Wilful defaulter declaration fails where subsidiary investments came from internal accruals and banks relied only on an audit report.

Borrower investments in subsidiaries were not treated as diversion or siphoning because the funds were found to have come from internal accruals and cash surpluses, not from borrowed money; on that basis, the wilful defaulter framework could not be invoked. The Court also held that a wilful defaulter declaration could not rest solely on a forensic audit report where the banks had not independently verified the source of funds or objectively assessed the borrower's track record. Mechanical reliance on an incomplete audit and failure to apply the circular's requirements of conscious, reasoned evaluation rendered the notice and declaration unsustainable.

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Issues: (i) Whether investments made by the borrower in subsidiaries could be treated as diversion or siphoning of funds when the investments were found to have been made from internal accruals and cash surpluses, and not from borrowed funds. (ii) Whether a declaration of wilful defaulter could stand when the show-cause and the eventual decision were founded solely on the forensic audit report without independent objective assessment of the source of funds and the borrower's track record.

Issue (i): Whether investments made by the borrower in subsidiaries could be treated as diversion or siphoning of funds when the investments were found to have been made from internal accruals and cash surpluses, and not from borrowed funds.

Analysis: The Master Circular treated wilful default under clauses dealing with diversion and siphoning as dependent on misuse of borrowed funds. Diversion and siphoning, as defined in the circular, required borrowed funds to be deployed for purposes other than those for which finance was sanctioned or to be transferred to subsidiaries or unrelated activities. The lender banks' own restructuring documents recorded that the investments in subsidiaries were funded from cash surpluses and not from borrowed monies. Once that factual position stood acknowledged, the core ingredient for invoking the wilful defaulter framework was absent.

Conclusion: The alleged investments did not amount to diversion or siphoning of borrowed funds and could not sustain a wilful defaulter declaration.

Issue (ii): Whether a declaration of wilful defaulter could stand when the show-cause and the eventual decision were founded solely on the forensic audit report without independent objective assessment of the source of funds and the borrower's track record.

Analysis: The circular required a conscious and objective evaluation at each stage, including scrutiny of the borrower's track record, and the default had to be intentional, deliberate and calculated. The forensic audit report itself noted that the source of funds had not been verified, yet it was treated as the sole basis for issuance of notice and for the final declaration. The banks also failed to engage with their own restructuring records, which had earlier treated the transactions as strategic and had not classified the borrower as a diversion case. Such mechanical reliance on an incomplete audit report fell short of the procedure and standard mandated by the circular.

Conclusion: The show-cause process and the wilful defaulter declaration were unsustainable for want of objective application of mind and compliance with the circular.

Final Conclusion: The wilful defaulter findings were legally unsustainable, and the bank's challenge to the quashing of those findings failed.

Ratio Decidendi: A borrower can be branded a wilful defaulter under the RBI framework only where borrowed funds are shown, on an objective and reasoned assessment, to have been intentionally diverted or siphoned off; a declaration based solely on an unverified forensic report, without independent examination of the source of funds and the borrower's overall track record, is invalid.

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