Wilful Defaulter Declarations: Procedure and Defence

A wilful defaulter declaration is not a finding that a borrower failed to repay. It is a finding that the borrower failed to repay deliberately — despite capacity, or after diverting, siphoning or disposing of the money or the security. Because the declaration carries severe civil consequences and is made by the lender itself rather than by a court, the RBI framework surrounds it with procedural safeguards, and it is the breach of those safeguards, far more often than the merits, that gets declarations set aside.

This note sets out the current framework, the two-committee procedure a lender must follow, what the declaration actually does to a borrower, and the grounds on which such declarations are challenged before the High Court.

Which RBI framework currently governs wilful default?

The governing instrument is the Reserve Bank of India (Treatment of Wilful Defaulters and Large Defaulters) Directions, 2024, issued on 30 July 2024 and brought into force later that year. It replaced the Master Circular on Wilful Defaulters dated 1 July 2015, which had governed the field for close to a decade and which continues to be relevant when examining declarations made under the older regime.

Two features of the 2024 Directions matter in practice.

The scope of lenders is wider. The earlier circular was addressed principally to banks and all-India financial institutions. The 2024 Directions extend to a broader set of regulated lenders, including non-banking financial companies and asset reconstruction companies, so an NBFC borrower can now face the same classification process that was previously confined to bank credit.

The process is more tightly codified. The Directions require every lender to have a board-approved policy, prescribe the composition of the two committees, mandate a show cause notice with reasons, and require a reasoned final order. That codification cuts both ways: it gives lenders a defensible template, and it gives borrowers a precise checklist against which to test what the lender actually did.

The framework applies where the outstanding amount is Rs 25 lakh and above. A separate category — the "large defaulter" — captures borrowers with substantially larger outstandings whose accounts stand classified as doubtful or loss, and exists mainly for credit-information reporting rather than for the disabilities that follow a wilful default finding.

What must a lender establish beyond default?

A wilful default arises where the borrower has defaulted in meeting payment or repayment obligations and one of the events specified in the Directions is established. The limbs most commonly invoked are these:

The specified events should always be read from the text of the Directions as they stand on the date of the notice, because the enumeration was revised in 2024 and a show cause notice has to be tested against the limb actually invoked.

The word doing the work in every limb is and. Default is the entry condition, not the finding. A lender that establishes only the default, and nothing beyond it, has not established wilful default — and an order that simply recites the outstanding amount and concludes that the default is wilful is vulnerable for exactly that reason.

How are diversion and siphoning distinguished?

The two are frequently pleaded together and are not the same thing.

Diversion is about the purpose the funds were put to within the borrower's own affairs. Typical instances include using short-term working capital to fund long-term capital expenditure contrary to the terms of sanction, transferring funds to group companies or subsidiaries without approval, routing turnover through banks outside the consortium without permission, acquiring shares or other assets not contemplated by the sanction, and a shortfall between the amounts drawn and the amounts demonstrably deployed which the borrower cannot account for.

Siphoning is narrower and more serious: the funds left the borrower's operations altogether, for purposes unconnected to the business, in a manner detrimental to the financial position of the borrower or the lender. Establishing siphoning ordinarily requires the lender to trace the money, not merely to point to a gap in the books.

The practical significance is evidentiary. Diversion can often be answered from the borrower's own records — sanction terms, end-use certificates, audited statements, board resolutions. Siphoning is an allegation of extraction and, if the lender's material does not trace the funds out of the business, it is an allegation that has not been made out.

Who can be named besides the borrower entity?

The unit of classification is not only the corporate borrower.

Promoters and whole-time directors who were in charge of, and responsible to, the company for the conduct of its business may be named where the evidence connects them to the act constituting wilful default. The finding is personal and must rest on personal material.

Non-whole-time directors, including independent and nominee directors, are on a different footing. The framework protects them: such a director is not to be classified unless it is established that the wilful default occurred with that person's consent or connivance, or that the person was aware of it and did not record an objection. A declaration against an independent director supported only by the fact of board membership is one of the more readily challenged categories of order.

Guarantors may be classified where the guarantee has been invoked and the guarantor, having the means to honour it, declines to do so. The precondition is invocation. A guarantor against whom the guarantee was never invoked has not refused anything, and the classification lacks its factual foundation.

What is the two-committee procedure a lender must follow?

The Directions route the decision through two committees, deliberately separating the authority that proposes from the authority that decides. In practice the exercise runs in five steps.

