What happens to the borrower if he/she defaults on a personal loan? In case of a secured loan like a home or car loan, the lender can take over the asset that is used as collateral to secure the loan. However, in the case of an
unsecured loan like a personal loan, what is the legal recourse that a lender will take to recover dues from the borrower?
An unsecured loan does not offer any security to the lender and hence, there is no immediate threat to the borrower about lenders having any claim on their assets. “An unsecured loan is without any security or mortgage as guarantee for repayment and solely based on borrowers credit rating. Hence, assets cannot be appropriated. Recovery is based on the contract term of dispute resolution and through the process of law,” says Harsh Pathak, a Delhi based advocate.
What this means is that the lender on their own does not have the right to possess any of your assets. “Assets of a borrower can only be attached following the due process and through a court order on whatever assets the court deems fit. Borrower’s assets are beyond the recovery net of the lender, and only come for realisation of debt pursuant to the assessment and order of the competent court,” adds Pathak.
Here is a look at how the lender will recover dues from a borrower who has defaulted on a personal loan and the options available with such a defaulting borrower.
Damage control at first instance
Lenders typically get serious with regards to recovery when there is a prolonged delay in repayment of the loan. “The borrower’s account is classified as a non-performing asset (NPA) if the repayment is overdue by 90 days,” says Sonam Chandwani, Managing Partner at KS Legal & Associates. The lender will start legal proceedings once your loan account turns into an NPA, which means only after you have not paid three consecutive EMIs. The lender will give you a notice of 60 days to clear the dues before starting the legal proceedings. This is the time you should try your best to settle the default.
“At the outset, if borrowers can convince the lender that defaults are temporary and repayment would soon become regular, the lender may delay the legal proceedings. Therefore, clear and honest communication with the lender can stall or at the very least delay proceedings initiated by the lender, if any,” says Chandwani.
Lender may set off debt with bankers’ lien
There are many unsecured loans where the asset is not mortgaged but only a lien is marked on the assets like safe custody, bond, fixed deposit, shares, mutual funds etc. Once a lien is marked, the borrower cannot sell the assets before clearing the dues and lender removing the lien.
So, what happens if the borrower has defaulted and is unable to pay the dues?
“The lender may have a right to exercise banker’s lien and right to set off if it has been contractually agreed by the borrower. Banker’s lien is the right of retaining assets delivered to the bank’s possession unless the borrower to whom they belonged has agreed that this right shall be excluded, such as in the case of valuables kept in the bank for safe custody,” says Manisha Shroff, Partner, Khaitan & Co.
A bank may exercise the option to set off the dues against your deposits. “A lender also has a right to set off a debt owed by a borrower against a debt due from him. For example, a bank can set off the amounts owed by the borrower against the money deposited by the borrower in the accounts of the bank, if contractually agreed,” says Shroff.
If you have fixed deposits or savings account with a bank, then in such a situation the bank may recover dues from these deposits.
Lender goes for a lawsuit for recovery of money
In usual circumstances the lender does not have any right on the borrower’s property but if the lender files a suit in the court and gets a favourable order, things can change. “A brief action or summary procedure is available for recovery of money under the Civil Procedure Code, 1908, by way of the institution of a suit in a court of appropriate jurisdiction,” says Shroff.
The jurisdiction of the suit is determined first based on territorial jurisdiction and then on pecuniary jurisdiction. The pecuniary value (total dues claimed by lender) of the suit becomes a deciding factor on whether the lender will file the suit either in the district court or in the high court.
“When the lender obtains a decree from a court of law against the borrower, he is to get the decree satisfied by way of execution proceedings. The execution comes to an end when the judgment-creditor or decree-holder gets cash or other thing granted to him by judgment, decree, or order,” says Shroff. At this stage as well, the borrower can get a final chance to settle the loan without involving attachment of any asset.
However, if the borrower is unable to settle the dues, he/she faces the threat of his/her assets being attached. “In the event the borrower is unable to comply with the decree of court, the court may, upon application by the lender, attach the assets of the borrower,” says Shroff.
Lender can approach Debt Recovery Tribunal for loan above Rs 20 lakh
A lender can initiate recovery dues by approaching the Debt Recovery Tribunal (DRT) under the Recovery of Debt Due to Banks and Financial Institutions Act, 1993 (DRT Act). This option is available only for high value of outstanding as the amount of debt should not be less than Rs 20 lakh, according to the DRT Act.
“The DRT Act is not applicable where the amount of debt due is less than Rs 20 lakh or any other amount not below Rs 1 lakh, in cases where the central government may by notification specify. Thus, in essence, minimum debt which is to be recovered from DRT should not be less than Rs 20 lakh,” says Shroff.
The borrower also gets the opportunity to be heard and present his facts before the tribunal which can be considered by the tribunal before passing a final order. “Upon completion of the proceedings under DRT, if the DRT finds fit, it may pass orders for appointing a receiver of the property/assets of the borrower, before or after the grant of Recovery Certificate (RC) or appoint a commissioner for collecting details of defendant/respondent’s property or sale thereof,” adds Shroff.
After going through the case history and presented facts if the tribunal passes the order for attachment of the property, then the recovery office of DRT may proceed toward attachment and sale of the borrower’s assets.
Rights of a defaulting borrower
A borrower defaulting on an unsecured loan may exercise the following rights: Right to sufficient notice, Right to be heard, Right to humane treatment and Right to report grievance.
“Apart from other contractual rights that an individual borrower may have under the loan agreement, the Reserve Bank of India (“RBI”) has formulated Fair Practices Code (“FPC”) to streamline loan recovery practices for banks and financial institutions,” says Shroff.
Banks cannot indulge in misconduct or bypass the procedure laid down by the law against the defaulters. “In case of misconduct by banks, NBFCs, ARCs, the defaulter shall have legal rights against the same. In the event of harassment or coercion by the bank or recovery agents, the borrower may approach the banking ombudsman under the relevant framework of the RBI. In cases of continued harassment, a police complaint can also be filed or an injunction can be filed before the civil court,” says Chandwani.
If the lender has taken the legal proceedings to a court or DRT you need to follow the proceedings and represent your case. “In case of an unsecured loan, lenders typically try to obtain an injunction on sale or disposition of any and all assets. However, banks cannot sell all the assets; they can only sell such assets as would be sufficient to realise the amount of defaulted loan along with interest, costs and expenses etc.,” says Mani Gupta, Partner at Sarthak Advocates & Solicitors.
If the matter has gone against you in court or the DRT, you need to make sure its impact is limited. “If the borrower has an asset whose sale would realise sufficient proceeds to meet the liability, the borrower should inform the DRT/ court of the same and seek that injunction be limited to such asset. Apart from this, certain types of property cannot be sold in execution of decree,” adds Gupta.
Be pro-active to settle the dues
A serious default, where the lender needs to write off a significant outstanding amount of your loan, can impact your credit history severely. With a poor credit history it is almost unlikely that the borrower will get any credit in future. Even if you settle the dues later on it will always reflect in your credit history and will take many years to improve your credit score.
Though, it may be difficult and time-consuming process for the lender to get a claim on the borrower’s asset to recover the unsecured loan’s due, however, if it happens the cost for the borrower will be much more than the due amount as the lender will not only recover the principal but also the interest, penalties and cost of the legal suit.
“Borrower should be proactive in settling the loan, otherwise it cost penal interest, adverse credit rating, late fees and legal cases. As civil cases are common and permissible on default cases. However, in exceptional circumstances criminal cases for breach of trust or cheating can also be initiated,” says Pathak. So, the better way is to be proactive and take some hard calls about liquidating your own assets and settling the dues at right time at a lesser cost.