Non-Executive Director cannot be Treated as Wilful Defaulter without Proof of Involvement: Madras HC Quashes IOB Order [Read Order]

In a recent decision, the Madras High Court ruled that a non-executive and non-full-time director cannot be called a wilful defaulter or face punishments unless there is strong and clear proof of his involvement, agreement, or knowledge about the alleged default.

Kambala Bapiraju, the person who filed the case, was a non-executive and non-full-time director of Sai Regency Power Corporation Private Limited, a company that generates power. He was appointed as a director in 2005 and had no role in the daily running of the company.

Later, the company went into liquidation under the National Company Law Tribunal (NCLT). Indian Overseas Bank had given loans to the company and, based on a forensic audit report, claimed that funds were misused and diverted. In January 2021, the bank sent a show cause notice to him, suggesting to label him as a wilful defaulter.

He replied that he was only a non-executive director with no part in management or money decisions, and he pointed to RBI guidelines that protect such directors unless their wrongdoing is clearly proven. Even after his reply and documents, the bank passed an order in September 2021 calling him a wilful defaulter, mainly based on the forensic audit report that was never given to him.

Aggrieved by the order, the petitioner approached the Madras High Court. While the case was going on, RBI issued a circular in July 2024, after which his name was removed from the list because the company was in liquidation. But the bank said punishments would still continue against him as a former director.

The petitioner’s counsel argued that the petitioner had no shareholding, received no remuneration, attended only two board meetings, and was not part of any key managerial decision-making.

The counsel argued that RBI circulars clearly state that non-whole time directors should not be treated as wilful defaulters except in rare cases where their consent, connivance, or knowledge of default is conclusively proved through board minutes or records. The counsel argued that no such evidence existed and that continuation of penal measures was illegal.

The bank’s counsel argued that the forensic audit showed serious irregularities and that the petitioner failed to appear for personal hearings. They also argued that although his name was removed from the wilful defaulters list, penal measures could still apply under the RBI’s 2024 circular.

Justice N. Sathish Kumar, who heard the matter, observed that classification as a wilful defaulter carries serious civil and economic consequences and strict compliance with RBI guidelines is mandatory. The court observed that RBIcirculars clearly protect non-whole time directors unless there is conclusive proof of their awareness or involvement in the wilful default.

On examining the records, the Court observed that there was no material showing that the petitioner participated in management decisions, consented to the alleged diversion, or was aware of the default through board proceedings.

The court explained that the forensic audit report was not shared with the petitioner and the impugned order did not contain any reasoning connecting the petitioner’s role with the alleged default. The court also pointed out that mere designation as a director or non-appearance at a personal hearing cannot justify branding a person as a wilful defaulter or continuing penal measures.

The court held that once the petitioner’s name was removed from the wilful defaulters list, penal measures could not continue in the absence of conclusive evidence of involvement. The court quashed the impugned order passed by the bank insofar as it related to the petitioner and allowed the writ petition. No costs were imposed.

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