Step 1 — Examination of the account

The lender is required to examine the aspect of wilful default in eligible accounts once they are classified as non-performing, and to complete the classification process within the period the Directions prescribe. The examination is conducted against the lender's board-approved policy and is expected to be evidence-led: statements of account, sanction and disbursement records, end-use verification, stock and book-debt statements, inspection reports and, in larger accounts, a forensic audit.

Step 2 — The Identification Committee and the show cause notice

An Identification Committee of senior officials, constituted under the board-approved policy, examines the evidence. If it forms a prima facie view that an event of wilful default has occurred, it must issue a show cause notice to the borrower and to every other person proposed to be classified — promoter, director, guarantor, or person in charge.

The notice is not a formality. It must set out the grounds relied upon and identify which limb of the definition is invoked, and the recipient must be given a reasonable period, not less than the minimum the Directions prescribe, to make written submissions. A notice that recites the definition in the abstract, without telling the borrower which acts are said to constitute diversion or siphoning, does not permit a meaningful reply.

Step 3 — The Identification Committee's reasoned proposal

After considering the submissions, if the Committee still forms the opinion that wilful default is made out, it records its reasons and makes a proposal to the Review Committee. Critically, that reasoned proposal must be served on the borrower. The borrower cannot make an effective representation to the reviewing authority without knowing what the proposing authority concluded and why.

Step 4 — Representation and personal hearing before the Review Committee

The Review Committee is chaired by the lender's Managing Director and Chief Executive Officer, or the person in charge where there is no such office, together with independent or non-executive directors. The borrower is entitled to make a written representation to it and to be offered an opportunity of personal hearing.

Two points on the hearing are commonly misunderstood. First, the borrower has no right to be represented by a lawyer at this in-house stage; the Supreme Court settled that in State Bank of India v. Jah Developers Pvt. Ltd. (2019), while simultaneously holding that the borrower must receive the Identification Committee's order and must have a real opportunity to represent against it, with the Review Committee obliged to pass a reasoned order. Second, the opportunity must be offered; if a borrower who has been properly offered a hearing does not avail of it, the Committee may proceed on the material before it.

Step 5 — The reasoned final order

Classification takes effect only on the Review Committee's order. That order must be a speaking order — it must engage with the borrower's submissions, record a finding on the specific limb relied upon, and, where deliberate non-payment is alleged, record a finding on capacity to pay. It must then be communicated to the borrower, and the name reported to the credit information companies.

What happens once the declaration is made?

The consequences are cumulative and outlast the loan.

The IBC consequence is the one promoters underestimate. Section 29A(b) does not merely restrict borrowing; it excludes the promoter from bidding for the company's own assets in its resolution process, and the connected exposure of personal guarantors to corporate debtors has to be assessed alongside it.

Because the disabilities attach to the person and not merely to the account, settling the loan does not undo the history. That asymmetry is why the classification stage is usually worth contesting properly rather than deferring to the recovery negotiation.

On what grounds are declarations set aside?

Courts are conscious that the classification is made by the creditor, in its own cause, with civil consequences of a quasi-penal character. They do not sit in appeal on the lender's commercial appreciation of the evidence. They do scrutinise the process closely. The recurring successful grounds are these.

No show cause notice, or a notice without particulars. The most common defect. A notice that does not identify the transactions relied upon, or the limb invoked, forecloses a meaningful reply.

Non-supply of the material relied upon. Where a forensic audit report or investigation report is the basis of the allegation, withholding it while relying on it is a denial of hearing. The Supreme Court's reasoning in State Bank of India v. Rajesh Agarwal (2023) — decided in the context of classifying an account as fraud — reads the audi alteram partem rule into a comparable in-house RBI classification process and requires that the borrower be furnished the report and heard before the adverse finding is recorded. The parallel with wilful default classification is close and is routinely argued.

The Identification Committee's order was never served. Without it, the representation to the Review Committee is made in the dark, which is the precise vice Jah Developers addressed.

No opportunity of personal hearing before the Review Committee, or a hearing offered on notice so short that it was illusory.

A non-speaking order. An order that records the conclusion without engaging with the reply is set aside routinely, usually with liberty to the lender to redo the exercise.

Overlap between the two committees. Where the same officer sits on, or effectively controls, both the identifying and the reviewing body, the two-stage structure collapses and the safeguard is defeated.

No finding on capacity to pay. Where the case is deliberate non-payment, the absence of any finding that the borrower could have paid is a failure to make out the limb at all.

