Wilful Defaulter Classification: Process and Challenge

A wilful defaulter is not simply a borrower who could not pay. That distinction carries the whole subject. The Reserve Bank’s framework targets the borrower who had the money and chose not to pay, or who took the money and put it somewhere else. A business that failed honestly, lost its market or was sunk by a customer’s collapse is a defaulter. It is not a wilful defaulter, and a lender that treats the two as the same has made an error a High Court can correct.

The governing document changed recently. The old Master Circular on Wilful Defaulters dated 1 July 2015 was replaced by the Master Direction on Treatment of Wilful Defaulters and Large Defaulters, 2024, which took effect from 1 November 2024. Searches still throw up the old circular, so it is worth saying plainly: the 2024 Direction is the operative document, it reaches a wider set of regulated lenders than the circular did, and it tightened both the timeline and the procedure.

What counts as wilful default

Under the 2024 Direction there is wilful default where a borrower has defaulted in meeting payment obligations to the lender and at least one of the following also applies.

• Capacity to pay. The borrower had the means to honour the obligation and did not.
• Diversion of funds. The money was not used for the purpose for which the facility was sanctioned.
• Siphoning of funds. The money left the entity altogether and is not represented by any asset of the borrower.
• Disposal of secured assets. Movable or immovable fixed assets given as security were sold or removed without the lender’s approval.

A guarantor is within reach too. Where a guarantee has been invoked and the guarantor does not honour it despite having the means, the guarantor can be classified in the same way as the borrower.

Two figures matter and they are routinely confused. The examination is required where the outstanding is Rs 25 lakh and above. A large defaulter is a different category altogether, meaning an outstanding of Rs 1 crore and above in an account classified as doubtful or loss. That is a reporting label, not a finding of misconduct, and being on the large defaulter list is not the same as being tagged a wilful defaulter.

Note what does not qualify. A default caused by a genuine business reverse, a delayed government receivable, a fire, a market collapse or the borrower’s own debtors failing is default and nothing more. The lender has to identify the specific act and record it. “The account is irregular and the promoters are not cooperating” describes an NPA. It is not a finding of wilful default.

The process the lender must run

This is a quasi judicial exercise with civil consequences, and courts treat it that way. The 2024 Direction requires the whole thing to be completed within six months of the account being classified as NPA, so it helps to know exactly how an account becomes an NPA and on what date. The Direction also prescribes a two committee structure, and the separation between the two committees is not decorative.

Step 1: examination and evidence

The lender examines the aspect of wilful default in every NPA of Rs 25 lakh and above. The material is usually a forensic audit report, a stock audit, statements of account, the borrower’s own financial statements, and a transfer trail showing where the disbursed funds went.

Step 2: show cause notice

An Identification Committee of senior officials records its satisfaction and issues a show cause notice to the borrower, and where relevant to the promoter, whole time director or guarantor. The 2024 Direction requires the notice to allow at least 21 days for a written reply.

Step 3: hearing

The borrower is entitled to be heard before the committee. Whether an advocate may appear at this stage has been contested, and the answer turns on the lender’s own board approved policy and on the facts, so ask for that policy in writing rather than assume either way.

Step 4: proposal to the Review Committee

If the Identification Committee remains satisfied after the reply and the hearing, it makes a proposal for classification and communicates it to the borrower with reasons. The borrower may then make a representation to the Review Committee, ordinarily within 15 days.

Step 5: reasoned order

The Review Committee, chaired at managing director or chief executive level with independent or non-executive directors on it, passes a reasoned order which must be communicated to the borrower. A classification never communicated, or communicated as a one line intimation, is a weak order and looks like one on the record.

Stage	Who acts	Time
Examination of wilful default	Lender	Every NPA of Rs 25 lakh and above
Entire process to be completed	Lender	Within 6 months of NPA classification
Reply to show cause notice	Borrower	At least 21 days allowed
Representation to Review Committee	Borrower	Ordinarily 15 days
Reasoned order, then reporting	Review Committee	Before the name goes to credit information companies

What the tag actually does

The classification is reported to all credit information companies and sits on the borrower’s credit record. The consequences are severe and they outlast the loan.

