1. Litigation Law Alert Dec, 2012
THE WILFUL DEFAULTER’S CASE
A case comment from Kale Law Office, New Delhi, India
(Wilful defaults of dues under a derivative transaction with a bank are covered by the
Master Circular issued by the RBI)
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2. 1
INTRODUCTION DIVERGENT VIEWS OF THE HIGH COURTS
Interpreting the Master Circular on Wilful default issued Calcutta High Court.
by the Reserve Bank of India, the Supreme Court of India
in a judgment dated 11.12.2012i has held that that the Adopting a strict and a literal interpretation of clause 2.1,
circular would not only cover normal banking transactions and placing emphasis on the use of the term "lender" in
like borrowing and lending but also derivative contracts. sub-clauses (a), (b), (c) and (d), the Calcutta High Court
was of the view that Master Circular applies only in the
Interpretation of clause 2.1 ii of the Master Circular which context of a conventional lender-borrower relationship.
defines the term ‘Wilful default’ through the use of the Consequently, default by a party availing a derivative
terminology ‘lender’ in the sub-clauses was the key facility could not be enforced by a bank under the Master
consideration before the Court. The judgment Circular.
concerns Deutsche Bank, ICICI and Kotak, which had
struck derivative deals with Finolex, Emcure Bombay High Court.
Pharma and Hind National Glass respectively. In passing
the judgment the Supreme Court has reconciled the The Bombay High Court on the other hand adopted a more
divergent views taken by the Calcutta and the Bombay liberal interpretation and held that the Master Circular
High Court and has held iii; could be invoked to enforce a defaulting party’s obligation
to repay under a derivative transaction. In holding so the
“…“Keeping in mind the mischief that the Master High Court relied upon certain pari materia circulars
Circular seeks to remedy and its purpose, we issued by the RBI, which do not relate to wilful default but
interpret the words used in the definition of relate to prudential norms, assets classification as non-
‘Wilful default’ in clause 2.1 of the circular to performing assets, etc. It is interesting to note this line of
mean not only a Wilful default by a unit which reasoning adopted by the Bombay High Court was not
has defaulted in meeting its repayment approved by the Supreme Court, as the Court was rightly of
obligations to the lender, but also to mean a unit the view that the relied upon circulars do not deal with the
which has defaulted in meeting its payment same subject matter.
obligations to the bank under facilities such as a
bank guarantee…”
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3. 2
KEY ARGUMENTS such party from whom the dues are payable to the bank is
not a borrower.
Bank(s). Reserve Bank of India
The principal contention of the banks was that the word The Reserve Bank of India referred to sub-clause (d) of
"borrower" in the Master Circular covers not only a loanee clause 2.1 of the Master Circular and argued that the words
but also any other customer of the bank enjoying a credit "bank" and "lender" have been used inter changeably in the
facility such as a derivative transaction. For this reliance Master Circular and therefore the expression "lender" in
was placed on Section 45A(b) of the Reserve Bank of India the definition of would include a bank.
Act, 1934 and Section 2(c) of the Credit Information
Companies (Regulation) Act, 2005 which defines a
"borrower" as covering a person to whom "any credit VIEWS OF THE SUPREME COURT
facility" has been granted, including any credit facility
other than a loan.
As said earlier the Supreme Court, interpreted the phrase
'Wilful default' also to bring within its sweep defaults in
Defaulting Companies
meeting payment obligations to the bank under derivative
transaction.
