High Court of Kerala (18.05.2022) in Ravis Exports & Ors. Vs. The Union of India & Ors. [WP(C) No.2427 of 2020] held that;
In the absence of serving the order of COE on the petitioners, there could never have been a declaration of the petitioners as wilful defaulters since the Master Circular as directed by the Supreme Court contemplates declaration as wilful defaulter only after serving the copy of the order of COE and the consequent decision of the Review Committee.
The procedure adopted by the 4th respondent while declaring the petitioners as wilful defaulters has thus failed to grant an opportunity to represent on law and on facts against the decision of the COE.
Without giving or serving to the petitioners the order of the COE, petitioners cannot be expected to represent against the said decision.
The reasons for declaring the petitioners as wilful defaulters have not been specified, except by merely referring to the grounds stated in the show cause notice.
The reply/ explanation submitted by the petitioners has not been independently considered.
The Review Committee also failed to consider or assess the order of the COE independently and failed to appreciate the failure to serve the order of COE on the petitioners.
It is also surprising to note that even the guarantors have been declared as wilful defaulters without discerning the distinction between the borrower and guarantor and whether the guarantors in the instant case fell within the category of guarantors who could be declared as wilful defaulters.
Excerpts of the order;
Petitioners have been declared as wilful defaulters by a Bank based on a Master Circular issued by the Reserve Bank of India. Challenging the validity of such a declaration, petitioners have invoked the extraordinary jurisdiction under Article 226 of the Constitution of India.
# 2. The first petitioner – a proprietary concern, had availed a credit facility of Rs.14.50 crores from the 4th respondent for the purpose of its cashew processing business. Petitioners 2 to 4 mortgaged several valuable properties for availing the said credit facility and thus became the guarantors to the credit facility availed by the 1st petitioner.
# 3. According to the petitioners, cashew industries in the State of Kerala are facing severe crisis and the 1st petitioner also fell into dire straits due to which it defaulted in repayment of the loan. The floods that inundated the State in the year 2018 also contributed to the default, resulting finally in the account of the 1st petitioner being declared as non-performing. Steps were therefore initiated by the bank under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (for short, the SARFAESI Act').
# 4. In the meantime, taking note of the precarious situation of the once thriving cashew industry, the Government initiated steps to explore the possibility of reviving the said industry and appointed a Committee. While the Committee appointed by the Government was considering the measures to revive the cashew industry, the 4th respondent issued a notice to the petitioners requiring them to show cause reasons as to why they should not be declared as wilful defaulters. Five instances were specified in the show cause notice dated 21.12.2018 as grounds of default and granted an opportunity to the petitioners to submit their explanation. The first petitioner submitted a detailed explanation on 16.07.2019 controverting the various grounds raised in the show cause notice and asserted that petitioners are not wilful defaulters and also requested for consideration of the proposal for revival including the grant of an additional credit limit to enable them to comply with the packing credit obligation and to regularise the loan account.
# 5. Later, petitioners were served with a communication dated 18.10.2019 issued by the Chief Manager of the 4th respondent intimating that the Committee of Executives on Wilful Defaulters (hereinafter referred to as 'COE') had decided to declare petitioners as wilful defaulters on the grounds mentioned in the show cause notice and that an opportunity is granted to them in terms of the Reserve Bank of India Guidelines to file a representation before the Review Committee on Wilful Defaulters (hereinafter referred to as 'Review Committee') within 15 days. A subsequent communication was also issued by the Chief Manager of the 4th respondent stating that the Review Committee in its Meeting held on 27.12.2019 confirmed the decision of the COE and decided to declare the petitioners as wilful defaulters. The communications intimating the decision of the Committee of Executives on Wilful Defaulters and the decision of the Review Committee produced as Ext.P19 and Ext.P21 are challenged in this writ petition.
# 6. A counter affidavit has been filed by the Chief Manager on behalf of the 4th respondent Bank, contending inter alia that the first petitioner had availed a credit facility totalling to Rs.14.50 crores. It was stated that 1st petitioner had diverted the funds and the stocks/ proceeds of the sale and had not even taken any serious efforts for completion of erection of mechanised cashew processing units, apart from violating exchange control regulations by not carrying out exports from the funds availed for the packing credit facility. The 4th respondent also asserted that though petitioners had gained huge profits from operating the unit, no amounts were remitted by them to the Bank reflecting their intention to cheat and that it was in such circumstances that the bank decided in its meeting on 13.12.2018 to initiate proceedings to declare the petitioners as wilful defaulters and thereafter issued a show cause notice dated 21.12.2018.
