T. R. Radhakrishnan
Reserve Bank of India introduced the scheme of wilful defaulter in pursuant of the instructions of Central Vigilance Commission during the year 1999 and subsequently modified as per the recommendations of the Working Group constituted by RBI in consultation with the Government in the year 2002. The purpose of introducing the scheme is “To put in place a system to disseminate credit information pertaining to wilful defaulters for cautioning banks and financial institutions so as to ensure that further bank finance is not made available to them.” Besides, such wilful defaulters also will lose their right to avail One Time Settlement (OTS) scheme and the bank and financial institution may also proceed against them criminally to recover the dues. RBI also has formulated various steps to be undertaken by the banks and financial institutions before declaring the accounts as wilful defaulters. But, rightly or wrongly, the banks and financial institutions overlook all RBI directives and classify the defaulted accounts as wilful defaulters as a matter of routine and they take undue advantage of the ignorance of the borrowers regarding RBI guidelines. Hence, it is imperative that the borrowers should know the norms under which they can be declared as wilful defaulter.
1. Who is a wilful defaulter?
As per RBI guidelines the wilful defaulter is defined as follows.
a. Unit:The term ‘unit’ includes individuals, juristic persons and all other forms of business enterprises, whether incorporated or not. In case of business enterprises (other than companies), banks / FIs may also report the names of those persons who are in charge and responsible for the management of the affairs of the business enterprise.
b. “The unit has defaulted in meeting its payment / repayment obligations to the lender even when it has the capacity to honour the said obligations.
c. 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 purposes for which finance was availed of but has diverted the funds for other purposes.
d. 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.
e. 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.”
Besides, RBI guidelines also have laid down further clarifications for declaration of wilful defaulter as under.
2. Diversion of Funds:
“The term ‘diversion of funds’ referred to should be construed to include any one of the undernoted occurrences:
a. Utilisation of short-term working capital funds for long-term purposes not in conformity with the terms of sanction;
b. Deploying borrowed funds for purposes / activities or creation of assets other than those for which the loan was sanctioned;
c. Transferring borrowed funds to the subsidiaries / Group companies or other Corporates by whatever modalities;
d. Routing of funds through any bank other than the lender bank or members of consortium without prior permission of the lender;
e. Investment in other companies by way of acquiring equities / debt instruments without approval of lenders;
f. Shortfall in deployment of funds vis-à-vis the amounts disbursed / drawn and the difference not being accounted for.”
3. Siphoning of Funds:
“The term ‘siphoning of funds’ should be construed to occur if any funds borrowed from banks / FIs are utilised for purposes unrelated to the operations of the borrower, to the detriment of the financial health of the entity or of the lender. The decision as to whether a particular instance amounts to siphoning of funds would have to be a judgment of the lenders based on objective facts and circumstances of the case.”
4. End-Use of Funds
The banks / financial institutions should ensure that the end use of finance advanced by way of term loan should be utilised for the purpose for which it is being sanctioned failing which the entity will be construed to have diverted or siphoned the finance for other purposes.
5. Guarantees furnished by individuals, group companies & non-group companies
In cases where guarantees furnished by the companies within the Group on behalf of the wilfully defaulting units are not honoured when invoked by the banks / FIs, such Group companies should also be reckoned as wilful defaulters.
6. Identification of wilful defaulter.
The banks and financial institutions should not declare an entity as wilful defaulter unilaterally and arbitrarily but should comply with the norms set by Reserve Bank of India. Further, “the identification of the wilful default should be made keeping in view the track record of the borrowers and should not be decided on the basis of isolated transactions / incidents. The default to be categorised as wilful must be intentional, deliberate and calculated.” The following actions are to be initiated by the banks and financial institutions before the declaration of the borrower entity as wilful defaulter as per RBI guidelines. .
