Lender’s Liability in Corporate Borrowings

When a Corporation receives Rs. 7 Crores of loan from a bank, it has got itself a full-fledged banker. But,
when the same corporation receives a loan amounting to Rs. 70 Crores, it not just gets a full-fledged banker,
but also something similar to a partner.

Abstract
This paper attempts to study the lender’s liability in corporate borrowings through the case study of
Kingfisher Airlines and that how the negligence on the part of the banks led to such a fiasco of corporate
borrwing setup. The paper shows the concept of liability in case of corporate borrwings is not just limited to
the borrower, rather it is also applicable on the lender. Also, there are ways in which the lender’s liability can
be avoided and better transparency and public accountability can be ensured.

Introduction
The Kingfisher Loan fiasco has been in highlights everywhere from the time it came out in the media. The
case is a result of the flaws of the system which majorly cosists of flaws made by the banks while making
approvals for such loans. In the middle of all the sentiments and anger, the most important aspect which is
connected to the heart of the problem is less traversed. The aspect is of ‘lender’s liability’.1 Lender’s liability
is an American Concept and means the liability of the lender in case of some breach of contract, fiduciary
relationship, or alleged wrongful behaviour. the concept of lender’s liability cover not just due diligence on
the part of lender while granting loans, but also make a lendor liable in case they fail to take appropriate and
timely measures to stop the debt from becoming bad-debt.2

Corporate Borrowings
An adequate amount of capital is needed for the smooth and successful functioning of any business. There
can be two ways to get the capital for your business. First, through the internal sources by way of issuing the
equity share capital. While the second can be done through external sources such as commercial borrowings,
issue of debentures, fixed deposits, loans from banks, etc. Borrowing is the term used when the capital is
raised through some external sources.

There can various types of borrowings that a company can opt for:

1
​Daniel R. Fischel, “The Economics of Lender Liability”, Vol. 99, ​Yale L.J., 1​ 31-154 (1989).
2
Rowan McR. Russell, “Impact of Recent Corporate Collapses on Negotiating and Drafting Syndicated Loans”, Vol. 27, No. 2,
Am. ​Bar​ Assoc., 397-427 (1993).
1. Long term borrowings
This kind of borrowing is preferred where the funds are to be borrowed for a longer period of time.
The time period for which the funds can be borrowed under such kind of borrowing is 5 years or
more.

2. Short term borrowings

This kind of bowwing is preferred where funds are required for a very short period of time. The term
for which the funds are borrowed under this kind of borrowings is up to 1 year. This kind of
borrowing is usually used to generate an amount for the working capital.

3. Medium-term borrowings
Funds borrowed for a period of 2-5 years.

4. Secured borrowings
In this kind of borrowing, the lender has access over the assets of the company and thus an obligation
to the debt is deemed as security.

5. Unsecured borrowings
In this kind of borrowing, debt contains a financial obligation.

6. Syndicated borrowings
This kind of borrowing is generally used when the borrower needs a large amount of fund and such
fund is generally raised through a group of lenders.

7. Bilateral borrowings
Wherein the company borrows from a particular kind of financial institution it is termed as bilateral
borrowing. Only a single kind of contract is there between the parties to the borrowing.

8. Private borrowing
Under this kind of borrowing the loan is taken from a bank or some financial institution.

9. Public borrowing
It consists of the financial institutions that can be freely traded on a public exchange.
Lender’s Liability
Lender’s liability in originality is an American Doctrine, which in its traditional sense was understood as a
loan made by the lender in a bad faith with an intent to fraud or misrepresent. The liability of a lender is
generally an output of his conduct and not an activity. Generally, lender’s liability arises in cases of breach
of some central or state statutory obligations or in case of breach of some judicial pronouncement. Thus, the
lender is found to be liable in cases where he exercises control over the affairs of the borrower beyond his
limits, i.e, excessive control or engages in some fraudulent conduct against the borrower or the creditors of
the borrower, or engages in some conduct that is been prohibited by some Central or State laws.