• No further credit. No lender is to sanction additional facilities to a classified borrower, and the bar continues for one year after the name is removed from the list.
• No new venture. Promoters and directors of a classified entity are kept out of institutional finance for floating a new venture for five years after removal of the name.
• No resolution plan. Section 29A of the Insolvency and Bankruptcy Code 2016 disqualifies a wilful defaulter from submitting a resolution plan, which shuts the door on a promoter buying the company back through insolvency.
• Capital markets. SEBI regulations restrict a classified entity and its promoters and directors from raising public funds and from holding certain positions in listed entities.
• Restructuring. Ordinary restructuring routes close. A compromise settlement is still possible under the Reserve Bank’s 2023 framework, but only under a board approved policy and with a cooling period before any fresh exposure.
• Publication of photographs. Some lenders do this. It is permitted only under a board approved policy and only after the process above is complete, and premature publication is itself a ground of challenge.

Criminal proceedings run on a separate track. Wilful default is not by itself an offence. Where the same facts disclose cheating or criminal breach of trust, the lender may file a complaint under the Bharatiya Nyaya Sanhita 2023, which replaced the Indian Penal Code 1860 for offences committed on or after 1 July 2024. The two proceedings are independent, and closure of one does not decide the other.

How the classification is challenged

There is no statutory appeal. That surprises people, and it sends many of them to the wrong forum. The Debt Recovery Tribunal cannot set aside the classification. Its jurisdiction is recovery under the Recovery of Debts and Bankruptcy Act 1993 and challenges to SARFAESI enforcement, which is a different fight with different rules. The classification is challenged by a writ petition under Article 226, in Madhya Pradesh before the High Court at Jabalpur or its benches. That is writ and appellate work rather than tribunal practice, and the difference in approach is real.

Because it is a writ, the case is decided on the record and on process rather than by a fresh trial of the facts. The grounds that carry weight are procedural.

• The material relied on was never supplied. If the order rests on a forensic audit report, the borrower is entitled to it, or to enough of it to answer. Non supply is the single most common reason these orders fall.
• No real hearing. A hearing given as a formality after the decision was effectively taken is not a hearing.
• No reasoned order. A Review Committee order that records agreement with the Identification Committee and nothing else does not meet the standard.
• No identified limb. The order does not say which limb of wilful default is made out, or treats an ordinary business loss as diversion.
• Capacity to pay never examined. This limb needs evidence that funds were available. It cannot be inferred from the fact of default.
• Defective committees. Committees not constituted as the Direction requires, or the same officers sitting on both, undermine the entire exercise.
• Directors tagged by office. A non whole time or independent director cannot be classified merely because of the position held. There must be material showing consent, connivance or awareness without dissent.
• Guarantor tagged without invocation. A guarantor who was never called upon under the guarantee has not failed to honour it.
• Timeline breached. Classification made long after the NPA, on stale material, with no explanation for the delay.

A writ has no fixed limitation period, but delay defeats relief. Once the name is reported to credit information companies the harm compounds every month, so the petition should follow the order quickly rather than wait until the next loan application is refused.

Getting the name removed

Repayment is the cleanest route. Once the account is paid or settled, the lender is expected to remove the name from the list. Follow that up in writing instead of assuming it happened, because stale entries with credit information companies are common and take time to correct at the credit bureau end even after the lender acts.

A compromise settlement can also lead to removal, subject to the lender’s policy and the cooling period. What does not work is a part payment coupled with a request to keep the classification in abeyance. The Direction does not contemplate a suspended tag.

Mistakes that make the position worse

• Not replying to the show cause notice. Silence forfeits the strongest chance to put facts on record, and the writ court will be told the borrower had his opportunity and did not use it.
• Replying with grievances instead of evidence. The reply must answer the specific transactions the lender points to, with ledger entries, invoices, board resolutions and bank statements attached.
• Treating the recovery case and the classification as one fight. They are separate proceedings, and winning one does not decide the other, although what is pleaded in the recovery matter can be read back in the writ.
• Signing an omnibus admission in a settlement proposal. Words admitting diversion, written casually to get an offer moving, come back in the show cause notice.

We act for borrowers, promoters and guarantors in these matters, and the pattern rarely changes: the case is won or lost at the reply to the show cause notice, long before any petition is drafted. Gather the sanction letters, end use certificates, audited accounts and the fund flow for the disputed period first.

This is general information on the Reserve Bank’s 2024 Direction and not legal advice on any specific account, notice or order. The answer turns on the documents in your own file. To discuss those facts, use the contact page.