Thursday, December 13, 2012

‘Willful defaults’ even cover those cases where ‘lender-borrower’ relationship is missing among parties and banks

In the instant case the moot question which arose before the Supreme Court was as under:

“Whether the expression ‘lender’ used in para 2.1 of RBI’s Master Circular dated 01.07.2008 on willful defaults should be restricted to a bank which had lent funds by way of loans and advances or it could be extended to cover a bank to which customer owes money under a derivative transaction”

Deliberating on the above issue the Supreme Court held as under:

1) The purpose of RBI’s Master Circular on willful defaults was  “to put in place a system to disseminate credit information pertaining to willful defaulters for cautioning banks and financial institutions so as to ensure that further bank finance is not made available to them”;

2) This Master Circular was issued pursuant to Central vigilance commission’s instructions, which covered “all cases of willful default of Rs. 25 lakhs and above” and were not confined to only willful default by a borrower of his dues to the bank in a lender-borrower relationship;

3) The mischief that was sought to be remedied was that banks should not be exploited by parties who have the capacity to pay their dues to the banks but who willfully avoid paying their dues to the banks;

4) It is crystal clear from a bare reading of para 2.6 of the Master Circular that non-funded facilities such as a guarantee is covered by the Master Circular and when a guarantee is invoked by a bank/financial institution but is not honoured, the defaulting constituent of the bank is treated as a willful defaulter even though it may not have borrowed funds from the bank in the form of advances or loans.

On basis of above, it was held that ‘willful defaults' of parties under a derivative transaction with a bank are covered by the Master Circular - Kotak Mahindra Bank Ltd. v. Hindustan National Glass & Ind. Ltd. [2012] 28 140 (SC)

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