Issue with willful defaulter designations

Source: The post Issue with willful defaulter designations has been created, based on the article “Do we still need the ‘wilful defaulter’ framework?” published in “Indian express” on 9th May 2024.

UPSC Syllabus Topic: GS Paper 3- Indian economy and mobilisation of resources

Context: The article discusses the Bombay High Court’s decision to strike down a rule allowing public banks to issue lookout circulars against wilful defaulters. It suggests that the concept of “wilful defaulter” needs reconsideration due to outdated processes and potential misuse by banks. Issue with willful defaulter designations

What is a willful defaulter?

Willful defaulters are borrowers who intentionally avoid repaying loans despite having the financial capacity to do so. Being labeled as a wilful defaulter prevents them from accessing more loans and restricts them from participating in credit and equity markets. The Reserve Bank of India (RBI) and Securities and Exchange Board of India (SEBI) enforce these penalties.

For information on defaulters, RBI prioritises public interest read this article here

What are the different court rulings regarding willful defaulters?

1. Takano v SEBI: The Supreme Court ruling on inspection rights in securities law influenced later cases. It ensured that regulatory authorities follow fairness principles and allow access to relevant investigation materials.

Jah Developers Case (2019): The Supreme Court decision emphasized the need for proper procedural safeguards. It ensured that wilful defaulters receive fair treatment before being classified.

Viraj Chetan Shah v Union of India: The Bombay High Court invalidated the rule allowing public banks to request lookout circulars (LoCs) against wilful defaulters.

It held that this practice violated the fundamental rights to equality (Article 14) and life (Article 21).

Milind Patel v Union Bank of India: This case clarified that commercial lenders must follow natural justice principles. Borrowers should have access to all investigation material before being designated as wilful defaulters.

Why are wilful defaulter designations controversial?

Lender Bias: Banks classify borrowers as wilful defaulters despite being parties to credit contracts, leading to potential bias. This violates the principle of nemo judex in causa sua, meaning no one should judge their own case. Banks might deflect blame for their poor credit appraisal onto borrowers.

Institutional Misalignment: Initially, the designation was for information sharing but has evolved into a blacklist system, preventing access to loans and markets. This shift occurred without adapting the safeguards required for fair treatment.

Alternatives Exist: The Insolvency and Bankruptcy Code, 2016, provides a more structured process for handling defaults. With this code in place, the article questions the practicality of the wilful defaulter framework.

For details information on the Insolvency and Bankruptcy Code read this article here

Question for practice:

Discuss the controversies surrounding the designation of wilful defaulters in India.