Presentation on IBBI’s Discussion Paper on ‘Streamlining Processes under the Code: Reforms for Enhanced Efficiency and Outcomes’

– Team Resolution | resolution@vinodkothari.com

Read our comments here.

Affixing Vicarious Liability on Directors: See a Breakthrough

Introduction:

It is well established that a company, being an artificial legal entity, conducts its day-to-day operations through a collective body of individuals known as the Board of Directors. This body bears direct responsibility for the company’s functioning and decision-making. Consequently, in instances of default, both the company and its directors are often held accountable. Under Section 2(60) of the Companies Act, 2013 (hereinafter referred to as “the Act”), directors can be designated as “officers who are in default,” thereby making them personally liable in specific situations.

Despite its artificial nature, a company is recognized as a separate legal entity under the law. Therefore, for any offence committed by a company, it is primarily the company itself that is liable to face legal consequences. However, this fundamental principle is sometimes overlooked, and directors are held accountable for the corporation’s adverse actions. This stems from the perception that directors act as the “mind” of the company and control its operations.

Recently, the Supreme Court of India, in Sanjay Dutt & ORS. v. State of Haryana & ANR (Criminal Appeal No. 11 of 2025), reaffirmed the distinction between the company’s liability and that of its directors. This decision underscores the importance of adhering to the principle of separate legal personality, ensuring that directors are not unfairly held liable unless their personal involvement or negligence in the offence is established.

Brief facts of the Case: 

The case under discussion revolves around a complaint lodged under the Punjab Land Preservation Act, 1900 (PLPA) against three directors of a company, alleging environmental damage caused by uprooting trees using machinery in a notified area. The appellants (directors of Tata Realty and related entities) sought to quash the complaint, asserting that the alleged actions were conducted by the company and not attributable to them personally. The complaint, however, excluded the company as a party and focused on the directors’ liability under Section 4 read with Section 19 of the PLPA.

Key observations by the Supreme Court:

  1. Primary Liability of the Company: The Court emphasized that the company itself, as the licensee and beneficiary of the land, was primarily liable for any violations. Excluding the company from the complaint undermined the case’s premise.
  1. Vicarious Liability Not Automatic: The Court reiterated that directors cannot be automatically held vicariously liable unless the statute explicitly provides for such liability or there is evidence of their personal involvement in the offence.
  1. Lack of Specific Allegations: The complaint failed to attribute specific actions or responsibilities to the directors. It merely assumed liability based on their official positions, which is insufficient for criminal prosecution.
  1. Legal Fiction Requires Explicit Provision: Vicarious liability in criminal matters requires clear statutory backing. The PLPA contains no provisions imposing vicarious liability on directors for offences committed by the company.

Understanding the Concept of Vicarious Liability:

The concept of vicarious liability allows courts to hold one person accountable for the actions of another. This principle is rooted in the idea that a person may bear responsibility for the acts carried out by someone under their authority or on their behalf. In the corporate context, this doctrine extends to holding companies liable for the actions of their employees, agents, or representatives.

Initially developed within the framework of tort law, the doctrine of vicarious liability later found application in criminal law, particularly in cases involving offences of absolute liability. This marked a departure from the once-prevailing notion that corporations, as artificial entities, could not commit crimes. Modern legal interpretations now recognize that a corporation may be held criminally liable if its human agents, acting within the scope of their employment, engage in unlawful conduct.

Doctrine of Attribution:

Currently, a company does not have the immunity to safeguard itself under the blanket of laxity of mens rea, an important component for the constitution of a criminal intent. It was established that corporations are  liable for  criminal and civil wrongdoings if the offences were committed through the corporation’s ‘directing mind and will’. This attribution of liability to the corporations is known as the ‘Doctrine of Attribution’

‘Doctrine of Attribution’ says that in the event of an act or omission leading to violation of criminal law, the mens rea i.e. intention of committing the act is attributed to those who are the ‘directing mind and will’ of the corporations. It can be said that Doctrine of Attribution is a subset of Principle of Vicarious Liability wherein a corporation can be held responsible even in case of a criminal liability.

