2024 (2) TMI 1576 - HC - Companies Law

Review Committee order declaring petitioner wilful defaulter under RBI Master Circular set aside for procedural lapses under Clauses 3(a)/(b)

Ratul Puri Versus Bank of Baroda through General Manager Sh. V.K. Khandelwal Stressed Assets Management Branch & Its Nominated Counsel Mr. Kush Sharma KSA Law Offices LLP

Ratul Puri Versus Bank of Baroda through General Manager Sh. V.K. Khandelwal Stressed Assets Management Branch & Its Nominated Counsel Mr. Kush Sharma KSA ... ISSUES PRESENTED AND CONSIDERED 1. Whether the declaration of a person as a 'wilful defaulter' under the RBI Master Circular (2015) was validly made where the alleged diversion/siphoning concerned investments in subsidiaries - i.e., whether the Master Circular is attracted only when 'borrowed funds' are diverted or siphoned. 2. Whether issuance of a show cause notice after an inordinate and unexplained delay (years after alleged events and after the noticee ceased to be director) vitiates the wilful-defaulter proceedings absent adequate justification. 3. Whether the Identification Committee and the Review Committee complied with the procedural and substantive mandates of the Master Circular - in particular, whether they examined relevant materials, applied their minds and recorded reasons on the material placed before them. 4. What is the appropriate standard of proof in proceedings under the Master Circular and how does it affect judicial review of administrative determinations declaring wilful default? 5. What weight may be given to a forensic audit in support of wilful-defaulter proceedings where the forensic report did not verify the source of funds invested in subsidiaries and where the lenders' own CDR/FRC documents recorded prior knowledge of the investments? 6. Whether admission of the corporate borrower to CDR (and its classification in CDR categories) is inconsistent with a subsequent finding of diversion of borrowed funds, and whether the lenders' conduct during CDR estops them from later invoking the Master Circular. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Applicability of the Master Circular only to diversion/siphoning of borrowed funds Legal framework: Clauses 2.1.3(b)-(c) and 2.2 of the Master Circular define wilful default as including diversion/siphoning of funds and expressly define diversion/siphoning to involve deployment of 'borrowed funds' for purposes other than sanctioned uses. Precedent treatment: The scheme has been construed in prior decisions to attract serious civil consequences and to require reasonable construction and procedures (as in authority addressing the need for natural justice and reasoned orders in wilful-defaulter/fraud classification contexts). Interpretation and reasoning: The Master Circular's definitions and Clause 2.2 make clear that diversion/siphoning presupposes borrowed funds. The Committee's jurisdiction under the Master Circular is therefore triggered only if the funds alleged to have been diverted were indeed borrowed funds of the lender. Internal accruals/cash surpluses used for investments fall outside the triggering nexus. Ratio vs. Obiter: Ratio - the Master Circular cannot be invoked unless the alleged diverted/siphoned funds are shown to be borrowed funds; findings to the contrary are ultra vires. Obiter - none significant beyond application. Conclusion: Where contemporaneous bank/consortium documents (FRS) record that investments were funded from cash surpluses/internal accruals and not borrowed funds, the Master Circular's diversion/siphoning provisions do not apply and a wilful-defaulter declaration on that basis is unsustainable. Issue 2 - Inordinate delay in issuance of show cause notice Legal framework: No express limitation in the Master Circular; established administrative-law principle that powers must be exercised within a reasonable time and delay must be objectively considered (court may strike down action tainted by inordinate/unexplained delay). Precedent treatment: Authorities recognize that where no time-limit is prescribed, the power must be exercised within a reasonable period; unexplained delay can indicate arbitrariness and abuse. Interpretation and reasoning: The bank's own documents (loan sanctions, Flash Report, CDR materials, FRS) disclosed the investments long before the forensic audit; the bank was therefore aware of the alleged facts yet waited many years (and until after the noticee's exit) to issue notice. Promptness is a determinator of reasonableness; unexplained long delay ordinarily militates against the validity of the proceedings and requires strict scrutiny. Public interest in enforcing scheme does not dispense with requirement of objective consideration of delay. Ratio vs. Obiter: Ratio - inordinate and unexplained delay in issuance of show cause notice, despite knowledge of relevant facts, is a ground to nullify proceedings unless adequately justified. Obiter - courts may still consider merits where public interest requires. Conclusion: The delay was inordinate and unexplained; failure of committees to objectively deal with that delay contributed to invalidity of the process, though the Court also addressed the merits given public interest. Issue 3 - Compliance with procedural and substantive mandates of the Master Circular (application of mind, recording reasons) Legal framework: Clauses 3(a)-(c) require Identification Committee to 'examine' evidence and 'conclude' before issuing show cause and Review Committee to pass a reasoned order; principles of natural justice and requirement to consider representation apply to administrative actions with grave civil consequences. Precedent treatment: Supreme Court authorities require reasoned orders and that administrative authorities take into account material put forward by affected parties; failure to deal with replies/relevant material is a ground for interference. Interpretation