Wilful Defaulters and Non-Cooperative Borrowers

RBI

Background

The Central Vigilance Commission had, in the year, 1998 directed Reserve Bank of India (RBI) to collect information on wilful defaults of loans of Rs.25 lakhs and above and disseminate it to the reporting Banks and FIs. Pursuant to the said direction, a scheme was framed by RBI with effect from 1st April 1999 under which Banks and notified All India Financial Institutions were required to submit to RBI the details of Wilful Defaulters. The scheme was modified by RBI regularly, based on feedbacks received from different stakeholders.

In 2014, RBI has issued detailed guidelines on Framework for Revitalising Distress Assets in the Economy, wherein it has for the first time coined the term Non-Cooperative Borrower, with a view to ensuring better corporate governance structure in companies and ensuring accountability of independent/professional directors, promoters, auditors, etc. by providing for new classification and additional provisioning for loans granted to non-cooperative borrowers.RBI has also advised Banks/FIs to classify/declassify a borrower as non-cooperative borrower and report information on such borrowers to Central Repository of Information on Large Credits.

Who is a wilful defaulter?

A ‘wilful defaulter’ is defined as a borrower who intentionally defaults on its repayment obligation, despite adequate cash flows, or has diverted/siphoned off funds, or not utilised the funds for the purpose for which it was taken. Recently, RBI widened the scope of wilful defaulters by covering ‘guarantors’ under its purview.

According to RBI a ‘wilful default’ would be deemed to have occurred if any of the following events is noted:

  1. The unit has defaulted in meeting its payment / repayment obligations to the lender even when it has the capacity to honour the said obligations.
  2. 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.
  3. 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.
  4. The unit has defaulted in meeting its payment / repayment obligations to the lender and has also disposed of 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.

In the above explanation, the term ‘Unit’ includes individuals, juristic persons and all other forms of business enterprises, whether incorporated or not and the term ‘Lender’ covers all banks/FIs to which any amount is due, provided it is arising on account of any banking transaction, including off-balance sheet transactions such as derivatives, guarantees and letters of credit.

RBI has clarified that, 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 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.

Mechanism for identification of Wilful Defaulters

RBI has advised Banks and FIs to put in place a transparent mechanism for the entire process of identification of wilful defaulter and imposition of penal provisions. It has advised to ensure that 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 mechanism for identification of Wilful Defaulters should generally include the following:

  1. The evidence of wilful default on the part of the borrowing company and its promoter/ whole-time director 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.
  2. If the Committee concludes that an event of wilful default has occurred, it shall issue a Show Cause Notice to the concerned borrower and the promoter / whole-time director 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 borrower and the promoter / whole-time director for a personal hearing if the Committee feels such an opportunity is necessary.
  3. 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 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.

Whether Directors of a Company can be categorised as wilful defaulters?

The following categories of directors, who come under Section 2(60) of the Companies Act, 2013, which defines an officer who is in default, can be categorised as a wilful defaulter:

  1. whole-time director
  2. 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;
  3. 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.

It is made clear by RBI that, except in very rare cases, a non-whole time director should not be considered as a wilful defaulter unless it is conclusively established that:

  1. 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,
  2. the wilful default had taken place with his consent or connivance.

However, the above exception will not apply to a promoter director even if not a whole time director.

What are the penal measures against wilful defaulters?

Banks and FIs are required to take following actions against the wilful defaulters:

  1. No additional facilities should be granted by any bank / FI to the listed wilful defaulters. In addition, such companies (including their entrepreneurs / promoters) 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, Financial Institutions, NBFCs, for floating new ventures for a period of 5 years from the date of removal of their name from the list of wilful defaulters as published/disseminated by RBI/CICs.
  2. The legal process, wherever warranted, against the borrowers / guarantors and foreclosure for recovery of dues should be initiated expeditiously. The lenders may initiate criminal proceedings against wilful defaulters, wherever necessary.
  3. Wherever possible, the banks and FIs should adopt a proactive approach for a change of management of the wilfully defaulting borrower unit.
  4. A covenant in the loan agreements, with the companies to which the banks / FIs have given funded / non-funded credit facility, should be incorporated by the banks / FIs to the effect that the borrowing company should not induct on its board a person whose name appears in the list of Wilful Defaulters and that in case, such a person is found to be on its board, it would take expeditious and effective steps for removal of the person from its board.

Whether criminal action can be initiated by Banks / FIs against wilful defaulters?

RBI has advised Banks / FIs to seriously and promptly consider initiating criminal action against wilful defaulters or wrong certification by borrowers, wherever considered necessary, based on the facts and circumstances of each case under Sections 403 and 415 of the Indian Penal Code, 1860.

It should also be ensured that the penal provisions are used effectively and determinedly but after careful consideration and due caution. Towards this end, banks / FIs are advised to put in place a transparent mechanism, with the approval of their Board, for initiating criminal proceedings based on the facts of the individual case.

Who is a Non-Cooperative Borrower?

RBI notification dated 22.12.2014 defines a ‘non-cooperative borrower’ as one who does not engage constructively with his lender, by defaulting in timely repayment of dues while having ability to pay, thwarting lenders’ efforts for recovery of their dues by not providing necessary information sought, denying access to assets financed / collateral securities, obstructing sale of securities, etc. In effect, a non-cooperative borrower is a defaulter who deliberately stone walls legitimate efforts of the lenders to recover their dues.

What is the procedure for identification of a Non-Cooperative Borrower?