# 7. The counter affidavit of the fourth respondent also pleaded that, on the basis of the representation of the 5th petitioner that they were in the process of reviving the unit, the COE took a lenient view and decided to keep the matter in abeyance till 30.09.2019. However, after the said date, since it was informed that petitioners had failed to settle the accounts as promised and instead, requested for more additional working capital, the COE decided to declare all the petitioners-the principal borrower and the guarantors, as wilful defaulters by its decision of 11.10.2019 which was communicated to the petitioners as per Ext.P19 dated 18.10.2019. The 4th respondent further pleaded that the meeting of the Review Committee was held on 27.12.2019 and taking note of the failure of the petitioners to make any representation against the decision of the COE, the Review Committee decided to declare the petitioners as wilful defaulters. According to the 4th respondent, petitioners were declared as wilful defaulters by scrupulously following the guidelines issued by the Reserve Bank of India in the Master Circular and that the decisions were taken after approaching the issue with a lenient view and in due compliance with the principles of natural justice. It was also stated that issuing the Lookout Circular (LOC) was a procedural formality on declaration of persons as wilful defaulters and that the same was in tune with the orders issued by the Ministry of Foreign Affairs.
# 8. I have heard Sri.John Prakash, the learned counsel for the petitioners, Sri.S.Manu., the learned Assistant General of India on behalf of the Union of India and Sri.G.Srikumar, the learned Senior Counsel duly instructed by Smt.R.Rema, the learned counsel for the 4th respondent.
# 9. Adv.John Prakash contended that the Committees were not constituted properly as contemplated by the Master Circular and that the order of the COE as well as the Review Committee were not given to the petitioners thereby infringing their legal rights. It was further contended that the declaration is legally invalid since it had no statutory backing. The learned counsel also argued that declaration as a 'wilful defaulter' had the effect of drastic consequences including an intrusion into the fundamental rights of a person guaranteed under Article 19(1)(g) of the Constitution and such restrictions cannot be introduced by way of Circulars.
# 10. Sri.G.Srikumar, the learned Senior Counsel on the other hand contended that, apart from there being no challenge on the validity of the circular, the 4th respondent had complied with all requirements of natural justice. The learned Senior Counsel asserted that the legal mandate of giving notice is satisfied in the instant case since the 4th respondent had communicated the order of the COE and the Review Committee through its Chief Manager which is sufficient compliance. It was also pointed out that petitioners had not even represented against Ext.P19 and hence they cannot now turn around and question the decision declaring them as wilful defaulters.
# 11. While appreciating the rival contentions, it is noticed that the Reserve Bank of India had issued a master circular dated 01.07.2013 addressed to all the banks describing it as a Master Circular on Wilful Defaulters. The purpose for issuing such a Circular was explained as one intended to place a system to disseminate credit information pertaining to wilful defaulters for cautioning banks and financial institutions to ensure that further bank finance is not made available to them. The term wilful defaulter is defined in the master circular as occurrences, if any, of the following events :
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 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 given for the purpose of securing a term loan without the knowledge of the bank/ lender.
# 12. Subsequently on 01.07.2015, the Reserve Bank of India issued another Master Circular, consolidating the instructions on how all scheduled banks are to deal with wilful defaulters. Though the definition of the term 'wilful defaulter' is the same as mentioned in the circular of 2013, the mechanism for identifying a wilful defaulter was varied and was substituted as below :-
“3. Mechanism for identification of Wilful Defaulters The mechanism referred to in paragraph 2.5 above should generally include the following :
a. 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.
b. 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/ wholetime director for a personal hearing if the Committee feels such an opportunity is necessary.
c. 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.
d. Xxx
e. xxx
# 13. The consequences that will ensue on declaration of a person as wilful defaulter is also mentioned in the Master Circular and are as follows :-
a) No additional facilities to be granted by any bank/ financial institutions.
b) Entrepreneurs/ Promoters would be barred from institutional finance for a period of 5 years.
c) Any legal proceedings can be initiated, including criminal complaints.
d) Banks and financial institutions to adopt proactive approach in changing the management of the wilful defaulter.
e) Promoter/ Director of wilful defaulter shall not be inducted by another borrowing company.
f) As per S.29A of the Insolvency and Bankruptcy Code, 2016, a wilful defaulter cannot be a resolution applicant.
