What is a Wilful Default?

Wilful default, sometimes referred to as wilful misconduct, occurs when a party in a contract, agreement, or any obligation fails to do what they were supposed to or ordered to do. The person who was under obligation to do something i.e. the obligor intentionally failed when there is wilful default.

The word default means non-fulfilment of an obligation.

Wilful default is more than carelessness or negligence. The word 'wilful' means that the person failed on purpose and they did it willingly. When they did a particular act, they were aware that it was in breach of the agreement or obligation but still they went ahead.

The RBI defines a wilful default as a situation where a borrower fails to meet repayment obligations despite having the capacity to do so, diverting the loan for purposes other than its intended use, siphoning off funds that are no longer available in other forms, or disposing of assets securing a term loan without informing the lender.

Who is a Wilful Defaulter?

Essentials of a Wilful Defaulter are as follows:

• Intentional Non-Payment: The borrower deliberately avoids paying back the loan, even though they have the means to do so.
• Diversion of Funds: The money borrowed is used for purposes other than what it was intended for.
• Misleading Information: The borrower provides false information or hides important facts to get the loan or to avoid paying it back.
• Disposal of Assets: The borrower sells or transfers assets given as collateral for the loan without the lender's knowledge or permission, reducing the lender's chance of recovering the loan.

Thus, a Wilful Defaulter means a borrower who has access to funds to repay their loans but still chooses not to, and defaults on the repayment of the loan.

Importance of Addressing a Wilful Defaulter

• Protection of Financial Stability
• Maintaining Asset Quality
• Safeguarding Public Money
• Ensuring Fairness and Equity
• Preventing Moral Hazard

What is Master Circular on Wilful Defaulter?
The Reserve Bank of India (RBI) Master Circular on Wilful Defaulters provides a framework for identifying, declaring, and acting against borrowers who have deliberately defaulted on their loan obligations.

The Reserve Bank of India (RBI) has now released Directions called as the Reserve Bank of India (Treatment of Wilful Defaulters and Large Defaulters) Directions, 2024. This is also available in the website of the Reserve Bank. It has announced stricter measures against wilful defaulters.

This Master Direction on wilful defaulters serves as a comprehensive guideline delineating the regulatory framework and procedures for classification of borrowers as wilful defaulters. This directive plays a crucial role in maintaining the integrity of the financial system by outlining the measures and consequences for those borrowers who deliberately default on their financial obligations.

The Master Direction was released for comments from stakeholders and members of the public in September 2023. Based on feedback received, the final Reserve Bank of India (Treatment of Wilful Defaulters and Large Defaulters) Directions, 2024 is published on 30th July, 2024 in the website of RBI.

The primary objective of these Directions is to provide for a non-discriminatory and transparent procedure, having regard to the principles of natural justice, for classifying a borrower as a wilful defaulter by the lenders.

These Directions shall come into force after 90 days from placing it on the website of the Reserve Bank.

Can a person paying interest of a loan regularly but unable to pay the entire EMI be declared as a Wilful Defaulter?
A person who is regularly paying the interest on a loan but is unable to pay the entire EMI (Equated Monthly Instalment) cannot automatically be declared a wilful defaulter under the RBI guidelines.

The RBI's definition of a wilful defaulter is specific and involves several criteria that must be met before such a declaration can be made.

Section 3 (t) of the Reserve Bank of India (Treatment of Wilful Defaulters and Large Defaulters) Directions, 2024 defines "wilful default" as follows:
(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:

1. the borrower has the capacity to honour the said obligations;
2. the borrower has diverted the funds availed under the credit facility from lender;
3. the borrower has siphoned off the funds availed under the credit facility from lender;
4. the borrower has disposed of immovable or movable assets provided for the purpose of securing the credit facility without the approval of the lender;
5. The borrower or the promoter 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 or has disposed of immovable or movable assets provided for the purpose of securing the credit facility, without the approval of the lender or has failed in 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. Section 3 (u) of the Reserve Bank of India (Treatment of Wilful Defaulters and Large Defaulters) Directions, 2024 defines "wilful defaulter" as:

1. a borrower or a guarantor who has committed wilful default and the outstanding amount is ₹25 lakh and above, or as may be notified by Reserve Bank of India from time to time, and
2. where the borrower or a guarantor committing the wilful default is a company, its promoters, and the director(s), subject to the provisions of para 4 (1) (c) below. In case of an entity (other than companies), persons who are in charge and responsible for the management of the affairs of the entity.

(2) Words and expressions used herein and not defined in these Directions, but defined in the Reserve Bank of India Act, 1934 or the Banking Regulation Act, 1949 or the Credit Information Companies (Regulation) Act, 2005, or the Companies Act, 2013, shall have the meanings assigned to them in those Acts.

Hence, a person who is regularly paying the interest on a loan but is unable to pay the entire EMI (Equated Monthly Instalment) cannot be declared a wilful defaulter under the RBI guidelines.

The inability to pay the full EMI due to genuine financial constraints, especially when the borrower is consistently paying the interest component, would not typically meet the criteria for wilful default. Wilful default generally requires intent or deliberate actions that indicate the borrower is intentionally avoiding repayment despite having the means to do so.

However, if there are concerns about the borrower's financial situation, the bank may explore restructuring the loan, negotiating new repayment terms, or other options rather than declaring the borrower a wilful defaulter.