A Lender’s Liability under the following circumstances:

1. In case of a Breach of a Contract/ Fraud

For decades, lenders were the one who sued the borrowers for the breach of contract. But, with the
birth of the concept of lender’s liability, now the same right is given to the borrowers as well. An
agreement to a loan is just like any other contract and if the same is entered upon with a motive to
defraud the other or without the consent of both parties, the same can be held to be void. In case of a
breach of the loan agreement by the party lending it, he can be sued by the other party. The remedy
which is most commonly sought after by the aggrieved party in the case of the breach of contract is
the recovery of damages.

2. Fiduciary Relationships
In a fiduciary relationship, one person owes a special duty towards the other because of his position
and the fiduciary is bound to look after the interests of the other person and take special care of him.
Before, the borrowers were able to establish that the lender is bound by some fiduciary duties
towards and thus should be liable in case of breach of such duties. However, later on, the lenders
limited the contention of the borrowers with respect to the fiduciary relationship between the lender
and the borrower.

3. Inappropriate Collateral Sales

Lenders can also attract liability in case they sell the collateral security after the default of the loan.
The method, manner, time, place, and terms of the sale must be commercially reasonable and if the
sale is proved to be commercially unreasonable in nature, the lender may be held liable.

Background to the Concept of Lender’s Liability

Back in the year 2003, the Ministry of Finance decided to formulate a statute similar to the American Statute
‘The Truth in Lending Act, 1968’. But, there was no such law made until the Reserve Bank of India
formulated the guidelines on the Fair Practices Code for Lenders in 2003.3 As per these guidelines, all the
banks laid down there own guidelines on the fair practice. The primary code of conduct that these guidelines
laid were related to the way of dealing with the borrowers by the lenders and that the banks should be
sympathetic towards the borrowers in their times of distress. Eventually, these guidelines turned ineffective
when used against the increasing problems as if they were never adequate to tackle such issues. Later on in
the year 2004, the idea of lender’s liability was heard in the case of ​Mardia Chemicals Limited v. Union of
​ herein the constitutionality of the Securitization and Reconstruction of Financial Assets and
India4 w
Enforcement of Security Interests (SARFAESI) Act, 2002 was challenged. The Supreme Court in the case
stated some observations, but they were in a different parallel primarily focusing on the liabilities of the
lending banks while providing for their rights under the Act in question. Since then the concept of lender’s
liability has come a long way and is on absolutely different than the concept which was propounded then.
Now, the lender’s liability must make the lender’s accountable and responsible whenever they are negligent
in a way or are acting upon some malafide intent at the time of granting of the loan or in case they fail to
take necessary actions on time to recover the debt from the defaulting borrowers. For example, banks
involving themselves in belligerent lending where they clearly know all the risks present.

Other Side of the Coin

The past decade has proved that the RBI guidelines have not benefitted much while the problem of
Non-performing asset has increased drastically. It is accepted that the public sector banks have a great
responsibility of giving loans to the various social sectors which ultimately increases the no. of NPA’s on
their balance sheets. However, why there is no burden on the lenders when they are clearly diverging from
the established norms of governance or where the culture of loose credit is prima facie visible.
If we apply the Doctrine of Lender’s liability to the case of Kingfisher Airlines which is a typical example of
crony capitalism and hustling lending. The Indian banks have granted credit merely on the basis of the
highly escalated trademark value. In the year 2009, Grand Thornton valued the brand who had never made a
profit from the day of its existence, of a whopping amount of INR 4111 crores. 5
Back in the year 2009, Kingfisher brand belonged legally to the United Breweries Ltd. and it was only after
2010 that the trademarks for the kingfisher were applied for the registration of the trademark in the name of
Kingfisher Airlines. There were serious flaws in the valuation of the trademark of the Kingfisher. Kingfisher
tried to take advantage of the brand’s successful performance in the sector of beverages which was the main
reason why the banks fall into the pit and lend the loans in the first place. In the year 2008 and 2010 for the