# 14. The Master Circular also specifies in clause 2.1 that the identification of wilful default should be made taking note of the track record of the borrower and should not be decided on the basis of isolated transactions or incidents. The Master Circular further stipulates that the default to be categorised as wilful must be intentional, deliberate and calculated.
# 15. Thus, on a perusal of the aforesaid clauses in the Master Circular, it can be understood that the impact of declaring a person as a wilful default is drastic and may even have a tendency to impact the fundamental rights of a citizen. Though the learned counsel for petitioners questioned the validity of the Master Circular conferring power upon the banks to declare a person as wilful defaulter, since such a pleading is absent, this Court refrains from considering the said contention. Whether the Reserve Bank of India is vested with powers to confer the banks with authority to declare a person as wilful defaulter or not and whether those are reasonable restrictions are issues that are therefore kept open for consideration, in an appropriate case.
# 16. In the decision in State Bank of India v. M/s. Jah Developers Pvt. Ltd. and Ors. [AIR 2019 SC 2854], while considering the question as to whether a person is entitled to have a right to be represented by an Advocate before the Committees, it was held that the COE and the Review Committee are only in-house Committees which are purely administrative in nature, not vested with any judicial powers. In the said context it was observed as below :-
21. ….....What has typically to be discovered is whether a unit has defaulted in making its payment obligations even when it has the capacity to honour the said obligations; or that it has borrowed funds which are diverted for other purposes, or siphoned off funds so that the funds have not been utilised for the specific purpose for which the finance was made available. Whether a default is intentional, deliberate, and calculated is again a question of fact which the lender may put to the borrower in a show cause notice to elicit the borrower's submissions on the same. However, we are of the view that Art.19(1)(g) is attracted in the facts of the present case as the moment a person is declared to be a wilful defaulter, the impact on its fundamental right to carry on business is direct and immediate. This is for the reason that no additional facilities can be granted by any bank/ financial institutions, and entrepreneurs/ promoters would be barred from institutional finance for five years. Banks/ financial institutions can even change the management of the wilful defaulter, and a promoter/ director of a wilful defaulter cannot be made promoter or director of any other borrower company. Equally, under S.29A of the Insolvency and Bankruptcy Code, 2016, a wilful defaulter cannot even apply to be a resolution applicant. Given these drastic consequences, it is clear that the Revised Circular, being in public interest, must be construed reasonably. This being so, and given the fact that paragraph 3 of the Master Circular dated 01.07.2013 permitted the borrower to make a representation within 15 days of the preliminary decision of the First Committee, we are of the view that first and foremost, the Committee comprising of the Executive Director and two other senior officials, being the First Committee, after following paragraph 3(b) of the Revised Circular dated 01.07.2015, must give its order to the borrower as soon as it is made. The borrower can then represent against such order within a period of 15 days to the Review Committee. Such written representation can be a full representation on facts and law (if any). The Review Committee must then pass a reasoned order on such representation which must then be served on the borrower. Given the fact that the earlier Master Circular dated 01.07.2013 itself considered such steps to be reasonable, we incorporate all these steps into the Revised Circular dated 01.07.2015. (emphasis supplied)
# 17. A glance at the above observations of the Supreme Court reveals that the decision of the COE ought to be given to the borrower, as soon as it is made and thereafter an opportunity is to be given to the borrower to represent against the said decision, based on which the Review Committee must pass a reasoned order. The order of the Review Committee must also be given to the borrower. Apart from the above, a perusal of the Master Circular reveals that the COE must consider the explanation submitted by the borrower and give reasons for recording the fact of wilful default. The aforementioned safeguards are inbuilt mechanisms to prevent arbitrary action on the part of banking entities to declare persons as wilful defaulters merely for the asking. Yet another safeguard is provided in paragraph 2.1.3 of the Circular that the identification of wilful default should be made keeping in view the track record of the borrowers and conclusion should not be based on isolated transactions/ incidents and the default to be categorised as wilful must be intentional, deliberate and calculated.