a. “In cases of project financing, the banks / FIs seek to ensure end use of funds by, inter alia, obtaining certification from the Chartered Accountants for the purpose. In case of short-term corporate / clean loans, such an approach ought to be supplemented by ‘due diligence’ on the part of lenders themselves, and to the extent possible, such loans should be limited to only those borrowers whose integrity and reliability are above board. The banks and FIs, therefore, should not depend entirely on the certificates issued by the Chartered Accountants but strengthen their internal controls and the credit risk management system to enhance the quality of their loan portfolio.”
b. “The requirement and related appropriate measures in ensuring end-use of funds by the banks and FIs should form a part of their loan policy document. The following are some of the illustrative measures that could be taken by the lenders for monitoring and ensuring end-use of funds:
(i) Meaningful scrutiny of quarterly progress reports / operating statements / balance sheets of the borrowers;
(ii) Regular inspection of borrowers’ assets charged to the lenders as security;
(iii) Periodical scrutiny of borrowers’ books of accounts and the ‘no-lien’ accounts maintained with other banks;
(iv) Periodical visits to the assisted units;
(v) System of periodical stock audit, in case of working capital finance;
(vi) Periodical comprehensive management audit of the ‘credit’ function of the lenders, so as to identify the systemic-weaknesses in their credit administration.”
(vii) “In connection with the guarantors, in terms of Section 128 of the Indian Contract Act, 1872, the liability of the surety is co-extensive with that of the principal debtor unless it is otherwise provided by the contract. Therefore, when a default is made in making repayment by the principal debtor, the banker will be able to proceed against the guarantor / surety even without exhausting the remedies against the principal debtor. As such, where a banker has made a claim on the guarantor on account of the default made by the principal debtor, the liability of the guarantor is immediate. In case the said guarantor refuses to comply with the demand made by the creditor / banker, despite having sufficient means to make payment of the dues, such guarantor would also be treated as a wilful defaulter. This treatment of non-group corporate and individual guarantors was made applicable with effect from September 9, 2014 and not to cases where guarantees were taken prior to this date. Banks/FIs may ensure that this position is made known to all guarantors at the time of accepting guarantees.”
(It may be kept in mind that the aforesaid list of measures is only illustrative and by no means exhaustive.)
7. Who has to identify the Wilful Defaulters and the procedure thereof.
(i) The evidence of wilful default on the part of the concerned person / persons of borrowing company / enterprise at the relevant time should be examined by a Committee headed by an Executive Director or equivalent and consisting of two other senior officers of the rank of GM / DGM of the bank / financial institution.
(ii) If the Committee concludes that an event of wilful default has occurred, it shall issue a Show Cause Notice to the concerned person / persons of the Borrower Company / enterprise and call for their submissions and after considering their submissions issue an order recording the fact of wilful default and the reasons for the same. An opportunity should be given to the concerned person / persons of Borrower Company / enterprise for a personal hearing if the Committee feels such an opportunity is necessary.
(iii) The Order of the Committee should be reviewed by another Committee headed by the Chairman / Chairman & Managing Director or the Managing Director & Chief Executive Officer / CEOs and consisting, in addition, to two independent directors / non-executive directors of the bank / financial institution and the Order shall become final only after it is confirmed by the said Review Committee. However, if the Identification Committee does not pass an Order declaring a borrower as a wilful defaulter, then the Review Committee need not be set up to review such decisions.
(iv) With regard to a Company incorporated under the Companies Act the concerned person is one as defined under section 2(60) of the Companies Act, 2013 which states “an officer who is in default is to mean only the following categories of directors:
(a) whole-time director.
(b) where there is no key managerial personnel, such director or directors as specified by the Board in this behalf and who has or have given his or their consent in writing to the Board to such specification, or all the directors, if no director is so specified;
(c) every director, in respect of a contravention of any of the provisions of Companies Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the Board or participation in such proceedings and who has not objected to the same, or where such contravention had taken place with his consent or connivance.
