Nonpayment of dues under Foreign Exchange derivative contracts covered under willful default

Honourable Supreme Court held that banks were entitled to declare as willful defaulter anyone who did not pay their dues under the foreign exchange derivative contract. The Bank had sanctioned Derivatives/Forward contract facility to Hindustan Glass for the purpose of hedging foreign currency exposures. The Respondent Company was informed by the bank that a sum of Rs crores and above was due and payable by the Company. The Company did not pay and in 2008, the RBI issued a master circular.

The Master Circular contained instructions of the RBI to banks and financial institutions regarding reporting of willful defaulters to other banks and financial institutions and the measures to be imposed on willful defaulters by such banks and financial institutions. The bank intimated the company that it had classified the company as a willful defaulter. The company filed a writ before the Calcutta High Court which was pleased to hold that the Master Circular applied only to lending transactions of a bank or financial institution and as in the foreign exchange derivative transactions between the bank and company, there was no such lending transactions and the bank was not the lender and the respondent company was not the borrower, it could not be declared as a willful defaulter in terms of the Master Circular and accordingly no action could be taken against the company under the Master Circular.

A writ was also filed in the Bomby High court on the question whether Master Circular covered default by a party in complying with the payment obligations under derivative transactions which was answered in the affirmative by the court. In view of these contrary decisions of the Bombay High Court and Calcutta High Court, the Supreme Court was to decide whether banks were entitled to declare as a willful defaulter any person who did not repay his dues under a foreign exchange derivatives contract. Another issue which was to be decided was whether lenders could get the names of defaulting borrowers from CIBIL.

Keeping in mind the mischief that the Master Circular seeks to remedy and the purpose of the Master Circular, we interpret the words used in the definition of ‘willful default’ in clause 2.1 of the Master Circular to mean not only a willful default by a unit which has defaulted in meeting its repayment obligations to the lender, but also to mean a unit which has defaulted in meeting its payment obligations to the bank under facilities such as a bank guarantee.

The Master Circular by itself does not have penal consequences, whereas Sections 403 and 415 of the IPC have penal consequences. The provisions of Sections 403 and 415 of the IPC obviously have to be strictly construed as these are penal provisions and will get attracted depending on the facts and circumstances of each case, but the provisions of the Master Circular need not be strictly construed. As we have held, the Master Circular has to be construed not literally but in its context and the words used in the definition of “willful defaulter” in the Master Circular have to draw their meaning from the context in which the Master Circular has been issued.

The court observed credit information” is not confined to information relating to a borrower of the bank, but may also relate to a constituent of the bank who intends to take some credit from the bank. The purpose of the Master Circular being to caution banks and financial institutions from giving any further bank finance to a willful defaulter, credit information cannot be confined to only the willful defaults made by existing borrowers of the bank, but will also cover constituents of the bank, who have defaulted in their dues under banking transactions with the banks and who intend to avail further finance from the banks.

Information relating to defaulters of dues under derivative transactions who intend to take additional finance from the bank obviously will come within the meaning of credit information under Section 45A(c)(v) of the 1934 Act.

In these Civil Appeals, we are concerned with the interpretation of the Master Circular and on interpretation of the Master Circular, we find that the Master Circular covers not only willful defaults of dues by a borrower to the bank but also covers willful defaults of dues by a client of the bank under other banking transactions such as bank guarantees and derivative transactions.

*Contributed by Mr. Aakarsh Kamra

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