CORPORATE LAWS
RBI’s Wilful Defaulter
Circular: All director's
painted with the same brush
An analysis of Ionic Metalliks v. Union of India
[2014] 49 taxmann.com 222 (Guj.)
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1. All scheduled commercial banks (excluding RRBs and LABs)
and All India Notified Financial Institutions are empowered
vide the RBI Master Circular1 (“Master Circular”) dated 2-7-2012
to list its borrowers upon fulfilment of any of the conditions
laid down in clause 2.1 of the Master Circular, as wilful
defaulters and thereby to stop any future financial assistance
to them.‘Wilful default’ is defined in clause 2.1 of the Master
Circular as follows:
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“A wilful default would be
deemed to have occurred if
any of the following events
is noted:(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.
(b) The unit has defaulted in meeting its payment/repayment
obligations to the lender and
has not utilised the finance
from the lender for the specific
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purposes for which finance was availed
of but has diverted the funds for other
purposes.
(c) 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.
(d) 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 6 DBOD – MC
on Wilful Defaulters – 2014 given by
him or it for the purpose of securing
a term loan without the knowledge of
the bank/lenders.”
As per clauses 5.1 and 5.2 (reproduced in
the later part of this case analysis) of the
Master Circular, the Reserve Bank of India
(“RBI”) has extended the scope of classification
as wilful defaulter to all the directors and
promoters/entrepreneurs of the defaulting
company. The consequence of being classified
as a wilful defaulter in case of the directors,
as per clause 2.5(d)2 of the Master Circular,
entails them being ousted from the board of
any other borrowing company. As per clause
2.5(a)3 of the Master Circular, the promoters/
entrepreneurs can be debarred from seeking
institutional financial assistance for floating
new ventures for a period of 5 years. In
the light of an increasing number of wilful
defaults by companies, such as the Kingfisher
Airlines and a strong need to strengthen the
corporate governance regime, the judgment by
a two Judge Bench of the Gujarat High Court
(“Court”) in Ionic Metalliks v. Union of India4
(“Ionic Metalliks Case”), dated September
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banks and financial institutions, whose scope
to categorize certain borrowers as wilful
defaulters has been held to be constitutional;
and secondly, to the directors of the defaulting
companies, who can no longer be held liable
without due regard being paid to their type
and control in the company’s decision-making
which may have led to the default.
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2. The petitioners, in the instant case, had
availed of loan facilities from the respondents,
Punjab National Bank and Standard Chartered
Bank, respectively. Shortly thereafter all of
the three bank loans were declared as Non
Performing Assets (NPA) by the Respondentbanks on the ground of wilful default in
payment and siphoning off of funds, and,
subsequently, show-cause notices were served
on the petitioners as per the Master Circular.
Additionally, a notice under section 13(4)
of the Securitization and Reconstruction
of Financial Assets and Enforcement of
Security Interest Act, 2002 (which states
the possible recourse which can be taken
against a defaulting borrower) was served
by the Standard Chartered Bank upon the
petitioners. Thereafter, the petitioners filed
a Special Civil Application in the Gujarat
High Court, praying that: (a) the RBI Master
Circular, dated July 2, 2012 be declared
ultra vires the Constitution of India, 1950
(“Constitution”) and/or the Securitization
and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002
and/or the Reserve Bank of India Act, 1934
and/or the Banking Regulation Act, 1949 and/
or the Recovery of Debts Due to Bank and
Financial Institutions Act, 1993 and/or the
Credit Information Companies (Regulation)
Act, 2005 and/or the Indian Contract Act;
(b) the notice issued to the petitioners be
quashed for the reason that it was bereft
of any reasons and necessary particulars for
listing the petitioners as wilful defaulters.
