Recovering loans has always posed significant challenges for financial institutions in India. While these institutions are entrusted with the responsibility of recouping bad loans, concerns have arisen regarding the fairness and ethicality of certain tools at their disposal. One such contentious tool is the issuance of Look Out Circulars (LOCs) by banks, which has gained renewed attention following a recent judgment by the Delhi High Court in the case of Nipun Singhal vs Union Of India & Ors. The court’s ruling emphasized that LOCs cannot be solely utilized as a means of debt recovery. This write-up delves into the intricacies of loan recovery, the impact of LOCs on an individual’s fundamental right to freedom of movement in India, legal challenges surrounding this issue and the challenges faced by banks and financial institutions in the country.
Loan transactions are fundamentally commercial in nature, governed by the terms and conditions set out in the transaction documents and underpinned by civil and commercial laws. Relevant legislation includes the Banking Regulation Act, Contract Act, Transfer of Property Act, and other connected commercial laws pertaining to the creation of security interests over movable and immovable assets. Additionally, if the transaction involves international elements, the Foreign Exchange Management Act and related regulations issued by the Reserve Bank of India (RBI) come into play. Consequently, loan defaults primarily constitute breaches of civil contracts, leading to civil remedies rather than criminal actions.
Criminal laws become applicable when instances of fraud, criminal breach of trust, embezzlement, or money laundering are detected. In such situations, the role of investigative and law enforcement agencies becomes pivotal in addressing the criminal aspects of the borrower’s actions. Therefore, while banks and financial institutions must initiate and continue their efforts to recover loans, they are equally obligated to adhere to RBI guidelines concerning potential criminal aspects of these accounts and internal accountability procedures.
It is important to note that legal action is typically considered a last resort when all attempts to regularize the account have failed, or when the borrower is no longer financially capable of overcoming their financial distress. However, with the introduction of the “Special Mention Account” (SMA) system by the RBI in 2014, the banks’ leverage during this phase has diminished.
Powers available to Banks to enforce recovery and securities: Banks in India possess various powers to enforce securities without court intervention under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act and the Contract Act. For recovery through the court process, banks can utilize remedies provided by the Debt Recovery and Bankruptcy Act, 1993, the Commercial Courts Act, 2015, civil suits under the Civil Procedure Code and arbitration proceedings under the Arbitration Act, amongst others.
Furthermore, banks have the right to enforce specific types of securities, such as ships and aircraft, under the Admiralty (Jurisdiction and Settlement of Maritime Claims) Act 2017 and the detention of aircraft under the Finance Act 1994. International conventions, like the Cape Town Convention, facilitate the exercise of rights by charge holders.
Since 2016, banks also have the option of initiating insolvency proceedings against corporate entities and their guarantors under the Insolvency and Bankruptcy Code, 2016.
In addition to these recovery options, regulatory actions can be triggered, some of which have both civil and criminal implications. These actions may include declaring an account as fraudulent, designating a borrower as a willful defaulter or non-cooperative borrower, or flagging an account as Red Flag. Such actions can significantly impact individuals’ rights to conduct business and borrow from the banking system.
Other Legislation to which complement recovery efforts:
Other legislations such as the Fugitive Economic Offenders Act, 2018, empower the government to attach and confiscate the properties of individuals declared as “fugitive economic offenders” who have fled the country to evade prosecution for economic offenses exceeding INR 100 crores. Depending on the nature of alleged mismanagement or fraud, creditors and banks can file complaints with regulatory bodies like the Securities and Exchange Board of India (SEBI) or the Ministry of Corporate Affairs (MCA)/ Serious Fraud Investigation Office (SFIO). They can also initiate actions under Section 447 of the Companies Act, 2013, for fraudulent activities that harm the interests of creditors. Provisions in the Insolvency and Bankruptcy Code, 2016, allow for the avoidance of transactions and acts intended to defraud creditors.
Despite the myriad of legal options available to banks, the effectiveness of recovery mechanisms remains a question. In cases of delays in loan recovery, banks often resort to alternative actions to exert pressure on promoters. The declaration of accounts as fraudulent by banks came under scrutiny in a Supreme Court State Bank of India & Ors Vs Rajesh Agarwal & Ors, emphasizing the need to adhere to principles of natural justice in such matters. The issue of declaring a borrower as a “willful defaulter” was also addressed by the Supreme Court in the State Bank of India v. Jah Developercase, reinforcing the importance of due process.