Personal classification without personal material. Naming a non-whole-time director, or a guarantor whose guarantee was never invoked, without evidence going to that individual.

Classification after settlement, or on a stale record. Where dues were settled, or the account's status changed materially, before the order was passed.

Two cautions are worth stating plainly. Success on these grounds ordinarily produces a quashing with liberty to the lender to proceed afresh from the defective stage — it is a procedural reset, not an acquittal on the merits. And the writ court will not re-appreciate whether funds were in fact diverted; that is the lender's call on the evidence, subject to perversity.

Where and how is the challenge brought?

There is no statutory appeal against a wilful defaulter declaration. The remedy is a writ petition under Article 226 before the High Court having territorial jurisdiction over the lender's decision-making office or the cause of action.

Maintainability against a private-sector lender has to be pleaded rather than assumed. A private bank or NBFC is ordinarily not "State" under Article 12, and writ jurisdiction does not run against the purely commercial or contractual side of its business. High Courts have nonetheless entertained challenges to wilful defaulter classifications by private lenders, on the footing that the classification is not a contractual act at all: the power is exercised under statutory directions issued by the RBI and produces disabilities imposed by law. That public element is what is relied upon to sustain the writ. The point is commonly contested, so the statutory source of the power is worth setting out on the face of the petition.

Three practical points shape the petition:

1. Move promptly. There is no limitation period, but the declaration is published and acted upon by third parties. Delay both weakens the equities and multiplies the consequential damage that has to be undone.

2. Plead the process, then the merits. The strongest petitions annex the sanction letters, the show cause notice, the reply, the Identification Committee order and the Review Committee order, and demonstrate the gap on the face of the record.

3. Seek interim protection specifically. Interim relief usually needs to be framed as a stay on the operation of the declaration and on its reporting or continued dissemination to the credit information companies, not merely a stay of "further proceedings".

A checklist for a borrower served with a show cause notice

• Diarise the reply date and confirm who else in the group or on the board has been served.
• Identify which limb of the definition is invoked, and against which specific transactions.
• Demand, in writing, copies of every document relied upon — forensic audit report, inspection reports, end-use verification, the statement of account.
• Reconstruct end-use from primary records: sanction terms, disbursement advices, purchase and payment records, audited financials.
• Address capacity to pay directly, with contemporaneous evidence of the borrower's financial position on the relevant dates, wherever deliberate non-payment is alleged.
• For related-party transfers, produce the commercial rationale, the board approval, and any lender consent on record.
• For alleged disposal of security, produce the lender's approval, or show that the asset was outside the security.
• If an individual is named, deal separately with that person's role, designation and actual involvement.
• Reserve, expressly, the right to a personal hearing before the Review Committee.
• Preserve the record of service — dates, modes, and what was and was not enclosed.

How lenders reduce the risk of their own orders being quashed

For banks, NBFCs and ARCs, the discipline is symmetrical. Orders survive scrutiny when the show cause notice is transaction-specific rather than definitional; when the material relied upon is supplied with the notice; when the Identification Committee's reasons are served before the representation stage; when the Review Committee is genuinely differently constituted; and when the final order records a finding on each limb invoked and on capacity to pay. Institutions that build this discipline into their board-approved policy leave fewer openings when a classification is tested. The same file discipline supports parallel debt recovery action and any subsequent proceeding, and it is one of the points examined when institutions appoint panel counsel for recovery work.

How this sits alongside SARFAESI, DRT and IBC

A wilful defaulter declaration is not a recovery mechanism. It does not realise a rupee. It is a regulatory disability that runs in parallel with the recovery machinery — SARFAESI enforcement against the security, an application before the Debt Recovery Tribunal for the balance and against guarantors, and, where the borrower is a corporate debtor, proceedings under the Insolvency and Bankruptcy Code.

The sequencing matters. A classification made while a resolution process is live can determine whether the promoter is shut out under Section 29A. A classification made while a Section 17 challenge to SARFAESI enforcement is pending before the DRT can affect the borrower's ability to fund a settlement. Borrowers and lenders both tend to treat the classification as an administrative side-issue to the recovery; it is usually the item with the longest tail. Definitions of the recurring terms used here are collected in the legal glossary, and the broader framework is set out under NPA resolution.

This article is general information on the law and procedure, and not legal advice; the outcome in any matter turns on its own record. For queries relating to a specific wilful defaulter notice or declaration, the chambers can be reached through the contact page.