The following measures procedure is to be followed by Banks/FIs in classifying/declassifying a borrower as non-cooperative borrower and reporting information on such borrowers to Central Repository of Information on Large Credits (CRILC):

  1. The cutoff limit for classifying borrowers as non-cooperative would be those borrowers having aggregate fund-based and non-fund based facilities of Rs.50 million from the concerned bank/FI. A non-cooperative borrower in case of a company will include, besides the company, its promoters and directors (excluding independent directors and directors nominated by the Government and the lending institutions). In the case of business enterprises (other than companies), non-cooperative borrowers would include persons who are in-charge and responsible for the management of the affairs of the business enterprise.
  2. Banks / FIs need to put in place a transparent mechanism for classifying borrowers as non-cooperative. A solitary or isolated instance should not be the basis for such classification. The decision to classify the borrower as non-cooperative borrower should be entrusted to a Committee of higher functionaries headed by an Executive Director and consisting of two other senior officers of the rank of General Managers/ Deputy General Managers as decided by the Board of the concerned bank/FI.
  3. If the Committee concludes that the borrower is non-cooperative, it shall issue a Show Cause Notice to the concerned borrower (and the promoter/whole-time directors in case of companies) and call for his submission and after considering his submission issue an order recording the borrower to be non-cooperative and the reasons for the same. An opportunity should be given to the borrower for a personal hearing if the Committee feels such an opportunity is necessary.
  4. The order of the Committee should be reviewed by another Committee headed by the Chairman / CEO and MD and consisting, in addition, of two independent directors of the Bank/FI and the order shall become final only after it is confirmed by the said Review Committee.
  5. Boards of banks/FIs should review on a half-yearly basis the status of non-cooperative borrowers for deciding whether their names can be declassified as evidenced by their return to credit discipline and cooperative dealings.

Consequences of declaration as a Non-Cooperative Borrower

If any particular entity is reported as non-cooperative borrower, any fresh exposure to such a borrower will by implication entail greater risk necessitating higher provisioning by banks/FIs. Therefore they will be required to make higher provisioning as applicable to substandard assets in respect of new loans sanctioned to such borrowers as also new loans sanctioned to any other company that has on its board of directors any of the whole time directors/promoters of a non-cooperative borrowing company or any firm in which such a non-cooperative borrower is in charge of management of the affairs. However, for the purpose of asset classification and income recognition, the new loans would be treated as standard assets.

Early Warning signals for wrongdoings in loan accounts

RBI in its notification dated 07th May 2015 on Framework for dealing with loan frauds has provided some early warning signals which should alert the bank officials about some wrongdoings in the loan accounts which may turn out to be fraudulent, which are given below:

  1. Default in payment of the banks/ sundry debtors and other statutory bodies, etc., bouncing of the high-value cheques
  2. Raid by Income tax /sales tax/ central excise duty officials
  3. Frequent change in the scope of the project to be undertaken by the borrower
  4. Under insured or over insured inventory
  5. Invoices devoid of TAN and other details
  6. Dispute on title of the collateral securities
  7. Costing of the project which is at wide variance with standard cost of installation of the project
  8. Funds coming from other banks to liquidate the outstanding loan amount
  9. Foreign bills remaining outstanding for a long time and tendency for bills to remain overdue
  10. Onerous clause in issue of BG/LC/standby letters of credit
  11. In mercantile trade, import leg not revealed to the bank
  12. Request received from the borrower to postpone the inspection of the godown for flimsy reasons
  13. Delay observed in payment of outstanding dues
  14. Financing the unit far away from the branch
  15. Claims not acknowledged as debt high
  16. Frequent invocation of BGs and devolvement of LCs
  17. Funding of the interest by sanctioning additional facilities
  18. Same collateral charged to a number of lenders
  19. Concealment of certain vital documents like master agreement, insurance coverage
  20. Floating front / associate companies by investing borrowed money
  21. Reduction in the stake of promoter / director
  22. Resignation of the key personnel and frequent changes in the management
  23. Substantial increase in unbilled revenue year after year.
  24. A large number of transactions with inter-connected companies and large outstanding from such companies.
  25. Significant movements in inventory, disproportionately higher than the growth in turnover.
  26. Significant movements in receivables, disproportionately higher than the growth in turnover and/or increase in ageing of the receivables.
  27. The disproportionate increase in other current assets.
  28. Significant increase in working capital borrowing as the percentage of turnover.
  29. Critical issues highlighted in the stock audit report.
  30. Increase in Fixed Assets, without corresponding increase in turnover (when a project is implemented).
  31. The increase in borrowings, despite huge cash and cash equivalents in the borrower’s balance sheet.
  32. Liabilities appearing in ROC search report, not reported by the borrower in its annual report.
  33. Substantially related party transactions.
  34. Material discrepancies in the annual report.
  35. Significant inconsistencies within the annual report (between various sections).
  36. Poor disclosure of materially adverse information and no qualification by the statutory auditors.
  37. Frequent change in accounting period and/or accounting policies.
  38. Frequent request for general purpose loans.
  39. Movement of an account from one bank to another.
  40. Frequent ad hoc sanctions.
  41. Not routeing of sales proceeds through bank
  42. LCs issued for local trade / related party transactions
  43. High-value RTGS payment to unrelated parties.
  44. Heavy cash withdrawal in loan accounts.
  45. Non-submission of original bills.

 

 

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About maheshspeak

I write randomly on law, jurisprudence, polity, travel, food and anything else interesting. You can also visit my personal homepage at maheshsreenivasan.com
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2 Responses to Wilful Defaulters and Non-Cooperative Borrowers

  1. Well Written Mahesh

    Like

  2. RAFFIUDDIN KHAN says:

    Thank you Mahesh Sir, for ellaborately writing the two types of borrowers.

    Like

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