Therefore, except in very rare cases, a non-whole time director should not be considered as a wilful defaulter unless it is conclusively established that:
(i) he was aware of the fact of wilful default by the borrower by virtue of any proceedings recorded in the minutes of meeting of the Board or a Committee of the Board and has not recorded his objection to the same in the Minutes; or,
(ii) the wilful default had taken place with his consent or connivance.
(iii) The above exception will however not apply to a promoter director even if not a whole time director.
(iv) As a one-time measure, Banks / FIs, while reporting details of wilful defaulters to the Credit Information Companies may thus remove the names of non-whole time directors (nominee directors / independent directors) in respect of whom they already do not have information about their complicity in the default / wilful default of the borrowing company. However, the names of promoter directors, even if not whole time directors, on the board of the wilful defaulting companies cannot be removed from the existing list of wilful defaulters.
(v) A similar process as detailed in sub-paragraphs (i) to (iii) above should be followed when identifying a non-promoter / non-whole time director as a wilful defaulter.
8. The role of the auditors.
(a) “In case any falsification of accounts on the part of the borrowers is observed by the banks / FIs, and if it is observed that the auditors were negligent or deficient in conducting the audit, they should lodge a formal complaint against the auditors of the borrowers with the Institute of Chartered Accountants of India (ICAI) to enable the ICAI to examine and fix accountability of the auditors. Pending disciplinary action by ICAI, the complaints may also be forwarded to the RBI (Department of Banking Supervision, Central Office) and IBA for records. IBA would circulate the names of the CA firms, against whom many complaints have been received, amongst all banks who should consider this aspect before assigning any work to them. RBI would also share such information with other financial sector regulators / Ministry of Corporate Affairs (MCA) / Comptroller and Auditor General (CAG)”.
(b) “With a view to monitoring the end-use of funds, if the lenders desire a specific certification from the borrowers’ auditors regarding diversion / siphoning of funds by the borrower, the lender should award a separate mandate to the auditors for the purpose. To facilitate such certification by the auditors, the banks and FIs will also need to ensure that appropriate covenants in the loan agreements are incorporated to enable award of such a mandate by the lenders to the borrowers / auditors.”
(c) “In addition to the above, banks are advised that with a view to ensuring proper end-use of funds and preventing diversion / siphoning of funds by the borrowers, lenders could consider engaging their own auditors for such specific certification purpose without relying on certification given by borrower’s auditors. However, this cannot substitute a bank’s basic minimum own diligence in the matter.”
(d) “The aspect of diversion of funds by the borrowers should be adequately looked into while conducting internal audit / inspection of their offices / branches and periodical reviews on cases of wilful defaults should be submitted to the Audit Committee of the bank.”
9. Reporting to Credit Information Companies.
Reserve Bank of India has granted certificates to four credit information companies and the banks and financial institutions are required to submit the list of suit-filed accounts and non suit filed accounts of wilful defaulters of Rs.25 lakh and above on a monthly or more frequent basis to all the four Credit Information Companies. This would enable such information to be available to the banks / FIs on a near real time basis. However, it is clarified that banks and financial institutions need not report cases where (i) outstanding amount falls below Rs.25 lakh and (ii) in respect of cases where banks have agreed for a compromise settlement and the borrower has fully paid the compromised amount and Credit Information Companies (CICs) have also been advised to disseminate the information pertaining to suit filed accounts of wilful defaulters on their respective websites.
In view of RBI initiative to declare the accounts as wilful defaulters as per the aforesaid norms, it is imperative and advisable that the borrowers should undertake an introspective and retrospective analysis of conduct of their accounts and to take such steps to avoid them being classified as wilful defaulters which if not taken, will have a far reaching adverse impact on their business. At the same time they can also be alert to the wrongful declaration of their accounts coming under the category of wilful default by the banks and financial institutions depriving of their access to funds.
(The author invites comments from readers and he can be contacted through his e-mail id firstname.lastname@example.org or mobile – 9229248048)