The landmark judgment in H.L. Bolton (Engineering) Co. Ltd. v. T.J. Graham & Sons Ltd., (1957 1 QB 159) provided a foundational understanding of corporate liability. The court compared a corporation with a human body, with its directors and managers representing the “mind and will” of the organization. These individuals dictate the company’s actions and decisions, and their state of mind is legally treated as that of the corporation itself. Employees or agents, by contrast, are viewed as the “hands” that execute tasks but do not represent the company’s intent or direction.

This conceptual framework underscores that while corporations are artificial entities, they can be held criminally liable when those who embody their directing mind commit offences. The recognition of corporate criminal liability has since evolved, balancing the need for accountability with the distinction between the roles of employees and the decision-makers within an organization.

You can read more about the corporate criminal liability here.

Analyzing the Sanjay Dutt Judgment:

  1. Liability must be expressly mentioned

In the present case, the Court underscored the principle that vicarious liability cannot be imposed on directors or office-bearers of a company unless explicitly provided by statute. This was reiterated in Sunil Bharti Mittal v. Central Bureau of Investigation, (AIR 2015 SC 923) where it was held that individual liability for an offence must be clearly established through direct evidence of involvement or by a specific statutory provision. Without such statutory backing, directors cannot be presumed vicariously liable for a company’s actions.

The Court further emphasized that statutes must clearly define the scope of liability and the persons to whom it applies. This clarity is essential to prevent ambiguity and ensure that only those genuinely responsible for the offence are held accountable.

  1. Personal involvement of Directors :

The Court reaffirmed that corporate liability does not inherently extend to directors unless supported by statutory provisions or evidence of personal involvement. In Pharmaceuticals Ltd. v. Neeta Bhalla and Anr. (AIR 2005 SC 3512), it was held that directors are not automatically vicariously liable for offences committed by the company. Only those who were directly in charge of and responsible for the conduct of the company’s business at the time of the offence may be held liable.

The judgment further emphasized that liability must stem from personal involvement or actions beyond routine corporate duties. Routine oversight or general authorization does not suffice to establish criminal liability unless it can be shown that the director personally engaged in, or negligently facilitated, the unlawful act.

  1.  In charge of’ and ‘responsible to

In K.K. Ahuja vs V.K. Vora & Anr. (2009 10 SCC 48), the Supreme Court analysed the two terms often used in vicarious liability provisions, i.e., ‘in charge of’ and ‘responsible to’. It was held that the ‘in-charge’ principle presents a factual test and the ‘responsible to’ principle presents a legal test. 

A person ‘responsible to’ the company might not be ‘in charge’ of the operations of the company and so in order to be vicariously liable for the act, both the principles must satisfy. It stated as, “Section 141 (of the Negotiable Instrument Act, 1881), uses the words “was in charge of, and was responsible to the company for the conduct of the business of the company”. There may be many directors and secretaries who are not in charge of the business of the company at all.

  1. The Complainant’s Burden of Proof:

Under Section 104 of the Bharatiya Sakshya Adhiniyam, 2023, the burden of proof lies on the complainant. It is the complainant’s responsibility to make specific allegations that directly link a director’s conduct to the offence in question. This principle was reiterated in Maksud Saiyed v. State of Gujarat (AIR 2007 SC 332), where the Court held that vague or generalized accusations against directors are insufficient.

A valid complaint must include:

  1. Clear and specific allegations detailing the director’s role in the offence.
  2. Evidence linking the director’s actions to the company’s criminal liability.
  3. Statutory provisions or legal grounds for attributing vicarious liability.

Referring to Susela Padmavathy Amma and M/s Bharti Airtel Limited (Special Leave Petition (Criminal) No.12390-12391 of 2022), wherein it was reaffirmed by the Supreme Court that even when statutes explicitly provide for vicarious liability, merely holding the position of a director does not automatically render an individual liable for the company’s offences.

To establish a director’s liability, the Court emphasized the need for specific and detailed allegations that clearly demonstrate the director’s involvement in the offence. It must be shown how and in what manner the director was responsible for the company’s actions.

The Court further clarified that there is no universal rule assigning responsibility for a company’s day-to-day operations to every director. Vicarious liability can only be attributed to a director if it is proven that they were directly in charge of and responsible for the day-to-day affairs of the company at the time the offence occurred.