3
​RBI Notification DBOD. Leg. No.BC. 104 /09.07.007/2002-03, May 5, 2003.
4
​2003(9)SCALE185
5
http://www.markables.net/files/Beyond_all_comparables_Kingfisher_brand_valuation.pdf.
purposes of the debt restructuring process, Kingfisher Airlines presented the brand Kingfisher to the banks as
collateral. However, the important question is were the banks right on their side to depend merely upon the
valuation of the brand and accept it as collateral which was based on the overrated revenue estimates?
Should have banks dug deeper than into the grounds of such valuation which was way higher than the
industry’s average before making loan approvals? If No, then does not it creates the lender’s liability on the
part of the banks? Just like the Kingfisher bird, the money too flew away.
Furthermore, In India, Suitcase banking is a common practice which is highlighted in the cases of ​Syndicate
Bank and Bhushan Steel Case.​ Thus, shortcomings on the part of the banks, especially in public sector banks
in evaluating the creditworthiness of the borrowers cannot be ignored. There is no event in India till date
where the banks are being made accountable for the happenings of such events.
There’s a theory of ​good money-about to go bad-saved by good money-finally goes bad.​ To put it simply, in
situations where a loan is about to turn bad, more loan is put into the same borrower or in some sister
company of the borrower in order to pay off the previous loan so that the banks are not required to put the
previous loans as NPAs. Ultimately what happens is that these loans turn out to be bad causing more loss
and trouble to the banks.6 This vicious cycle is termed as ​ever-greening of loans.
There is no surprise to it that in the case of a daring businessman like Mallya, banks took a back seat till the
things became chaotic and went out of their control. Laconically, the concept of lender’s liability should
cover not just due diligence on the part of banks while granting loans, but should also make banks liable in
case they fail to take appropriate and timely measures to stop the situations like these to happen. 7

Why the Opacity?

Another important dimension of lender’s liability is about bringing transparency and making a public
disclosure. Especially in the cases of public sector banks which are funded by the government, it becomes
their duty to maintain full transparency and be made liable in case of non-compliance.
Reserve Bank of India v. Jayantilal N Mistry8
In the year 2015, few private individuals asked for the information from the Reserve Bank of India by filing
an RTI with regard to the inspection reports, bank statements, business-related information, action taken
against the defaulters, etc. It was unreservedly denied by the RBI. The case went up to the Supreme Court of
India wherein the SC rebuked the RBI for safeguarding some banks from public embarrassment and
dismissed the contention of RBI pleading fiduciary relationship with the banks.

Conclusion: Is there a way out?

6
Reserve Bank of India v. Jayantilal N Mistry, AIR 1 SC 2016
7
​ ttp://articles.economictimes.indiatimes.com/2013-12-14/news/45191294_1_gross-npas-state-run-
h
banks-psu-banks.
8
​AIR 1 SC 2016
To conclude, if such instances of crony lending at the cost of macro-economic losses are to be avoided then
certain measures are to be taken to held such lender’s liable for their bad decisions and utter negligence. RBI
has a tendency to save the banks from public embarrassment and thus allows them to maintain secrecy. To
make a shift to solve the existing problems, it’s important for both the banks and the RBI to leave aside their
Ostrich approach by ignoring the core issue and pretending as if everything is absolutely fine. The approach
has to be preventive rather than curative in nature until and unless we have a proper credit rating system.
Furthermore, the banking secrecy laws need to be changed keeping in mind the current situation. There is
always a collision happening every now and then between the RTI and the secrecy provisions regulating
banks. These secrecy laws are generally used generally to guard the defaulters rather than using it to
safeguard actual confidentiality.9

9
Banerjee, Sudipto, 'Wilful Defaulter': Name and Shame Strategy V/S Procedural Safeguards. COMPANY LAW JOURNAL,
Vol. 1, 2015(January), pp. 1-13.