and reasoning: Minutes relied solely on the forensic audit; committees did not engage with or record reasons addressing material contemporaneously available (loan terms, Flash Report, TEV, Stock Audit, FRS) nor did they respond to petitioner's defence that investments were from internal accruals. The Review Committee merely affirmed the Identification Committee without adequate engagement. Failure to consider relevant materials and replies amounts to non-application of mind and procedural impropriety. Ratio vs. Obiter: Ratio - identification and review process must be based on examination of relevant material and record reasons reflecting due application of mind; mere recitation or mechanical affirmation is inadequate. Obiter - extent of required reasons may be brief but must show fair application of mind. Conclusion: The Committees failed to discharge mandated obligations; orders are vitiated for procedural impropriety and inadequate reasoning. Issue 4 - Standard of proof in wilful-defaulter proceedings Legal framework: Proceedings are administrative/civil but have grave civil and penal consequences; civil standard (preponderance) applies but degree of probability required rises with gravity of consequences. Precedent treatment: Authorities establish that within preponderance of probabilities there are degrees; graver the charge and consequences, the closer scrutiny and a higher degree of probability is required. Interpretation and reasoning: Given dire consequences (restriction on credit, reputational harm, penal and insolvency effects), the committees needed a higher degree of satisfaction on objective evidence before declaring wilful default. Reliance on a forensic report that did not verify source of funds and ignoring lenders' prior characterisation (FRS) falls short of such standard. Ratio vs. Obiter: Ratio - where civil administrative action has severe consequences, a higher degree of cogent probability (commensurate with occasion) is required; mere conjecture or untested forensic assertions are insufficient. Obiter - none additional. Conclusion: The evidence before the Committees did not attain the requisite degree of probability to support wilful-defaulter classification. Issue 5 - Reliance on the forensic audit and its sufficiency Legal framework: Evidence supporting wilful-defaulter determination must be objective and address essential elements, namely source of funds where diversion/siphoning is alleged. Precedent treatment: Administrative determinations must be founded on material placed in the show-cause and considered by the deciding bodies; later affidavits or post-hoc justifications cannot cure absence of reasons in the decision. Interpretation and reasoning: The minutes identifying grounds for show cause referenced the forensic audit, but the forensic report expressly stated it did not verify sources of funds for investments because these pre-dated its review period. Thus the forensic report did not establish that investments were made from borrowed funds. The lender banks' own FRS stated investments were funded from cash surpluses/FCCB. The committees' exclusive or primary reliance on the forensic report without addressing its limitation and other contemporaneous documents rendered their conclusion unsustainable. Ratio vs. Obiter: Ratio - a forensic audit that does not verify source of funds cannot, by itself, justify a wilful-defaulter finding predicated on diversion/siphoning of borrowed funds. Obiter - courts may examine forensic reports in public-interest contexts but must ensure completeness. Conclusion: The forensic audit, in the form relied upon, was insufficient to sustain the wilful-defaulter declaration. Issue 6 - Effect of CDR admission, CDR classification and lenders' prior knowledge Legal framework: CDR Master Circular envisages that borrowers involved in diversion/fraud are ineligible for restructuring and mandates specific scrutiny (TEV, stock audit, forensic audit/change of management) and classification (A-D) with corresponding consequences. Precedent treatment: Lenders' own CDR records and classification are relevant as objective contemporaneous material bearing on whether diversion was found or suspected at the time of restructuring. Interpretation and reasoning: The consortium documents (Flash Report, TEV, Stock Audit, FRS) recorded investments and treated them as strategic, funded from cash surpluses, and placed the borrower in Class-B (not Class-C which denotes diversion). Lenders neither sought change of management nor forensic audit prior to CDR approval. Having admitted and restructured the account on that basis, lenders cannot in hindsight treat the same investments as diversion of borrowed funds unless there is objective new material; their prior conduct and classification undermine a subsequent diversion finding. Ratio vs. Obiter: Ratio - lenders' contemporaneous classification and conduct in CDR are material and may estop or undermine later wilful-defaulter allegations unless new objective evidence emerges. Obiter - lenders must exercise public-fund duties diligently before admitting to CDR. Conclusion: Admission to CDR and Class-B classification, together with the FRS acknowledgment of internal funding, negate a later finding of diversion of borrowed funds absent fresh objective proof. OVERALL CONCLUSION The wilful-defaulter declaration was unsustainable. The Master Circular applies only to diversion/siphoning of borrowed funds; the lenders' own contemporaneous materials acknowledged internal accruals as the source of investments; the forensic audit did not verify source of funds; there was inordinate delay in issuing show cause notice despite knowledge; and both Identification and Review Committees failed to apply mind to relevant materials and to record adequate reasons. For these cumulative legal and procedural defects, the wilful-defaulter order was quashed.