Wilful default[1] by borrowers[2] and the exponential rise thereof in instances of deliberately defaulting on financial obligations not only poses a significant impediment to the growth of financial institutions globally, but also serves a stark reminder of risks that pervade the lending sector! Wilful default[3], distinct from other defaults, occur when borrowers, often well within their capacity to meet their financial obligations, deliberately choose not to repay their dues, thereby disrupting the delicate equilibrium of trust and accountability that financial institutions rely on. This predicament is particularly acute for lenders in India who are already operating within a complex legal and regulatory framework.

Recognizing this pressing issue and drawing from legal precedents and insights from Judgments/ Orders from the Hon’ble Supreme Court and Hon’ble High Courts alongside representations/ suggestions received from banks and other stakeholders, the Reserve Bank of India (“RBI”) decisively responded by taking significant steps to address the issue of wilful defaulters, culminating in the issuance of ‘Master Direction on Treatment of Wilful Defaulters and Large Defaulters’[4] (“Direction”). This Direction replaces the existing Circular on wilful defaulters and is aimed at establishing a non-discriminatory and transparent procedure for classification and treatment of wilful and large defaulters. It builds upon the evolving need with regards to ensuring that the regulatory framework does not merely punish default but prevents and mitigates its occurrence.

This blog delves into the applicability of the Directions, the compliance management obligations with regards to mechanism for identification of wilful default, measures that lenders need to undertake to address such defaults including initiation of criminal proceedings (where warranted) and reporting protocols to Credit Information Companies (“CICs”) and the imposition of financial restrictions on wilful defaulters. 

Applicability:

This Direction / Master Circular casts a wide net of compliance obligations on various categories of lenders and credit-related entities with regards to identification and treatment of wilful defaulters.

1. Lenders: The provisions regarding wilful defaulters apply to lenders[5], including commercial banks, cooperative banks, and non-banking financial companies (“NBFCs”);
2. Asset Reconstruction Companies (“ARCs”), and Credit Information Companies (“CICs”)[6]: ARCs and CICs are bound only to the extent of reporting requirements contained in the Direction. While ARCs deal with distressed assets and take on the loans of defaulters, CICs gather and disseminate information on defaulters to provide insights on creditworthiness. Their role is primarily that of custodians of information to ensure that lenders and other financial entities are aware of defaulters when extending further credit.
3. All Regulated Entities (“REs”) and restrictions on financial accommodation: Compliance obligations are with regards to restricting further financial accommodation to wilful defaulters. This restrictive obligation applies to all Regulated entities (“REs”)[7] under RBI’s regulatory purview, irrespective of size / falling under the purview of ‘lender’. Once classified as a wilful defaulter, borrowers are prohibited from accessing further credit facilities.
4. Large Defaulters: The provisions regarding large defaulters (borrowers with an outstanding amount of Rs. One (1) crore or more) apply to all REs under RBI’s regulatory purview, irrespective of qualifying as ‘lender’.

Key Compliance Management Obligations for Lenders

Mechanism for identification and classification of wilful defaulter:

1. A structured internal mechanism is required to be implemented by lenders for identifying and classifying wilful defaulters, taking into account the defaulting borrower’s overall track record;
2. Lenders are required to ensure that determination of wilful defaulter is not based on isolated incidents or singular transactions and default must meet conditions of ‘wilful default’, characterized by intentional, deliberate and calculated actions;
3. Thorough investigation is required by the lender’s internal committee, followed by a show-cause notice to the defaulting borrower/ guarantor/ promoter/ director/ persons in charge and responsible for the management of the affairs of the defaulting entity;
4. After receipt and review of the borrower’s response, the identification committee submits a recommendation, which is subject to review by a review committee within the lender’s organization.
5. The review committee shall assess the facts on record, including written representations, and take a reasoned decision and communicate the same to the wilful defaulter.

Review of accounts for identification of wilful default:

1. Lenders are required to scrutinize all Non-Performing Asset (NPA) accounts with outstanding sums of Rs. Twenty-five (25) lakhs and above, or as otherwise stipulated by the RBI, for possibility of ‘wilful default.’
2. In the event wilful default is identified during the preliminary internal examination, lender is required to complete the classification and formal declaration of the borrower as a ‘wilful defaulter’, within six (6) months from the date the account is categorized as a Non-Performing Asset (“NPA”).

Measures against wilful defaulters:

In the event a borrower is classified as a ‘wilful defaulter’, a series of punitive measures are prescribed for implementation by lenders under the Direction:

1. No additional credit facilities:

• • Lenders may not extend credit facilities to ‘wilful defaulters’ or their associated entities;
  • The above-mentioned prohibition shall be effective for one (1) year after defaulting borrower’s name is removed from the List of Wilful Defaulters (“LWD”);
  • Lenders may not provide credit for new ventures involving ‘wilful defaulters’ or their associated entities for five (5) years after removal from the LWD.

2. Disqualification from restructuring: Wilful defaulters and their associated entities are ineligible for restructuring of existing loans.

3. Legal action: Lenders may initiate legal action against the borrowers/ guarantors for foreclosure/ recovery of dues expeditiously;

4. Public disclosure: Lenders are mandated to create a non-discriminatory, board-approved policy with clear criteria for publishing the photographs of wilful defaulters.

5. Implementing transparent mechanism for identification of wilful defaulters: Lenders must implement a transparent process for identifying wilful defaulters to ensure fair application of penal provisions and eliminate discretion.