  1. MCA Directive to RD and ROCs: Circular Dated March 2, 2020:

It’s noteworthy that, even MCA, vide its General Circular no. 1/2020 dated 2nd March, 2020, directed Regional Directors and Registrar of Companies that at the time of serving notices relating to non-compliances, necessary documents may be sought so as to ascertain the involvement of the concerned officers of the company.

  1. Duties of Directors under the Companies Act, 2013

Section 166 of the Act lists down duties of directors of a company. To summarise, directors must adhere to the company’s articles, act in good faith for members’ benefit, exercise due care and independent judgment, avoid conflicts of interest, undue gain. However, of note, it does not mention that a director shall be responsible for all the affairs of a company. 

In addition to the above case, the following related judgements are also noteworthy:

  1. Pooja Ravinder Devidasani vs. State of Maharashtra and another, (2014) 16 SCC 1: In this case, the Court asserted that, only those persons who were in-charge of and responsible for the conduct of the business of the Company at the time of commission of an offence will be liable for criminal action.
  1. S.M.S. Pharmaceuticals Ltd. vs Neeta Bhalla and another, (2005) 8 SCC 89: the Court considered the definition of the word “director” as defined in Section 2(13) of the Companies Act, 1956. It held that “…There is nothing which suggests that simply by being a director in a company, one is supposed to discharge particular functions on behalf of a company. It happens that a person may be a director in a company but he may not know anything about the day-to-day functioning of the company…”.
  1. SEBI vs. Gaurav Varshney, (2016) 14 SCC 430: The Court held that even a person without any official title or designation such as “director” in a company may still be liable, if they fulfill the main requirement of being in charge of and responsible for the conduct of business at the relevant time. Liability is contingent upon the role one plays in the affairs of a company, rather than their formal designation or status.
  1. Maharashtra State Electricity Distribution Company Limited and Anr., v. Datar Switchgear Limited and Ors., (10 SCC 479): The Supreme court held that wherever by a legal fiction the principle of vicarious liability is attracted and a person who is otherwise not personally involved in the commission of an offence is made liable for the same, it has to be specifically provided in the statute concerned and it is necessary for the the complainant to specifically aver the role of each of the accused in the complaint.

Vicarious liability must be explicitly provided for in the statute and supported by clear evidence of personal involvement and criminal intent. Also, it is necessary for the complainants to make specific averments in the complaints.  

Conclusion:

The above judgments reinforces the principle that corporate and individual liabilities are distinct. Vicarious liability of directors is not presumed and can only be imposed with statutory backing or compelling evidence of personal involvement. By placing the burden of proof on the complainant, the judiciary ensures fairness and prevents misuse of the legal system to harass directors without substantive evidence. This balanced approach safeguards both corporate governance and individual accountability.

You can read more about this subject here.

Supreme Court confirms, sale certificates from confirmed auction sales do not require mandatory registration

Barsha Dikshit and Neha Malu | resolution@vinodkothari.com

In the context of an auction sale conducted during liquidation or by a secured creditor, the sale certificate serves as a critical document, evidencing the transfer of title to the purchaser upon confirmation of the sale. Its legal nature and the procedural requirements such as registration and the payment of stamp duty have often been a subject of scrutiny and debate. 

The Hon’ble Supreme Court in the matter of State of Punjab & Anr. v Ferrous Alloy Forgings P. Ltd. & Ors. reaffirmed the principle that a sale certificate issued by the authorised officer is not compulsorily registrable under section 17(1) of the Registration Act, 1908. The Court further clarified that compliance with Section 89(4) of the Registration Act, which provides for forwarding of a copy of the sale certificate by the authorised officer to the registering authority, is sufficient to satisfy the statutory requirements. However, in instances where the purchaser voluntarily presents the original sale certificate for registration or uses the same for some other purpose, the document is liable to attract stamp duty as prescribed under the Indian Stamp Act, 1899, or the relevant state enactments governing stamp duty. 

This article examines the legal framework governing sale certificates in auction sales, analyzing the procedural and practical nuances associated with their registration and the evolving interpretations rendered by courts in the context of SARFAESI Act and Insolvency and Bankruptcy Code, 2016. 

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Interest Imbalance: Will the disproportionate interest Split in Loan Transfers be liable to withholding tax?