Conflict with Fundamental Rights:
Concerns arise when banks misuse the power to issue LOCs as a means of pressuring borrowers, potentially infringing upon an individual’s right to freedom of movement. Allegations have been made that LOCs are sometimes issued without due process or adequate investigation, leading to instances where people not directly involved in cases, were prevented from traveling abroad. Legal challenges have been mounted against the issuance of LOCs, with individuals arguing that their fundamental rights are being violated.
It is not as if only Banks are vested with powers to open LoC :
It is worth noting that the authority to issue LOCs does not rest exclusively with banks. This mechanism has been in place since 1979, and various government agencies, such as the Ministry of External Affairs, Customs, Income Tax Department, Directorate of Revenue, Central Bureau of Investigation, Regional Passport Officers, Serious Fraud Investigation Office, and Bureau of Immigration, have the power to issue LOCs. In 2019, Public Sector Banks (PSBs) were granted the authority to request LOCs for cases involving willful defaulters or instances where process for criminal action is being initiated.
Ambit of Fundamental Rights:
The right to travel abroad is considered an integral component of an individual’s right to personal liberty under Article 21 of the Indian Constitution, as established in the landmark case of Maneka Gandhi Vs Union of India (1978). The Supreme Court reiterated this principle in the case of Satwant Singh Sawhney vs D. Ramarathnam, emphasizing that no person can be deprived of their right to travel except through a procedure established by law.
How LoCs Impact these Fundamental Rights:
While LOCs restrict an individual’s fundamental right to freedom of movement, the courts have generally accepted them as “reasonable restrictions” within the bounds of the Indian Constitution. However, criticism usually emanates from the issue of the absence of provisions ensuring compliance with the principles of natural justice. There is no requirement to issue notices or notifications to individuals against whom LOCs are issued. In fact, affected individuals typically become aware of the LOC when they are prevented from boarding flights by the Bureau of Immigration. Guidelines specifying how conclusions about a person’s intent to leave the country to evade prosecution or recovery are reached are also lacking. Consequently, individuals often face difficulties when seeking to travel abroad for urgent exigencies.
The System needs an enabling mechanism:
That being said, there can be no denial of the fact that the country and the banking system, requires implementation of safeguards to prevent financial offenders from escaping the law and facilitate the recovery of misappropriated funds. High-profile cases, such as that of Nirav Modi, a jeweler accused of a massive bank fraud, underscore the need for stringent laws in this regard. The Indian Government initiated proceedings against Nirav Modi under the Fugitive Economic Offenders Act, leading to the attachment and auction of his assets. Similarly, investigations by multiple agencies, including the Central Bureau of Investigation (CBI), Enforcement Directorate (ED), and Income Tax (IT) Departments, have been launched against the Sandesara brothers, Nitin and Chetan, who have also been declared fugitives under the Fugitive Economic Offenders Act. As per the press release dated March 22, 2022 by Ministry of Finance, Government of India, as of March 15, 2022, assets worth INR 19,111.20 crores have been attached under the Prevention of Money Laundering Act (PMLA), with assets worth INR 15,113.91 crore being restituted to Public Sector Banks. Furthermore, assets worth INR 335.06 crores have been confiscated. These developments demonstrate the government’s commitment to addressing economic offenses and recovering assets.
Support from the legal system to Banks:
To support banks in their recovery efforts, the Indian Government has established Special Courts, including Tribunals to handle cases involving defaults of banks and financial institutions. Commercial courts have also been set up to address high-value commercial matters. In 2016, the Company Law Tribunals were established to handle corporate and insolvency matters. Although these special courts and tribunals were established with ambitious timelines for case disposal, delays often occur due to the shortage of quality of officials and insufficient infrastructure, resulting in prolonged legal battles.
Challenges of recovery abroad:
Challenges in recovering loans in international contexts can be broadly put into two categories: (i) in cases of loans extended to Indian entities for overseas projects and (ii) cases involving loan defaulters fleeing the country.
In the first category, loans provided for foreign ventures by Indian entities often involve complexities arising from risk assessments of the three ‘Cs’: the ‘Company’, the ‘Country’ where the project is located, and ‘Contingency planning’. In many such cases, promoters have minimal assets within India. Complex subsidiary structures enable them to evade both legal action and lenders. These cases require a thorough evaluation of country-specific risks, including political, economic, and regulatory factors, as well as an assessment of the entity’s ability to manage and mitigate these risks effectively. Understanding international contracts, agreements, and partnerships to identify potential legal risks is crucial. Proper evaluation of the entity’s supply chain, logistics, and distribution networks in foreign markets is also essential. Such projects necessitate continuous monitoring of performance and risk exposure, along with a well-defined exit strategy. Only a few banks in India possess the resources and expertise to conduct such assessments effectively. Therefore, there is a need to review existing bank mechanisms for financing such projects. Additionally, due to various challenges involved at the international level, very few banks proceed in taking legal action in overseas jurisdictions. There is a need to change this approach, by having well defined internal policies which could empower the officials to take decisions in recovery and legal matters.