Reporting of Wilful Defaulters and Large Defaulters:

Lenders and Regulated Entities are required to report wilful and large defaulters to Credit Information Companies:

1. Monthly reporting of Large Defaulters: All entities regulated by the Reserve Bank, including ‘lenders’, are required to submit the following information on ‘large defaulters’ to all Credit Information Companies (in prescribed format) every month:
   • A list of suit-filed accounts of ‘large defaulters’
   • A list of non-suit filed accounts of ‘large defaulters’ classified as doubtful or loss.
2. Monthly reporting of Wilful Defaulters: Lenders and Asset Reconstruction Companies to which the wilful defaulter account may have been transferred, are required to submit the following information to all Credit Information Companies at monthly intervals (in prescribed format):
   • a list of wilful defaulters in respect of suit filed accounts
   • a list of wilful defaulters in respect of non-suit filed account
3. Reporting of removal of Wilful Defaulter: The ‘lender’ or Asset Reconstruction Company (as the case may be) is required to notify all Credit Information Companies regarding removal of wilful defaulter’s name from the list of wilful defaulters within thirty (30) days after outstanding amount falls below Rs. Twenty-five (25) lakhs.
4. Impact of re-classification of NBFCs and Urban Co-operative Banks on Wilful Defaulter status: In the event an NBFC in the middle layer or above, or a Non-Scheduled Urban Co-operative Bank in Tier 3 or 4, is reclassified to a lower tier, they lose the authority to designate defaulting borrowers as ‘wilful defaulters.’ However, the obligation to update historical data with Credit Information Companies shall continue.
5. Preventive Measures Against Wilful Defaulters: Preventive measures play a key role in ensuring that wilful defaults are minimized. RBI has outlined several preventive measures for lenders to adopt. These include the following:

1. 1. Carrying out credit appraisal: During credit appraisal, all Regulated Entities must verify if the names of company directors, guarantors, or key management appear in the large defaulters or List of Wilful Defaulters list using DIN / PAN.

   2. Monitoring end-use of funds:

      • Rigorous monitoring of fund usage and obtaining borrower certificates confirming that funds are used for their intended purpose. If borrowers misrepresent this, lenders may consider initiating legal action, including criminal proceedings.

      • The loan policy is required to include measures to ensure the proper end-use of funds, such as:

        1. scrutiny of borrower reports and financials,

        2. regular inspection of assets pledged as security,

        3. periodic audits of accounts and ‘no-lien’ accounts.

   3. Training of personnel: Lenders may invest in training employees to recognize early warning signs of potential ‘wilful default’, such as sudden changes in financial health or suspicious transactions.

Preparing for implementation of Direction through Compliance Management System:

Adhering to compliance mandates under RBI’s Master Direction necessitates a shift from traditional, manual methods to cutting edge sophisticated compliance tools to ensure timely and accurate reporting. To navigate these regulatory changes efficiently, businesses can leverage sophisticated compliance management solutions such as Komrisk.

Komrisk is our flagship ‘Compliance Management Software/Tool/Solution’. It has a smart and automated features that offers an enterprise-level solution for regulatory compliance management. By leveraging cutting-edge technology, Komrisk empowers organisations to maintain a vigilant stance against non-compliance, identifying instances of defaults and delays with remarkable precision.

At the heart of Komrisk’s functionality lies its comprehensive repository of compliance obligations or legal content which is constantly being updated by a dedicated team of more than thirty lawyers. This repository of compliances is not a mere compendium of regulatory requirements but a dynamic and user-centric platform that presents compliance obligations bifurcated into different types on the basis of timeline, type of law, category of compliance (registration, filing, etc.) in easily actionable formats alongside corresponding penalties for non-compliance.

Further, Komrisk facilitates the uploading of tangible evidence of compliance, validating the completion of tasks with precision. The ability to upload and store evidence of compliance fortifies an organisations regulatory compliance posture, thereby providing incontrovertible proof of adherence to regulatory norms.

A hallmark of Komrisk is its flexible escalation mechanism, spanning up to ten hierarchical levels, thereby ensuring that compliance issues / non-compliance incidents are escalated through appropriate channels, enabling timely intervention and resolution. Further, it offers real-time dashboard reports, aggregated and real-time view of compliance status, delivering insights that are pivotal in empowering senior management with the ability to monitor compliance status in real-time and make informed decisions, swiftly address emerging issues and maintain a proactive stance on compliance matters.

To know more see our webinar on RBI’s Latest Directions: Strengthening Fraud Risk Management & Addressing Wilful Defaulters: RBI’s Latest Directions: Strengthening Fraud Risk Management & Addressing Wilful Defaulters – Lexplosion, and reach out to us at inquiries@lexplosion.in to implement a compliance management solution for your organization.

[1] wilful default-

(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.

[2] borrower means one who has availed credit facility from a lender.

[3] wilful defaulter means-

1. i) 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 RBI from time to time, and
2. ii) where the borrower or a guarantor committing the wilful default is a company, its promoters and the director (s). In case of entity (other than companies), persons who are in charge and responsible for the management of the affairs of the entity.

[4] large defaulter means a defaulter with an outstanding amount of ₹1 crore and above, and-

1. where suit has been filed; or
2. whose account has been classified as doubtful or loss (in accordance with the instructions issued by the Reserve Bank from time to time).

[5] Lender has been defined as AIFI, a bank, or NBFC which has granted a credit facility to the borrower.

[6] credit information company means a company that has been granted a certificate of registration under Section 5 of the Credit Information Companies (Regulation) Act, 2005.

[7] All entities regulated by the RBI irrespective of whether they fall within the definition of ‘lender’.

 

Written by: Nishtha Chakrabarti

Co-authored by: Abhishek Roy

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