Judicial Approach
Ratul Puri Vrs. Punjab National Bank on 29 February, 2024
Facts of the Case:
Ratul Puri, a prominent businessman and the nephew of former Madhya Pradesh Chief Minister Kamal Nath, approached the court seeking relief against a declaration by Punjab National Bank (PNB). Ratul Puri, the petitioner is also the former executive of Moser Baer India Ltd. Punjab National Bank (PNB), the respondent, is a major public sector bank in India. PNB's Review Committee under the RBI Master Circular had classified Ratul Puri as a "wilful defaulter" after his companies defaulted on loans amounting to INR 1,500 crores.

The bank initiated proceedings against Puri, alleging that he deliberately withheld repayment, despite the financial capability to do so, and that his conduct was fraudulent under the Reserve Bank of India's (RBI) guidelines. The bank initiated proceedings under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 to recover the outstanding dues.

Ratul Puri challenged the classification, claiming that the default occurred due to economic conditions and the downturn in the sector in which his companies operated. He contended that he had no fraudulent intent and that the classification as a wilful defaulter was arbitrary and unfair. Further, he argued that PNB failed to provide him with sufficient opportunity to present his case before the committee constituted for this purpose, thus violating principles of natural justice.

Issues:

1. Whether PNB's classification of Ratul Puri as a wilful defaulter was in accordance with RBI guidelines?
2. Whether the bank followed due process in initiating proceedings under the SARFAESI Act?
3. Whether economic conditions alone can absolve a borrower from being classified as a wilful defaulter?

Judgement:
The Court dismissed Ratul Puri's plea and upheld the decision of Punjab National Bank. It upheld PNB's classification of Puri's account as an NPA, finding it in line with RBI guidelines on income recognition and asset classification. However, the court directed PNB to reassess certain disputed transactions and provide a detailed account statement to Puri within 30 days.

The court emphasized the need for banks to maintain transparency in their dealings with borrowers, especially in cases involving large sums and complex transactions. While the court did not grant full relief to Puri, it directed PNB to consider any representation made by him regarding the reassessed transactions within a reasonable timeframe.

The court held that PNB had followed due procedure as per the RBI Master Circular on Wilful Defaulters, and the bank had provided sufficient opportunity for Puri to be heard (including proper notice and opportunity for representation).

It further stated that economic conditions, while relevant, do not automatically excuse a borrower from wilful default if other factors, such as diversion of funds, are evident.

The court also noted that Puri's companies had not utilized the loans for the purposes for which they were sanctioned, and there was sufficient material to conclude that he acted in a manner amounting to wilful default. The classification was found to be justified under the legal and procedural frameworks established by the RBI.

The court also advised both parties to explore the possibility of a one-time settlement to resolve the dispute amicably. The judgment balanced the rights of the borrower with the bank's need to recover bad loans, emphasizing due process and transparency in banking operations.

Analysis:
The case Ratul Puri vs. Punjab National Bank concerns the declaration of Ratul Puri as a "wilful defaulter" by the bank's Review Committee under the RBI Master Circular. The Delhi High Court dealt with this issue and pronounced its judgment on 29 February 2024.

Ratul Puri, who was involved with Moser Baer India Limited (MBIL) and its subsidiary, Moser Baer Solar Limited (MBSL), was declared a wilful defaulter based on alleged financial misconduct, including the diversion of funds. The Review Committee's decision was primarily based on a Forensic Audit Report, which the petitioner challenged as lacking concrete evidence. Puri argued that the transactions in question, particularly the lease agreements, were legitimate and not fraudulent as claimed by the bank. The Forensic Audit, according to Puri, failed to access relevant documents preceding the review period, and its findings were thus incomplete.

The Court emphasized that a declaration of wilful default requires a thorough and independent assessment, based on objective facts. The Court found that the bank's decision lacked substantial evidence to prove intentional wrongdoing and that the Forensic Audit alone could not justify such a conclusion. Consequently, the Delhi High Court quashed the Review Committee's order, noting that other banks involved in the same financial arrangements had dropped similar allegations against Puri.

In this case, the Honourable High Court has made a significant ruling addressing whether relying solely on the observations from a Forensic Audit Report is sufficient for a bank to conclude an event of wilful default or not. This judgment by the Delhi High Court has far reaching implications for the banking sector particularly regarding the determination of wilful default and the role of Forensic Audit Report in this process.

Some of the key points that are covered in this judgment are:

1. Sole basis for wilful default determination: The Court has scrutinised that whether observations in a Forensic Audit Report are alone to establish wilful default or not. It stated that such reports can only offer supporting evidence and they cannot serve as the sole basis for making such determinations.
    
2. Whether independent verification required or not: The lender bank was directed to conduct an independent assessment of defaults ensuring that they align with the criteria of being intentional, deliberate, and calculated as outlined in the Master Circular.
    
3. Importance of application of mind: The Court cautioned against rushing to declare wilful default solely based on the Forensic Audit Reports, emphasizing the necessity for banks to independently apply judgment in such matters.
    
4. Prudent applications of Master Circular: The judgement underscored the importance of judiciously invoking the Master Circular, advising against its blanket application and recommending its use only in cases of clear wilful default as per its provisions.
    
5. Avoidance of penal action on solitary instances: There was a warning against initiating penal action based on which the court emphasized the need for a comprehensive assessment before resorting to penal provisions under the Master Circular.

The ruling in this case establishes the precedent for the careful and balanced applications of banking regulations in the case of wilful default. It highlights its significance of thorough scrutiny and independent assessment by Banks ensuring fairness to borrowers while upholding the integrity of banking system.

Hence, this case highlights the importance of procedural fairness in the identification of wilful defaulters, especially where significant financial stakes are involved.