ITAT Ruling Clarifies Taxation on Disproportionate Interest share in Loan Transfers

– Dayita Kanodia | Finserv@vinodkothari.com

Direct Assignment of a loan or transfer of loan exposures refers to the process where financial institutions, such as banks, purchase a pool of loans or assets from other entities, typically NBFCs, without the involvement of a third-party intermediary. In this arrangement, the buying institution directly acquires the ownership of the loans or assets and the associated rights, including the right to receive future payments from the borrowers. This method allows the selling NBFC to offload its loans, thereby freeing up capital, while the purchasing institution gains the opportunity to enhance its loan portfolio and earn interest income from the acquired loans. This Direct Assignment is essentially what is popularly known as the transfer of loan exposure.

The RBI issued the transfer of loan exposures directions in 2021 regulating all transactions among regulated entities involving transfer of loan exposures.

Interest sharing and servicing after the transfer

Pursuant to a transfer of loan, it is not necessary that the future interest income arising from the loans would be shared in the same proportion as that of the transfer. For instance, if an NBFC assigns 90% of the loan portfolio to a bank, there is no mandate that all interest income received in the future would be shared in the same proportion of 90:10. Generally, the borrower is not made aware of the transfer and therefore it is important that the NBFC continues to service the loan. In such cases it is only fair that the NBFC gets a higher proportion of interest. Accordingly, it is quite common in direct assignment transactions to have a disproportionate interest share. 

The question which now arises is whether this excess interest income retained by the NBFC would be taxable under the provisions of the income tax act. 

ITAT Ruling and taxation on disproportionate interest share in loan transfers

A recent ITAT ruling of May 7, 2024 clarifies the taxation treatment for disproportionate interest share in case of loan transfers. In this case, NBFC assigned 90% of the loan portfolio to a bank via the direct assignment route. However, the bank was not receiving the entire interest on the 90% loan assigned but was only entitled to a fixed percentage of share while the NBFC retained the excess interest. Accordingly, the revenue department was of the view that the assessee was responsible to deduct TDS on the excess interest allowed to be retained by the NBFC under section 194A of the Income Tax Act. 

The revenue department further raised the question on deduction of TDS under SEction 194J and 194H of the Income Tax Act. 

Interest Retained not a result of money borrowed or debt incurred by the transferee

For the deciding the fate of the NBFC under section 194A of the Income Tax Act, the following was observed by the ITAT:

  1. For TDS to be deducted under section 194A of the Income Tax Act, the crucial aspect to be satisfied was whether the part interest allowed to be retained by the originating NBFC by the bank is payment in the nature of interest to the NBFC for any money borrowed or debt incurred by the bank.
  1. It was acknowledged that the 90% of the loan portfolio was assigned to the bank and consequently any default among the assigned loans would result in loss to the bank. 
  1. Any amount collected from the borrowers was initially getting deposited in an escrow account and was subsequently distributed between the NBFC and the bank in accordance with the agreement entered into by the entities. 
  1. It could not be shown that the interest allowed to be retained with the NBFC was a result of any money borrowed or debt incurred by the bank from the NBFC. 
  2. Accordingly, the assessee was under no obligation to deduct TDS on the excess interest retained by the NBFC under section 194A. 

Interest retained not in the nature of fees for any professional / technical services rendered by the transferor

The next issue which was adjudicated in the case was whether the interest allowed to be retained with the NBFC was a consideration for rendering professional / technical services by the transferor NBFC to the transferee bank. 

As per section 194J of the Act, any person, not being an individual or HUF, who is responsible for paying to a resident any sum, inter alia, by way of fees for professional services or fees for technical services shall at the time of credit of such sum to the account of payee deduct tax at source.