2.1 Issues before the division bench of the
Gujarat High Court
2.1.1 Master Circular constitutionally valid in
general terms: The two Judge Bench while dealing
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CORPORATE LAWS
with the first contention of the Petitioners,
held that insofar as the constitutionality
of the Master Circular was concerned, the
same did not suffer from the lack of power
under Article 19(1)(g) that was ‘the right to
carry on any profession, or to carry on any
occupation, trade or business’ for the reason
that no borrower wilfully failed to make
payments and was able to claim an inherent
right to seek financial assistant from a bank
and, therefore, was intra vires the Constitution.
The Court while relying on Md. Murtaza v.
State of Assam5, noted as follows:
“It (Master Circular) targets defaulters of
dues in excess of `25 lakh, thus laying
down the threshold limit for application
of the circular. It applies to only those
defaulters who can be categorized as ‘wilful’
as defined in the circular. It, thus, does not
cover those borrowers who are unable to pay
the debt without there being any element
of wilfulness. Surely, no borrower can
claim a vested right to seek financial
assistance from a bank or a financial
institution no matter how wilful or
chronic his defaults in repayment of
past dues may have been. The circular,
therefore, in general terms, is not arbitrary.
(Emphasis supplied).”
Further, it strengthened the view that the
Master Circular contained adequate safeguards
for ensuring transparency and minimizing
discretionary powers of banks and financial
institutions in the entire manner of recovery
of debt and stated that an enactment could
not be struck down on the mere possibility
of abuse of power.
2.1.2 Master Circular partially unconstitutional:
The Court stated that the Master Circular,
insofar as it brought all the directors (not
being the promoters/entrepreneurs) regardless
of their type under its purview for declaring
them as wilful defaulters vide clauses 5.1 and
5.2, sought to oust them from the board of
any borrowing company, was arbitrary and
even the nominee and independent directors
(who may not have the same amount of
control as other directors in the decisions of
the company leading to the wilful default),
cannot be held to be uniformly liable for
the same. Clauses 5.1 and 5.2 of the Master
Circular have been reproduced below:
“5.1 Need for Ensuring Accuracy
RBI/Credit Information Companies
disseminate information on non-suit
filed and suit filed accounts, respectively,
as reported to them by the banks/FIs
and responsibility for reporting correct
information and also accuracy of facts
and figures rests with the concerned
banks and financial institutions. Therefore,
banks and financial institutions should
take immediate steps to update their
records and ensure that the names
of current directors are reported. In
addition to reporting the names of
current directors, it is necessary to
furnish information about directors who
were associated with the company at
the time the account was classified as
defaulter, to put the other banks and
financial institutions on guard. Banks
and FIs may also ensure the facts about
directors, wherever possible, by crosschecking with Registrar of Companies.
5.2 Position regarding Independent and
Nominee directors
Professional Directors who associate with
companies for their expert knowledge act
as independent directors. Such independent
directors apart from receiving director’s
remuneration do not have any material
pecuniary relationship or transactions
with the company, its promoters, its
management or its subsidiaries, which in
the judgment of Board may affect their
independent judgment. As a guiding
principle of disclosure, no material fact
should be suppressed while disclosing the
names of a company, that is a defaulter
and the names of all directors should
be published. However, while doing so,
a suitable distinguishing remark should
September 16 To 30, 2014 ‹ Taxmann’s Corporate Professionals Today ‹ Vol. 31 ‹ 64
be made clarifying that the concerned
person was an independent director.
Similarly, the names of directors who
are nominees of government or financial
institutions should also be reported but a
suitable remark ‘nominee director’ should
be incorporated. Therefore, against the
names of Independent Directors and
Nominee Directors, they should indicate
the abbreviations “Ind” and “Nom”,
respectively, in brackets to distinguish
them from other directors.”
The Court rightly observed on the point
of ‘painting all the directors with the same
brush’ as under:
“This provision in the circular shatters
the concept of the identity of a company
different and distinct from its directors
without providing any safeguards. It does
not distinguish between a director who
is involved in the day-to-day functioning
of a company as against those who are
not. The circular paints all directors with
the same brush. Therefore, we have reached
to a conclusion that the Master Circular, so
far as it is sought to be made applicable to
all the directors of the company is arbitrary
and unreasonable.”
