Mere issuance of Liquidation Notice before Master Directions does not negate Obligation to comply with Directions in Judgment: Kerala HC [Read Order]

In a recent case, the Kerala High Court has held that mere issuance of liqudation notice before master directions does not negate obligation to comply with directions in judgment.

Tip Top Furniture Land, the first petitioner is a firm and the other petitioners are its partners. The 1st petitioner is one of the units of M/s. Tip Top Furniture Group. The Group manufactures, trades, imports, and exports wooden and other allied furniture. The six units of the Group had availed financial assistance from the HDFC Bank, which was taken over by the 2 nd respondent bank ('Bank',) in 2015. Since the petitioners defaulted in repaying some of the loans, the Bank initiated recovery proceedings, which are pending consideration before the Debt Recovery Tribunal - 1  Ernakulam.

Read More: Breach of Settlement Agreement Does Not Bar Financial Creditors from Filing Application u/s 7 of IBC: NCLAT

The Bank had also initiated proceedings for the liquidation of one of the Units of the Company under the Insolvency and Bankruptcy Code, 2016. The National Company Law Board, Kochi, had ordered the liquidation of the company, and the official liquidator conducted the sale of the company's assets in a public auction. The Group had submitted several onetime settlement proposals to the Bank, but they were all rejected.

Get a Handbook on TDS Including TCS as Amended up to Finance Act 2024, Click Here

The 1st petitioner was served with show cause notice by the Bank stating that their competent authority had examined the utilisation of credit facilities by the petitioners and found that they had committed the acts of fraud in terms of  RBI Master Directions of Frauds issued by the Reserve Bank of India (RBI) — the 1 st respondent.

The main allegation in the show cause notice is that the petitioners had not conducted any Forensic Audit/Transaction Audit of the Group. Even though the names of petitioners are mentioned in the show cause notice, no notice was served on them. The 1st petitioner had submitted reply notice specifically requesting the Bank to provide the details of the audit report of the competent authority. Thereafter, nothing was heard from the Bank.

While matters stood so, Master Directions was superseded by  Master Directions of Frauds. Shockingly, the petitioners were served with  order passed by the 3rd respondent classifying the petitioners as fraud in terms of  Master Directions. It is stated in order that the Bank would be taking a further course of action to report the names of the petitioners as fraud to the RBI. The order has been passed, ignoring the valid contentions put forth by the petitioners. Moreover, the petitioners were denied an opportunity of being heard. The actions of the respondents are illegal, unjust and arbitrary.

Get a Handbook on TDS Including TCS as Amended up to Finance Act 2024, Click Here

The respondents 2 and 3 have filed a counter affidavit contending that the Group had availed various financial facilities from the Bank. The borrowers had committed default in repaying the loan, resulting in the loan accounts being classified as Non Performing Assets. Further, O.A 148/2020 was filed to recover an amount of  ,574.94 as on 01.02.2020. During the pendency of the O.A., the private limited company, Tip Top Furniture Pvt. Ltd., went into liquidation. The 1st petitioner approached the Bank for a one-time settlement.

In the forensic audit report, it was revealed that the petitioners had (i) overstated/understated their assets/liabilities and profits in financial statements, (ii) drawn from cash credit account by submitting wrongful stock statements, (iii) disposed of/removed assets hypothecated without knowledge of the bank, (iv) non-routed purchase/sales transactions in Bank CC account, (v) indulged in large cash transactions in receipts/payments, (vi) diverted funds etc. In

The Bank issued  show cause notice to the petitioners asking them why they should not be classified as fraud as per the Ext.P6 Master Directions issued by the RBI. In response, the 1 st petitioner submitted reply letter asserting that they are not wilful defaulters and requesting a copy of the audit report of the competent authority to enable them to submit a comprehensive reply. Nevertheless, the 3rd respondent, via order, classified the petitioner and its partners as fraud.

It is pertinent to highlight that a show cause notice was issued on 30.05.2024 as per Master Directions. During the interval between the submission of reply letter dated 18.06.2024 and the passing of order dated

04.01.2025, Master Directions were repealed and superseded by Master Directions, which came into force on 15.07.2024.

Subsequently, the State Bank of India filed a review petition seeking clarification that the directions in Rajesh Agarwal's case were only prospective. However, the review petition was dismissed.

After the elucidation of the law in Rajesh Agarwal's case, the RBI promulgated Ext.P9 Master Directions of Frauds

and repealed all the earlier Master Directions of Frauds,including Ext.P.6 Master Directions.

Read More: NCLAT Upholds Liquidation of Go Airlines

It is crucial to note that the plea of the review petitioner in Rajesh Agarwal's case to clarify that the judgment was only prospective was declined by the Supreme Court. It was after the dismissal of the review petition that the RBI formulated Master Directions, specifically embedding the procedural formalities that have to be observed before classifying a defaulter as a fraud.

It is well-settled that procedural law and guidelines are generally retrospective. Even otherwise, in view of the specific directions in Rajesh Agarwal's case, it was obligatory on the part of respondents 2 and 3 to have furnished the report of the competent authority to the petitioners and have adhered to the directions in paragraphs 98 of Rajesh Agarwal's case and also the procedure laid down in Chapter Il of Master Directions.

A single bench of Justice C. S.Dias held that the mere fact that a show cause was issued before  Master Directions does not negate the obligation to comply with the directions in the judgment and the  Master Directions.

As there is an infraction of both the directions in Rajesh Agarwal's case and Master Directions by respondents 2, the court quashed the order and directed the 2nd respondent to furnish the petitioners a copy of the audit report of the competent authority and finalise the proceedings as per the procedure laid down in Chapter Il of Master direction.

To Read the full text of the Order CLICK HERE

Support our journalism by subscribing to Taxscan premium. Follow us on Telegram for quick updates