For this purpose the ITAT observed the following:

  1. The NBFC and the Bank entered into a tripartite service agreement pursuant to which the originating NBFC was appointed as servicer for the loans. The NBFC was therefore responsible for managing, collecting and receiving payment of the receivable and depositing the same in the ‘Collection and Payout Account’ to enable the distribution of the payout therefrom and providing certain other services.
  1. As per the service agreement, a one time service fee of Rs.1 Lakh was agreed to be payable by the bank to the NBFC as consideration for the services rendered.
  1. The ITAT brushed aside the contention of the revenue department that service fee of Rs 1L was inadequate and the excess interest allowed to be retained by the NBFC should in fact be considered as fee for rendering the services by the transferor NBFC. 
  1. There was a separate tripartite Deed of Assignment of receivables entered into by the parties according to which the bank paid the entire principal amount equivalent to 90% of the entire pool to the NBFC upfront. However, it was observed that the transfer being an independent commercial transaction cannot be on a cost to cost basis without there being any markup.
  1. Accordingly, the bank opted to pay the consideration for the loans assigned partially by way of an upfront payment equivalent to the principal amount of the loan assigned to it and partly by agreeing to earn a lower rate of interest on its portion of assigned loans and allowing the NBFC to retain the part interest received from the borrower.
  1. Therefore the liability under section 194J of the Income Tax Act was only for the service fee of Rs.1 L and cannot be extended to the excess interest share retained by the NBFC.
  1. Accordingly, the assessee was under no obligation to deduct TDS on the excess interest share retained by the NBFC under section 194J of the Income Tax Act. 

Interest retained not in the nature of commission / brokerage

The last issue in this case to be decided before the ITAT was whether the retained interest would fall in the category of commission or brokerage and was liable to TDS under section 194H of the Income Tax Act. 

As per section 194H of the Act, any person, not being an individual or HUF, who is responsible for paying to a resident, any income by way of commission or brokerage, shall at the time of credit of such income to the account of the payee deduct tax.

For determining the tax treatment under this section, the ITAT observed the following:

  1. It could not be said that the loans originated by the NBFC were on behalf of the bank.
  1. For the services rendered by the NBFC, it was observed that the same was pursuant to a separate service agreement which provides for payment of separate service fees in lieu of such services.
  1. Accordingly, it cannot be contended that the transferor NBFC was acting as an agent of the transferee bank.
  1. Accordingly, the liability to deduct TDS on the excess interest retained by the NBFC under section 194H of the Income Tax Act does not arise. 

Concluding Remarks 

In conclusion, the recent ITAT ruling has provided significant clarity on the taxation treatment of disproportionate interest shares in loan transfers, particularly in the context of Direct Assignment transactions. 

In this case, the ITAT emphasized that the interest retained by the NBFC was not a result of any money borrowed or debt incurred by the bank. Additionally, it was clarified that the interest retained did not constitute fees for professional or technical services rendered by the transferor NBFC, nor did it fall within the ambit of commission or brokerage.

As the financial landscape continues to evolve, such judicial pronouncements play a crucial role in fostering transparency, compliance, and fairness in taxation.

Relinquishment of source of profit in favour of an RP: also an RPT

Mahak Agarwal | corplaw@vinodkothari.com

The broad spectrum of the definition of Related Party Transactions (RPTs) under the Listing Regulation, continues to be an error prone area in terms of compliance. A recent SEBI ruling has further strengthens this aspect where the phrase ‘transfer of resources, services or obligations’ has been explained in an extremely new dimension with a commendable insight from the authorities which again shows that the regulators can no more be restricted by the imaginary boundaries placed by the corporates when it comes tightening the loose ends of corporate governance.

This article delves into the basis which the Regulators considered for concluding a mutual understanding and agreement between related parties to be an RPT notwithstanding the  contention of the company. The essential question of law involved in this case was whether the allocation of certain products and geographic areas between RPs constitutes an RPT. The article contains our analysis of SEBI’s order in the matter affirming the said stand.

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Summary of Important Supreme Court Judgements on IBC

Team Resolution | resolution@vinodkothari.com

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Rainbow versus Raman: A Riddle so crucial and so hard to resolve

– Vinod Kothari

The heart of insolvency law is the priority order or the waterfall given in sec. 53, and one of the very crucial issues in the priority of secured creditors is whether statutory claims will rank at par with secured creditors by virtue a provision in the respective laws giving the Government a status of a secured creditor, or will have to rank at the fifth priority as provided by sec. 53 (1) (e), there is a situation of uncertainty.

Essentially, the statute will have to step in, because courts can only interpret the law as seen and read by the courts; courts cannot mend the law to meet what might have been the design of the law. On the contrary, if the lawmakers leave the law as is, liquidators will have to face claims, as they already are facing, from state governments claiming equality of ranking with secured creditors, even though many liquidations might have already closed or distributed their assets.