The applicability of the circular was resisted by the
defaulting companies attempting to draw a legal
The judgment reflects a principled and a policy oriented
distinction between the relationship between the bank and
approach to legal issues involving debt of large
a borrower in a simple loan transaction from that in a
corporations to banks which are choking up public money.
derivative transaction for the purposes of the Master
The creative interpretation role played by the Supreme
Circular. According to them a derivative transaction does
Court, which is a hybrid tool of purposive and contextual
not involve lending of funds by way of a loan or an advance
interpretation deserves a mention. The color of the term
by the bank to its constituent and, therefore, the dues
“Wilful default” was drawn from (i) the definition of "credit
under a derivative transaction will not fall in any of the
information” under Section 45A(c) of the Reserve Bank of
sub- clauses (a) to (d) of clause 2.1, which defines a Wilful
India Act 1934, its practical usage and (ii) a neutral
defaulter .This argument sought to be logically placed on a
terminology “payment obligations” being used in sub
hypothesis that whereas in a derivative transaction, the
clauses (a) (b) (c) & (d) of clause 2.1 of the mater circular.
dues payable by a party to the bank may be a debt and the
bank may be a creditor and such party may be a debtor, but
the bank in a derivative transaction is not a lender and
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4. 3
Firstly, the purpose of the Master Circular.
In the Court’s view the purpose of the Master Circular was POTENTIAL IMPACT OF THE RULING
to prohibit any kind of financial assistance to defaulting
companies though a system of credit information of wilful The ruling will certainly, strengthen the hands of the
defaulters iv. Reserve Bank in ushering in financial discipline with
respect to credit policy and credit system in India.
To arrive at this conclusion what was principally relied
upon by the Court was a Central Vigilance Commission The ruling will also help banks to put pressure on
(CVC) instruction which mandated all lending banks to corporates that are unwilling to pay up when derivative
periodically report to the RBI, default by companies when deals backfire. Needless to state, further borrowing for
the loan amount exceeded Rs 25 Lacs (2.5 Million). The defaulting companies will become difficult.
Court noted that this CVC instruction which was not
confined to a lender-borrower relationship was germane to
the first Master Circular being issued.
Secondly, the Court was also of the view that "credit
information" as appearing under Section 45A(c) of the
Reserve Bank of India Act 1934 is not restricted to matters
stated in clause 2.1 of the Master Circular, but covers other
information which a bank considers to be relevant for the
more orderly regulation of credit or credit policy.
The final nail in the coffin was the observation that the
word 'lender' in sub-clauses of clause 2.1 means the "bank"
because "payment obligations" mentioned in clause (a) do
not ordinarily refer to obligations of a lender and further
that clause (d) has used the expression "bank/lender".
©Kale Law Office, New Delhi India
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5. 4
ENDNOTES
(c) The unit has defaulted in meeting its
iKotak Mahindra Bank Ltd. Vs. Hindustan National Glass payment/repayment obligations to the lender and has
siphoned off the funds so that the funds have not been
& Industries Ltd. & Ors. [Civil Appeal No. 8916 of 2012 utilized for the specific purpose for which finance was
arising out of SLP (C) No. 29599 of 2009] availed of, nor are the funds available with the unit in
2. Emcure Pharmaceuticals Ltd. & ANR. Vs. ICICI Bank the form of other assets.
Ltd. & Ors. [Civil Appeal No. 8917 of 2012 arising out of
SLP (C) No. 27730 of 2011] (d) The unit has defaulted in meeting its
3. Finolex Industries Limited & Anr. Vs. Reserve Bank of payment/repayment obligations to the lender and has
also disposed of or removed the movable fixed assets or
India & Ors. [Civil Appeal No. 8918 of 2012 arising out of
immovable property given by him or it for the purpose
SLP (C) No. 28477 of 2011] of securing a term loan without the knowledge of the
bank/lender.
ii 2.1 Definition of wilful default
The term "wilful default" has been redefined in iii Para 35.
supersession of the earlier definition as under:
iv Para 34
A "wilful default" would be deemed to have occurred if
any of the following events is noted: “…to put in place a system to disseminate credit
(a) The unit has defaulted in meeting its information pertaining to wilful defaulters for cautioning
payment/repayment obligations to the lender even when
banks and financial institutions so as to ensure that
it has the capacity to honour the said obligations.
further bank finance is not made available to them…"
(b) The unit has defaulted in meeting its
payment/repayment obligations to the lender and has
not utilized the finance from the lender for the specific
purposes for which finance was availed of but has
diverted the funds for other purposes.
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