being eligible for public issue if the issuer or its promoters are declared as Wilful Defaulters.
• Travel restrictions have also been imposed by the Ministry of Home Affairs to Immigration Authorities to retain or prevent such defaulting borrowers from leaving India. 
• Difficulty in raising any form of credit in the future as credit rating can be severely impacted. 

Before selling off the loans

The Lenders although have the option to sell off the Wilful Defaulters loan account however it must be noted that before such transfer the investigation with respect to the classification of Wilful Defaulter must be completed. That is to say, the lender may have to wait for at least 6 months from the date of classification of NPA apart from the Minimum Holding Period(which may be 3 to 6 months as the case may be) before transferring the loan exposure to other transferees.

Further, the details of such Wilful Default establishment shall be conveyed to the transferee who shall thereafter be responsible for undertaking the reporting requirements. Such reporting shall be continued by the transferee until the balance remaining to be recovered in their account plus the amount written off by the transferor falls below the threshold of INR 25 lakh.

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^[1]  As defined in the Credit Information Companies (Regulation) Act, 2005

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Read our other related articles

Links to our previous write ups
https://vinodkothari.com/wp-content/uploads/2017/02/Article_on_Wilful_defaulter-1.pdf