Can Banks Declare Wilful Default on CIRP Audit Reports?

In the complex landscape of insolvency proceedings under the Insolvency and Bankruptcy Code (IBC), 2016, companies undergoing Corporate Insolvency Resolution Process (CIRP) often face additional pressures from lenders. A critical question arises: Whether Wilful Default can be Alleged by Banks Upon Acquiring an Audit Report of a Company under CIRP? This issue pits banks' rights to protect their interests against borrowers' procedural safeguards.

This blog post delves into the legal nuances, drawing from Supreme Court judgments and RBI guidelines. Note that this is general information and not specific legal advice—consult a qualified lawyer for your situation.

Understanding Wilful Default and Its Implications

Wilful default occurs when a borrower intentionally defaults on loan repayments, often involving diversion of funds or deliberate non-payment despite capacity. RBI guidelines empower banks to classify such borrowers, imposing severe consequences like management changes, director disqualifications, and restricted credit access. As noted, Banks/financial institutions can even change the management of the wilful defaulter, and a promoter/director of a wilful defaulter cannot be made promoter or director of any other borrower company2022 Supreme(Online)(MAD) 9377 2023 0 Supreme(Guj) 155.

However, during CIRP, a moratorium under Section 14 of the IBC halts certain actions, raising questions about banks' ability to initiate wilful default proceedings based on audit reports obtained in this phase.

The Role of Audit Reports in Wilful Default Declarations

Audit reports, particularly forensic or transaction audits during CIRP, are valuable investigative tools. They uncover potential fund diversions, siphoning, or misconduct. Yet, they are corroborative tools but not the sole basis for declaring wilful default2021 0 Supreme(Del) 1243 2024 0 Supreme(Del) 443.

In State Bank of India v. Jah Developers Limited, the Supreme Court clarified: the forensic audit report can act as corroboration but cannot be the sole basis. The bank must independently find that the default is intentional, deliberate, and calculated, based on objective facts and circumstances, and must record this satisfaction properly2021 0 Supreme(Del) 1243. Simply acquiring a report during CIRP does not justify a declaration without this independent assessment.

Other sources affirm that The forensic audit report was relied upon as one of the reasons to establish wilful default2023 0 Supreme(Cal) 48, but emphasize it must align with objective evidence of misconduct like diversion of funds, unauthorized routing of sale proceeds, or malfeasance2024 0 Supreme(Del) 514 2025 0 Supreme(Del) 566.

Procedural Safeguards: Principles of Natural Justice

Declarations of wilful default are administrative proceedings, not judicial, but must follow fair procedures. Key requirements include:

• Independent Committee Review: Decisions rest with the bank's Identification and Review Committees, who must record their satisfaction 2021 0 Supreme(Del) 1243 2024 0 Supreme(Del) 443.
• Opportunity to Respond: Banks must provide the borrower with the audit report and a personal hearing. The declaration process must adhere to principles of natural justice. The bank must furnish the borrower with the audit report and give an opportunity to respond2025 0 Supreme(Bom) 120 2021 0 Supreme(Del) 1243 2019 5 Supreme 744.
• Transparency: Failure to share reports or allow rebuttal violates natural justice, often leading to quashing of declarations 2025 0 Supreme(Bom) 120.

For instance, courts have ruled that procedural violations, such as denying access to audit reports, invalidate declarations of wilful default2025 0 Supreme(Bom) 120. In ongoing CIRP, the moratorium under Section 14 prohibits certain proceedings... but does not automatically bar wilful default proceedings if proper procedures are followed2000 1 Supreme 10.

The grievance mechanism reinforces this: decisions to classify the borrower as wilful defaulter should be entrusted to a Committee of higher functionaries...2021 0 Supreme(Mad) 2592. Borrowers must receive notice and hearing, as seen in cases where fresh proceedings were initiated post-hearing 2016 0 Supreme(Del) 3920.

Judicial Precedents Shaping the Law

Supreme Court and High Courts have consistently upheld procedural rigor:

• SBI v. Jah Developers2021 0 Supreme(Del) 1243: Forensic reports require independent bank evaluation; withholding them invalidates declarations.
• Key Ruling2025 0 Supreme(Bom) 120: Quashed declaration due to non-disclosure of audit and lack of fair opportunity.
• Another Precedent2019 5 Supreme 744: Emphasized notice and documentation to avoid natural justice violations.

During CIRP, proceedings for identification of Wilful Defaulters under the RBI Master Circular... in the face of the ongoing CIRP must still comply 2021 0 Supreme(Del) 1929. Courts scrutinize if banks followed RBI Circular steps.

Integrating Forensic Audits During CIRP

Forensic audits in CIRP help creditors assess defaults but aren't conclusive proof. Banks can allege Wilful Default based on findings from forensic audit reports, even after acquiring and reviewing such reports during CIRP proceedings2024 0 Supreme(Telangana) 327 2024 Supreme(Online)(TEL) 18505, provided there's objective assessment of the audit findings and related evidence. Timing matters—banks often know of issues pre-CIRP—but procedural fairness is non-negotiable 2024 0 Supreme(Del) 514.

NCLT has rejected over-reliance on outdated reports: merely on the forensic report which had gone beyond a period of two years... fraudulent... transaction could not be established2023 0 Supreme(Cal) 48.

Exceptions, Limitations, and Practical Recommendations

While audit reports can't standalone justify wilful default, exceptions exist:

• If committees independently record intentional default after full procedure, declarations may hold.
• Reports corroborate but don't replace independent findings2021 0 Supreme(Del) 1243.

Recommendations for stakeholders:- For Banks: Furnish reports, grant hearings, document satisfaction per RBI guidelines 2024 0 Supreme(Cal) 1380 2021 0 Supreme(Cal) 70.- For Borrowers: Demand documents and respond promptly; challenge violations in writs.- General: Courts will quash non-compliant declarations, regardless of report contents.

Key Takeaways and Conclusion

Generally, banks cannot allege wilful default solely upon acquiring an audit report during CIRP. It requires independent committee satisfaction, recorded objectively, with full natural justice compliance—including report access and hearings 2021 0 Supreme(Del) 1243 2024 0 Supreme(Del) 443 2025 0 Supreme(Bom) 120.

The balance protects lenders from misconduct while safeguarding borrowers from arbitrary actions. As insolvency cases rise, adhering to these principles prevents costly litigation. Stay informed on RBI updates and judicial trends to navigate this terrain effectively.

Word count: 1028. This analysis draws from cited precedents; outcomes may vary by facts.