(Emphasis supplied).
2.1.3 Master Circular and principles of natural
justice: Rejecting the submission of the petitioners
that if the RBI was to lay down a policy
declaring borrowers as wilful defaulters and the
consequences of the same, it should have done
so by enacting a law within Article 13 of the
Constitution; and that if the Master Circular
was made in public interest then it should
have stated so in the requisite wordings, the
Court stated that the RBI derives its power
to frame a legislation, such as the impugned
Master Circular (which seeks to regulate the
affairs of banks and financial institutions in
the country so far as the law permits it to),
by the virtue of sections 21 and 35A of the
Banking Regulation Act, 1949 which allow
it to control the advances of, and to give
directions to, the banks and financial institutions
which come under its purview. Further, the
Legislature may delegate the authority to
frame such legislation on a body such as the
RBI which has considerable expertise in such
financial matters. The Court, relying on the
Supreme Court’s decision in Union of India
v. Azadi Bachao Andolan6, stated that it is a
settled position of law that so long as the
powers of an authority are traceable to a
source, it is not binding upon the authority
to indicate the same in an instrument framed
by it and the same would not infringe the
principles of natural justice. Placing reliance
upon the Supreme Court’s decision in Joseph
Kuruvilla Vellukunnel v. Reserve Bank of India7,
it noted as under:
“The law is well-settled that the Reserve
Bank of India, which is described as
the supreme bank of the country, is
empowered to regulate the banking system
and certain regulatory functions have
been assigned to it by the provisions
of the Reserve Bank of India Act, 1934
and the Banking Regulation Act, 1949.
It is in exercise of such powers that the
Reserve Bank of India has thought fit
to issue the impugned Master Circular.”
2.1.4 Show-cause notice vague, unreasonable and
liable to be quashed in principle: The Court
while dealing with the issue of the validity
of the notices served upon the petitioners
by the respondents opined that the showcause notices were vague and contained no
reasons for classifying the petitioners as wilful
defaulters. Quashing the notice issued by the
Punjab National Bank and allowing it to file
a fresh show-cause notice, it noted as under:
“The show-cause notice is absolutely
vague and contains no factual or other
materials. We fail to understand on what
basis the bank has alleged in the showcause notice that the funds provided by
the bank have been siphoned off and the
same were used for the purpose other
than the project for which the loan was
sanctioned. If such are the nature of the
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CORPORATE LAWS
allegations, then at least it is expected
of the bank to provide some materials
so that the petitioners can meet with
the same. It has to be held that there
is violation of the principles of natural
justice. One of the facets of the principles
of natural justice is fairness which, we
do not find on the part of the bank in
the proposed action.”
However, in contemplating over whether it
had writ jurisdiction under Article 226 of the
Constitution over Standard Chartered Bank
which happened to be a private bank, placing
reliance upon the tests devised by the Apex
Court in its decision in Ajay Hasia v. Khalid
Mujib8, reiterated in Jatyapal Singh v. Union of
India9 and Federal Bank Ltd. v. Sagar Thomas10,
to determine whether a private bank falls
under the writ jurisdiction of the High Court,
the Court held that it did not have the writ
jurisdiction over Standard Chartered Bank in
order to quash the show-cause notice issued
by it for the reason the bank in question,
being private in nature, was not an agency
and instrumentality of the State and could
not be considered an ‘authority’ under Article
12 of the Constitution. Further, it stated
that the Standard Chartered Bank could not
be said to be a private body performing a
public duty as it was not empowered to take
actions affecting the public. It suggested to the
petitioners to take recourse to the appropriate
judicial authority in order to furnish their
grievance regarding the invalidity of the
impugned show-cause notice.
