Legal Action Against Personal Loan Defaulters in India

If you default on a Personal Loan in India, you’ll be subjected to a structured legal procedure that begins with reminders and notices and then moves to legal action or civil recovery. Recent data shows that small ticket Personal loan defaults have been on the rise between December 2023 to June 2024.

Financial emergencies can constitute with unprecedented events such as a loss of employment or monetary loss. However, it is important to deal with a loan default immediately to avoid repercussions on your credit report. 

In this read, we are exploring in detail the consequences and legal action against Personal Loan defaulters in India and how you can deal with it in an informed manner.  Read on to know more!

What Legal Actions Can Be Taken Against a Personal Loan Defaulter?
 

If you default on a Personal Loan, the lender follows a predetermined sequence of recovery attempts before they pursue legal action. Ideally, the lenders will pursue with payment reminders and intensive recovery attempts before resorting to legal action against Personal Loan defaulters.

The sequence of legal actions taken against loan defaulters look somewhat like the following:

●    Demand Notice: The very first formal step is for the lender to send a legal notice describing the default with its amount (and additional default charges), and with a deadline for payment. This is your last window for clearing the dues or settling the loan before things take an unfortunate legal turn. You can also explore negotiation options with the lender, including options like loan restructuring and EMI reduction.
 

●    Major Default: Defaulting beyond 90 days can be marked as a major default, and your loan account is tagged as a Non-Performing Asset. The lender can now officially initiate the loan recovery process. As part of this, you can explore loan settlement options that will resolve the issue but will leave a long-standing negative impact on your credit report.

●    Action for Cheque Bounce: Under Section 138 of the Negotiable Instruments Act of 1881, bounced cheques or failed ECS (Electronic Clearing Service) payments are grounds for criminal charges. After the mandatory 15-day notice period, the lender may initiate proceedings that could lead to a fine or imprisonment for the borrower. 

●    Arbitration: Almost every loan agreement nowadays contains an arbitration clause (both lender and borrower agree to have the conflict resolved by a neutral third party i.e. an arbitrator). Arbitration is preferred since it happens in place of court proceedings and is also faster and less expensive. The outcome decided by the arbitrator is treated as the final word.

●    Civil Suit: If the loan remains unpaid for over 180 days, the lender can file a case against the borrower under Section 138 of the Negotiable Instruments Act of 1881.

●    Asset Seizure: If the court rules in favour of the lender, it issues an order for repayment, and if that is not followed, the borrower’s assets can be seized and sold off as directed by the court.

Also Read: What Happens If You Miss a Personal Loan EMI Payment?

RBI Guidelines for Loan Recovery

Though lenders have the right to recover their dues, their actions are regulated by the Reserve Bank of India. The RBI Fair Practices Code insists on humane and courteous conduct during recovery activities. No acts of intimidation, harassment, or public humiliation of a borrower on the part of the lender or its recovery agents are permitted. The lender must notify the borrower before taking recovery steps and must be transparent during the proceedings.

Also Read: How to Improve Credit Score in India After Default?

Distinguishing Between Civil and Criminal Liability

In India, a default on Personal Loan is essentially a civil matter and is not a criminal offence. It is considered a breach of contract wherein the lender seeks legal means to recover the money. It turns criminal only when there is a fraudulent intent to defraud.

This would typically arise when a borrower deliberately gives false information during the application process, defaults despite being able to pay, or disposes of the pledged collateral without the lender knowing. The Personal Loan defaulter is termed as a ‘wilful defaulter’, and criminal lawsuits can be filed against them.

Legal proceedings invoke a range of laws, like:
●    Prosecution for cheating under section 420 of the Indian Penal Code
●    The Insolvency and Bankruptcy Code (IBC), 2016 that restricts their control during the insolvency resolution process
●    Enabling lenders to take possession of mortgaged property under the SARFAESI (The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest) Act, 2002

The legal process thus remains civil and orientated towards payment in the case of genuine borrowers undergoing financial hardships.

Also Read: Major Steps to Follow to Avoid Missing Personal Loan EMI

To Conclude

Lenders can rightfully take legal action against Personal Loan defaulters under provisions of the Section 138 of the Negotiable Instruments Act of 1881. This takes place when you’ve defaulted on repayments for more than 180 days. Ideally, lenders would pursue with repeated payment reminders and intensive recovery attempts within the regulations of the Reserve Bank of India. The best way to avoid unnecessary escalation for a Personal Loan defaulter is to have a proactive and honest conversation with the lender. Try to negotiate the terms or explore debt restructuring to avoid legal procedures.

Frequently Asked Questions

Can one go to jail and be tried in India for defaulting on a Personal Loan?
No, as a loan default is a civil matter, imprisonment isn’t a consequence. But, under certain circumstances, a person can be jailed for having defaulted on a Personal Loan. For example, where criminal proceedings are instituted against him for issuing a bounced cheque under Section 138 of the Negotiable Instruments Act or if fraud is established.

What if I do not repay Personal Loan EMI for many years?
The lender can sue you within the limitation period, which is three years from the date of default. After this time period, however, the lender cannot sue you anymore, but your credit score is hit with a default status that remains for a minimum of seven years, hampering all your future credit approvals.

Can a lender just freeze my bank account?
No, a lender cannot freeze your bank account. First, the lender must obtain a formal order from competent legal authority, which confers upon the lender power to do this by way of asset attachment.

How can I settle an unpaid Personal Loan?
You should reach out to your lender directly and explain your financial difficulties. You can also try to negotiate for a one-time settlement (OTS) or more favourable loan restructuring. In an OTS, you essentially pay a reduced lump sum to close the loan, but this will still be recorded on your credit report.

What does a legal notice imply for someone who has defaulted on a loan?
The legal notice for someone who has defaulted on a loan means that the lender has officially communicated to the borrower to clear dues. It is the last warning given before a legal course is initiated.

What is NPA in lending?
A Non-Performing Asset (NPA) is a loan account in which repayments have been overdue for at least 90 days. In such cases, the loan is treated as a major default. 

Are there laws that govern the recovery of Personal Loans?
Yes, rules spread across legal provisions and RBI guidelines govern the recovery of personal loans in India. They aim at ensuring the recovery is prompt, fair, and transparent, without any harassment.

What is the meaning of a loan defaulter?
A defaulter is one who does not repay or returns late a loan or credit advanced to them. This adversely affects his credit history and, in turn, lessens opportunities for any future loans.