In the second category, where defaulters flee the country, challenges emerge from the complexities of international legal frameworks, extradition treaties, and the recognition of foreign court orders. Banks often face difficulties navigating diverse legal systems to recover their dues. Moreover, the lack of uniformity in international laws and varying extradition procedures in different countries significantly delays extradition processes. Defaulters exploit legal and procedural loopholes in foreign jurisdictions to resist extradition, further complicating recovery efforts. Collaboration with foreign regulatory and law enforcement agencies and adherence to international legal frameworks can play a pivotal role in addressing such complex cases and ensuring that banks can recover their funds. After the Satyam scandal came to light in India, with its founder B. Ramalinga Raju admitting to a massive financial fraud, the Indian authorities faced obstacles in enforcing Indian judgments in foreign jurisdictions, particularly in the United States, which required a separate recognition process. Consequently the enforcement of the judgment faced significant delays and complications due to differences in legal systems.
What needs to be done :
One effective approach is to leverage international legal mechanisms and treaties. For example, the United States has successfully used the Foreign Corrupt Practices Act (FCPA) to prosecute individuals involved in financial crimes abroad, even if the funds are in safe jurisdictions. The FCPA allows the U.S. to assert jurisdiction over foreign nationals and entities engaged in corrupt practices with connections to the United States. Banks in India can seek collaboration with foreign regulatory and law enforcement agencies and explore the possibility of prosecuting economic offenders under similar extraterritorial laws.
Additionally, international treaties like the United Nations Convention against Corruption (UNCAC) provide a framework for mutual legal assistance in the investigation and prosecution of corruption-related offenses, which often underlie financial fraud. Successful cases in the United States and other countries, where individuals have been held accountable for offshore financial wrongdoing, serve as precedents for pursuing justice and recovering assets across borders. Collaborating with foreign governments and leveraging international agreements for the exchange of financial information can be an effective way to identify and recover offshore assets. For example, in the Malaysia Development Berhad (1MDB) scandal, which involved embezzlement and misappropriation of billions of dollars, Malaysia managed to recover a substantial portion of the misappropriated funds through legal actions and international cooperation. Collaboration with foreign governments can be a powerful tool for identifying and recovering offshore assets.
While the Government’s proactive role in such matters is crucial, banks must also establish policies for funding and pursuing recovery and legal actions abroad. Officials often hesitate to initiate such actions due to cost, complexity, and uncertainties associated with overseas litigation. However, without proactive measures by banks, no automatic solutions are likely to emerge. Technical compliance and over-reliance on regulatory and legal frameworks may not lead to successful recovery; instead, disputes (on account regulatory actions such as willful default, LoC etc) often become entangled in costly and time-consuming legal battles.
In conclusion, the challenges associated with loan recovery in India are multifaceted, involving legal, operational, and international dimensions. Banks and financial institutions need to employ a comprehensive approach that combines legal remedies, international collaboration, and robust risk assessment to address these challenges effectively. The Indian Government, for its part, must continue to strengthen legal frameworks, streamline extradition processes, and facilitate international cooperation to support banks in their efforts to recover defaulted loans and ensure that financial offenders are brought to justice.
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Mukesh Chand, Senior Counsel – Email – MukeshChand@elp-in.com
Disclaimer: The information contained in this document is intended for informational purposes only and does not constitute legal opinion or advice. This document is not intended to address the circumstances of any individual or corporate body. Readers should not act on the information provided herein without appropriate professional advice after a thorough examination of the facts and circumstances of a situation. There can be no assurance that the judicial/quasi-judicial authorities may not take a position contrary to the views mentioned herein.
 W.P.(C) 9841/2022 & CM APPLs. 29064/2022, 30677/2023-Decided on 4th July 2023
 RBI Framework for Revitalising Distressed Assets in the Economy – Guidelines on Joint Lenders’ Forum (JLF) and Corrective Action Plan (CAP) of 26th February 2014.
 Civil Appeal No. 7300 of 2022 decided on 27th March 2023.
 CIVIL APPEAL NO. 4776 OF 2019 decided on 8th May 2019.
 1978 AIR 597, 1978 SCR (2) 621 Decided on 25th January 1978
 1967 AIR 1836, 1967 SCR (2) 525