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Clog on redemption of mortgage after publication of sale notice – SC reiterates word of law u/s 13(8)

– Team Resolution | resolution@vinodkothari.com

Introduction

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ( ‘SARFAESI Act’) provides methods that can be undertaken by a secured creditor to recover its dues in case of a default.

Section 13 of the SARFAESI Act being an important section contains provisions relating to ‘Enforcement of Security Interest’. Sub-section (2) and (4) of section 13 describes the manner and timeline within which the creditor can enforce its rights to recover the dues against a Non-Performing Asset (‘NPA’). While, on one hand, the creditor has a right to sell the secured asset; in juxtaposition is the right of the borrower to have the property released on repayment of dues. These rights are in conflict with each other and therefore, there is a need to have clarity around the point of time at which the borrower would lose the right of redemption and the lender’s right of sale becomes absolute.

At this stage, section 13(8) of the SARFAESI Act comes into picture. The present provision of section 13(8) states that where any default has been made by the borrower in terms of repayment of the dues, the amount outstanding if repaid by the borrower at any time before the date of publication of auction notice by the creditor, such a creditor shall not have any further right to transfer or to take any other step in relation to transfer of such secured asset. On a contrary, the earlier provision stated that the right of the borrower to redeem the mortgaged property shall be available till the date fixed for sale or transfer.

The provision of section 13(8) has often been debated upon wherein, several High Courts have held different views. However, a recent ruling of the Hon’ble Supreme Court in the matter of Celir Llp v Bafna Motors (Mumbai) Pvt. Ltd.[1] , has clarified the position and scope of section 13(8) before and after the amendment.

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Statutory dues cannot override section 53: Supreme Court clarifies the applicability of Rainbow ruling

– Barsha Dikshit | resolution@vinodkothari.com

Introduction 

Section 53 of Insolvency and Bankruptcy Code, 2016 (‘IBC’) has created a waterfall citing priority of dues. Whether it is distribution in liquidation process or resolution plan – both processes would need to honour the priorities under Section 53 of IBC. However, in September, 2022, in State Tax Officer v. Rainbow Papers Ltd., the Hon’ble Supreme Court (SC) held that by virtue of the ‘security interest’ created in favour of the Government under GVAT, the State is a ‘secured creditor’ as per the definition in IBC. Hence, as workmen’s dues are treated pari passu with secured creditors’ dues, so should the debts owed to the State be put at the same pedestal  as the debts owed to workmen under the scheme of section 53(1)(b)(ii). [Read our detailed analysis on Rainbow Papers ruling here]. As such, this ruling led to anomalies in interpretation, as it shuffled the already well-settled view on priorities of tax dues vis-a-vis secured creditors. 

Interestingly, the recent ruling of SC in Paschimanchal Vidyut Vitran Nigam Ltd. Vs. Raman Ispat Private Limited & Ors. [Civil Appeal Nos. 7976 of 2019] has confined the applicability of Rainbow Papers to its own factual circumstances, thereby, providing relief to all stakeholders, especially IPs undertaking liquidation/resolution processes, who started receiving demands from tax authorities on the strength of Rainbow Papers.

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Classification of fraud and reporting

Should borrower be given an opportunity of being heard?

-Rhea Shah, Executive | rhea@vinodkothari.com

Background

A recent ruling of the Supreme Court placed emphasis on the classification of an account as fraudulent and the consequences thereof. The ruling is in favour of incorporating the principles of natural justice during the process of declaring an account as fraudulent.

Fraud classification by banks and NBFCs is essentially guided by Master Directions on Frauds – Classification and Reporting by commercial banks and select FIs[1] and the Master Direction – Monitoring of Frauds in NBFCs (Reserve Bank) Directions, 2016[2], respectively (‘Fraud Directions’). However, there has been a certain extent of ambiguity as to the procedural aspects of the classification. While the basic purpose of such classification remains to ensure the early detection and reporting of a fraudulent transaction, it also entails significance in implementing a procedure that is fast and robust for the RBI to disseminate information regarding fraudulent borrowers and related parties.

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