Wilful Defaulter Classification Must Adhere to Principles of Natural Justice – High Court Strikes Down Arbitrary Declaration Based on a Discredited Audit Report
- REEDLAW
- Apr 2
- 4 min read
The High Court ruled that the classification of a wilful defaulter must adhere to the principles of natural justice and struck down the arbitrary declaration based on a discredited audit report.
The Bombay High Court Division Bench, comprising Justice Revati Mohite Dere and Justice (Dr.) Neela Gokhale reviewed a writ petition and held that the classification of an individual as a wilful defaulter must strictly adhere to the principles of natural justice, including access to relevant documents and a fair hearing, given the severe financial and reputational consequences of such classification. The Court further ruled that reliance on a discredited Transaction Audit Report (TAR) without affording the petitioner a meaningful opportunity to defend himself rendered the entire process arbitrary and legally unsustainable.
The High Court, upon issuing a rule and making it returnable forthwith, proceeded to hear the matter with the consent of the parties. The petitioner, an erstwhile director of Bhuwalka Steel Industries Limited (BSIL), sought to quash the Show Cause Notice (SCN) dated April 5, 2023, issued by Respondent No. 1 – Bank, along with subsequent orders of the Wilful Defaulter Committee (WDC) and the Wilful Defaulter Review Committee (WDRC). The petitioner contended that BSIL had undergone a resolution process under the Insolvency and Bankruptcy Code, 2016 (IBC), leading to a change in management. He challenged his classification as a wilful defaulter, asserting that it was based on a Transaction Audit Report (TAR) prepared by M/s. G.D. Apte & Co. at the behest of the erstwhile Resolution Professional (RP). He alleged that he had been denied access to the documents forming the basis of this classification, violating the principles of natural justice. Notably, the NCLT, Bengaluru Bench, had previously held that the TAR was based on mere assumptions and conjectures, further undermining the bank’s reliance on it.
The petitioner’s case stemmed from the initiation of CIRP against BSIL following a company petition filed by Indu Corporation Private Limited before the NCLT, Bengaluru Bench, in 2018, leading to BSIL’s admission into CIRP on April 8, 2019. The RP engaged M/s. G.D. Apte & Co. for a forensic audit, which allegedly uncovered fraudulent transactions, including related party dealings between BSIL and Shree Durga Trade Links Private Limited (SDTL). However, the NCLT, in its order dated March 10, 2021, rejected the TAR’s findings, deeming them speculative and unsubstantiated. Despite this, Respondent No. 1 relied on the same TAR to classify the petitioner as a wilful defaulter. The petitioner’s counsel, Senior Advocate Mr. Simil Purohit, argued that the SCN merely reproduced extracts from the TAR without supporting documents and that repeated requests for access to materials and a meaningful hearing had been denied. The WDC proceeded with its decision on September 14, 2023, declaring the petitioner a wilful defaulter without waiting for his response or granting a personal hearing. Although a hearing was eventually granted on February 28, 2024, it was rendered ineffective due to the continued denial of access to relevant documents.
Despite the petitioner’s persistent attempts to obtain the necessary documents from the RP and new management, he remained unsuccessful. The WDC reaffirmed its decision on June 13, 2024, and the WDRC upheld this classification on October 25, 2024. The petitioner argued that the entire process contravened principles of natural justice, as the bank had deprived him of crucial evidence while relying on a discredited TAR. His counsel cited precedents, including Milind Patel v. Union Bank of India and State Bank of India v. Jah Developers Private Limited and Others, REEDLAW 2019 SC 05003, to support his claim that such declarations necessitate strict adherence to due process. In response, the respondent’s counsel, Mr. Prakash Shinde, challenged the maintainability of the petition, asserting that Respondent No. 1, being a private sector bank since January 21, 2019, was not an instrumentality of the state under Article 12 of the Constitution. He further contended that the petitioner had been consulted during the TAR’s preparation and had multiple opportunities to provide clarifications. He maintained that all due procedures, including a personal hearing and access to TAR extracts, had been followed, and the WDRC’s confirmation of the decision was legally sound.
The High Court examined the RBI’s Master Circular on Wilful Defaulters, recognizing its objective of preventing financial institutions from extending credit to entities involved in fund diversion or siphoning. It acknowledged that the classification of wilful defaulters served as a deterrent but carried severe consequences, including financial exclusion, reputational harm, and potential criminal liability. Citing State Bank of India v. Jah Developers Private Limited and Others, REEDLAW 2019 SC 05003, the Court reaffirmed that such classifications affect the fundamental right to carry on business under Article 19(1)(g) of the Constitution and must therefore adhere to fair procedure. Similarly, in State Bank of India and Others v. Rajesh Agarwal and Others, REEDLAW 2023 SC 03002, the Supreme Court emphasized that classification under RBI’s Master Directions on Frauds, akin to being declared a wilful defaulter, required strict compliance with principles of natural justice due to its serious civil and penal consequences.
Applying these principles, the Court scrutinized the bank’s reliance on the TAR, noting that the NCLT had already dismissed its findings as speculative and lacking substantive proof. Despite this, the WDC proceeded with its decision without ensuring access to supporting documents. The Court held that such an approach violated the principles of natural justice, particularly given the significant consequences of the classification. It reiterated that any process leading to financial exclusion and reputational damage must meet stringent procedural safeguards, including access to evidence and a meaningful opportunity to defend oneself. Consequently, the Court found the bank’s actions unjustified, underscoring that procedural fairness is indispensable in cases involving wilful defaulter classification.
Mr. Simil Purohit, Senior Advocate, with Ms. Supriya Majumdar, Mr. Rishabh Chandra i/b Vaish Associates, Advocates, represented the Appellant.
Mr. Prakash Shinde, with Mr. Harsh Sheth, Ms. Niyati Merchant i/b MDP Legal, Advocates, appeared for Respondent No. 1.
Mr. Mohamedali M. Chunawala, Advocate, appeared for Respondent No. 2.
Subscribers can access the Case, including Case Analysis, Ratio Decidendi, Headnotes, Briefs, Case Research, Cited Case Laws, Case Law Cross-references, and the latest updates on Statutes, Notifications, Circulars, Guidelines, Press Releases and more.
Click on the following Citation/Link to access these resources: