Bombay High Court: Banks, Financial Institutions Must Provide Reasoned Orders While Declaring Wilful Defaulter

Bombay High Court: Banks, Financial Institutions Must Provide Reasoned Orders While Declaring Wilful Defaulter

The Bombay High Court has stressed the importance of banks and financial institutions issuing reasoned orders prior to categorizing an individual or entity as a wilful defaulter under the Reserve Bank of India's Master Circular.

The Court noted that being identified as a wilful defaulter restricts access to the financial sector. As a result, banks must exercise discretion judiciously, adhering to the directives laid down by the RBI in the circular.

In a judgment dated March 4, a division bench consisting of Justices B. P. Colabawalla and Somasekhar Sundaresan emphasized that banks and financial institutions intending to utilize the Master Circular to declare a wilful default must provide the reasoned orders issued by their Identification Committee and Review Committee.

During the proceedings, the Court considered a petition filed by Milind Patel, the former joint managing director of IL&FS Financial Services Limited (IFIN), challenging an order issued by the Union Bank of India in February 2023. The order classified the firm and its promoters as wilful defaulters under the 2015 Master Circular issued by the RBI.

According to the RBI's circular, banks and financial institutions are obligated to provide information on wilful defaulters on a quarterly basis, a directive that has also been communicated to the Securities and Exchange Board of India (SEBI).

According to the plea, in July 2022, the Union Bank issued a show cause notice to IFIN and Patel, signaling its preliminary conclusion that they should be classified as wilful defaulters.

Later, in February 2023, the bank's review committee issued an official order designating the firm and its promoters as wilful defaulters.

In February 2023, the review committee of the bank issued a decree labelling the company and its promoters as wilful defaulters.

As per the high court's ruling, once a final declaration designating an entity or firm as a wilful defaulter is issued, severe penalties follow.

The High Court succinctly summarized that wilful defaulters face exclusion from the financial sector. They are ineligible for further facilities from any bank or financial institution. Corporations declared wilful defaulters, along with their promoters and directors, are barred from accessing institutional finance from scheduled commercial banks, financial institutions, and non-banking financial companies for five years after their names are removed from the wilful defaulters list.

Similarly, civil recovery proceedings and criminal actions are to be pursued against such individuals when necessary. The High Court clarified that it was focusing solely on the repercussions outlined in the Master Circular and not delving into other legal implications that may apply to wilful defaulters under different legislation.

The High Court observed that the RBI's circular also mandates banks to evaluate evidence of wilful default.

The Court further noted, “The discretion conferred on these commercial banking entities to inflict penal consequences was meant to be kept to the bare minimum, which only underlines that the exercise of discretion has to be reasonable and not arbitrary. The absence of transparency with the reasons would render the exercise of discretion arbitrary. In this light, various petitions have been dealt with by writ courts, including the Hon'ble Supreme Court of India and multiple benches of this very High Court, in connection with the declaration of borrowers as wilful defaulters. However, for purposes of these proceedings and in the interest of brevity, we highlight just a few of them.”

The high court stressed the importance of providing not only the information referenced and relied upon in the Show Cause Notice (SCN) but also any information that could potentially discredit the allegations mentioned in the SCN. This is crucial to ensuring that both parties involved have access to all relevant information necessary to ascertain the truth.

Moreover, the court clarified that the objective of the proceedings initiated through the issuance of an SCN is not solely to establish the guilt of the noticee based on the allegations presented. Instead, the aim is to ascertain the truth regarding whether or not an individual should face "penal" consequences, as outlined by the RBI.

Consistent with this stance, the Court added that if a bank has conducted a forensic investigation into suspected diversion and misappropriation of funds and if the investigation reveals specific roles played by certain individuals, there could be instances where the investigation indicates that certain individuals may not have been involved in the diversion and misappropriation. In such cases, the information supporting this plausible inference would undermine the allegations made.

“Therefore, fair and transparent symmetrical access to information, as stipulated by the Hon'ble Supreme Court in Takano would mean providing access to not only incriminating material but also exculpatory material, since all such information would be relevant for arriving at the truth. Therefore, access to the record is a vital element of complying with principles of natural justice,” the Court said.

Following the Court's decision, the Union Bank ultimately withdrew its previous directives against Patel. As per the ruling, the bank was allowed to commence new proceedings, beginning with the issuance of a show cause notice, thereby guaranteeing Patel's access to relevant material.

The bank assured the court that it would grant Patel full access to all pertinent documents on record. The Court acknowledged this assurance in its judgment before concluding the petition.