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3. From the perspective of empowering the
banks and financial institutions to recover
bad debts from wilful defaulters, the Ionic
Metallik case (supra) is a landmark judgment
in the sense that it constitutionally validates
the power of the RBI to frame legislations
such as the Master Circular in the instant
case. Even though the question regarding the
constitutional validity of the Master Circular
had arisen previously in the case of Kotak
Mahindra Bank Ltd. v. Hindustan National Glass
& Industries Ltd.11, yet the Supreme Court
declined to decide the same as it was not
raised during the proceedings in the High
Court. The practical outcome of this Judgment,
as regards imputability of all directors in
the Master Circular, is doubtful considering
that in the past banks have not necessarily
listed all the directors on the board of the
company to be liable. For instance, recently
the United Bank of India listed only four of
the directors of Kingfisher Airlines including
Vijay Mallya as wilful defaulters. Thus, this
judgment can be seen as largely in favour
of the banks and financial institutions, as
while strengthening their stand in declaring
certain borrowers as wilful defaulters, what
it merely requires them to do is to make
an amendment to the Master Circular to the
effect of not classifying all the directors as
wilful defaulters, regardless of their type,
which is not a heavy loss to the banks by
any stretch of imagination. Perhaps the only
real benefit derived from this judgment by
the borrowing companies in the country is
that the banks and financial institutions would
now be dissuaded from serving show-cause
notices upon those which are bereft of any
reasons, reducing the scope for the banks
and financial institutions to take illegal and
arbitrary measures to protect their balance
sheets.
While the Ionic Metallik case (supra) answers
some crucial questions, at the same time
certain questions remain unanswered, making
it unlikely that the litigation would stop at
this juncture. The judgment is expected to
have at least persuasive value on the private
banks as well but what needs to be kept in
mind is the possible alternative outcome of
the judgment with respect to the show-cause
notice of the Standard Chartered Bank, had
the petitioners challenged its legal validity
instead of the constitutional validity. What
also remains to be seen is the effect of the
Ionic Metallik case (supra) on the Guidelines
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on Wilful Defaulters12 issued by the RBI on
September 9, 2014 which clarifies that the
liability of guarantors is co-extensive with
that of the borrowers and that they can be
proceeded against even before exhausting the
remedies against the borrowers.
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- The views expressed are personal views of the authors.
1. ‘Master Circular on Wilful Defaulters’ RBI/2012-13/43DBOD No. CID.BC. 10/20.16.003/2012-13.
2. A covenant in the loan agreements, with the companies in which the banks/notified FIs have significant stake, should be
incorporated by the banks/FIs to the effect that the borrowing company should not induct a person who is a promoter or
director on the Board of a company which has been identified as a wilful defaulter as per the definition at paragraph 2.1
above and that in case, such a person is found to be on the Board of the borrower company, it would take expeditious
and effective steps for removal of the person from its Board.
3. No additional facilities should be granted by any bank/FI to the listed wilful defaulters. In addition, the entrepreneurs/promoters
of companies where banks/FIs have identified siphoning/diversion of funds, misrepresentation, falsification of accounts and
fraudulent transactions should be debarred from institutional finance from the scheduled commercial banks, Development
Financial Institutions, Government owned NBFCs, investment institutions etc. for floating new ventures for a period of 5
years from the date the name of the wilful defaulter is published in the list of wilful defaulters by the RBI.
4. [2014] 49 taxmann.com 222 (Guj.).
5. 2011(9) SCALE 526.
6. [2004] 10 SCC 1.
7. AIR 1962 SC 1371.
8. AIR 1981 SC 487.
9. [2013] 6 SCC 452.
10. [2003] 10 SCC 733.
11. [2013] 117 SCL 521/[2012] 28 taxmann.com 140 (SC).
12. ‘Guidelines on Wilful Defaulters – Clarification regarding Guarantor, Lender and Unit’,RBI/2014-15/221DBOD.No.CID.
41/20.16.003/2014-15.
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