# 18. With the aforesaid salient features of the Master Circular, when this Court appreciate the contentions raised by the learned counsel for the petitioners, it grabs the immediate attention that the impugned orders Ext.P19 and Ext.P21 fails to satisfy the safeguards provided in the Master Circular.
# 19. Admittedly, the 4th respondent has affirmed in its counter affidavit that the orders issued by the COE and the Review Committee were not given to the borrower but only communicated through the concerned branch of the bank. The fourth respondent's assertion that it is practically unworkable for the said Committees to communicate its orders directly to various defaulters is contrary to the mandate of the Supreme Court as directed in State Bank of India v. M/s. Jah Developers Pvt. Ltd. and Ors. [AIR 2019 SC 2854]. In the said decision, as can be noticed from the extracted portion, it was directed that the orders of the COE as well as the Review Committee must be given to the borrower, as soon as it is made. The intention of the Supreme Court is unequivocal that the order itself must be given to the borrower to enable him to make a representation against the said order. The 4th respondent has produced the order of the COE as Ext.R4(d) which is dated 11.10.2019, while the communication issued to the petitioners is Ext.P19 dated 18.10.2019. A comparison of Ext.P19 with Ext.R4(d) clearly shows that petitioners were never served with Ext.R4(d) order of the COE. Ext.P19 is only a gist of Ext.R4(d). The contents of Ext.R4(d) is not the same as Ext.P19. Therefore the decision of COE remains unserved on the petitioners.
# 20. In the absence of serving the order of COE on the petitioners, there could never have been a declaration of the petitioners as wilful defaulters since the Master Circular as directed by the Supreme Court contemplates declaration as wilful defaulter only after serving the copy of the order of COE and the consequent decision of the Review Committee. The procedure adopted by the 4th respondent while declaring the petitioners as wilful defaulters has thus failed to grant an opportunity to represent on law and on facts against the decision of the COE. Without giving or serving to the petitioners the order of the COE, petitioners cannot be expected to represent against the said decision. Communicating the content or conclusion of the COE to the borrower through an officer of the Bank is not a sufficient compliance of the requirement of “giving the order-to the borrower”. Ext.R4(d) order itself ought to have been given to the borrower. In such circumstances, this Court is of the considered view that the process by which petitioners have been declared as wilful defaulters is perverse and contrary to the Master Circular of the Reserve Bank of India apart from conflicting with the peremptory directions of the Supreme Court in State Bank of India v. M/s.Jah Developers Pvt. Ltd. and Ors. [AIR 2019 SC 2854].
# 21 . Even otherwise, this Court notices the total lack of application of mind in the order of COE. There is also a manifest failure to consider the explanation offered by the borrower/ guarantors. The only reason mentioned in Ext.R4(d) under the column 'latest developments' is a failure of the firm to settle the account and the request for grant of additional working capital limits. The COE had not considered the reasons or explanation offered by the petitioners or their representatives while arriving at the decision in Ext.R4(d). In the communication issued as Ext.P19, the reasons for declaring the petitioners as wilful defaulters have not been specified, except by merely referring to the grounds stated in the show cause notice. The reply/ explanation submitted by the petitioners has not been independently considered. The Review Committee also failed to consider or assess the order of the COE independently and failed to appreciate the failure to serve the order of COE on the petitioners. It is also surprising to note that even the guarantors have been declared as wilful defaulters without discerning the distinction between the borrower and guarantor and whether the guarantors in the instant case fell within the category of guarantors who could be declared as wilful defaulters. Thus, Ext.P19 and Ext.P21 are bad in law.
# 22. In the nature of the conclusion arrived at as above, the question relating to the constitution of the Review Committee is not required to be considered. The above deliberations thus compel this Court to quash Ext.P19 and Ext.P21 communications and all proceedings therein declaring the petitioners as wilful defaulters. It is ordered accordingly. However, the 4th respondent is given the liberty to consider afresh the case relating to the petitioners after issuing fresh notices as contemplated and in accordance with law, if circumstances so warrant.
The writ petition is allowed as above.
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