When the borrowers face financial difficulties and then approach the bank for a loan settlement, the biggest question is: “Can a bank legally refuse my loan settlement request, and if it does, what legal options do I have?”
This confusion is completely understandable.
Understanding as to how loan settlements actually work, what are the rights that the borrowers have, and what are the remedies that are available when a bank refuses settlement proposals can help avoid costly mistakes and the unnecessary litigation.
What Loan Settlement Is and What It Is Not
Loan settlements refer to agreements made between borrowers and lenders where the lender agrees to accept less than the balance owed on a loan to fulfil that obligation.
Many borrowers mistakenly believe they have a legal right to settle their loans. They do not. The fact that you’re experiencing financial hardship doesn’t automatically mean you’re entitled to a loan settlement.
Some people confuse settlements with loan restructuring; these two actions are very different from one another. In a settlement, banks will close your loan account after receiving a reduced payment. With loan restructuring, you still owe the total amount of your loan but the terms of repayment may be changed; such as extending the length of your loan, lowering your monthly payment, or giving you a temporary delay in repaying your loan.
OTS (one-time settlements) are commonly offered by banks as formalized ways to recover bad loans through negotiated payments between banks and borrowers. Although an OTS program will give borrowers a chance to settle, it does not guarantee that you are entitled to do so.
What a Bank Refusing Loan Settlement Really Means
Many borrowers assume that once they make a reasonable offer, the bank must accept it. In reality, banks evaluate settlement proposals from a commercial and recovery perspective.
When a bank refuses a loan settlement proposal, it generally means that the bank believes:
- A higher recovery is possible;
- The value of the security is sufficient to recover dues;
- Recovery proceedings may yield better results;
- The borrower does not satisfy settlement criteria; or
- Internal policies do not permit acceptance of the proposal.
Therefore, rejection of a settlement request does not automatically mean that the bank has acted illegally.
However, the discretion of the bank is not unlimited. The decision needs to be fair, reasonable, and consistent with all the applicable laws and policies.
Is Loan Settlement Mandatory for Banks?
This is the most important question, and the legal position is very clear. No law in India requires a bank to accept every settlement proposal submitted by a borrower.
Banks are commercial institutions and have the right to decide whether accepting a reduced amount serves their financial interests. Indian courts have repeatedly held that loan settlement and One-Time Settlement schemes are matters of commercial discretion and not enforceable rights.
However, the courts have clarified that the banks cannot act arbitrarily, discriminatorily, or in the violation of their own policies while considering the settlement requests.
This distinction is extremely important although a borrower cannot force the settlement, they can challenge the unfair decision-making process.
Factors Banks Consider Before Approving a Settlement
Before accepting a settlement proposal, banks usually examine several factors.
The most important factors include the total outstanding dues, value of mortgaged property, availability of other securities, recovery prospects, financial condition of the borrower, repayment history, nature of default, and ongoing recovery proceedings.
For example, if a borrower has mortgaged a property worth substantially more than the outstanding dues, the bank may prefer enforcing its security interest instead of accepting a reduced settlement amount.
Similarly, the borrowers classified as the wilful defaulters often face the greater difficulty in obtaining the settlement approvals.
Because every case is only evaluated individually, the borrowers should avoid assuming that the financial hardship alone guarantees acceptance of a settlement proposal.
What Legal Rights Do Borrowers Have?
There is no legal requirement for borrowers to force a creditor to settle with them, but they still have a number of other legal rights that will help guarantee that they will receive their fair share of the property in the event of a bankruptcy or other loss. The rights include:
Borrowers have the right to receive record/registered statutory notices, to challenge unlawful recovery proceedings, to be treated fairly by their financial institutions, to use mechanisms to seek resolution of their grievances and to challenge arbitrary decisions made by a creditor in the proper forum.
The above statutory rights are extremely important when banks begin taking aggressive action to recover their debts after refusing to accept a proposed settlement.
The law creates the basis for the bank’s right to recover its due debts by requiring that any such recovery is performed according to statutory procedures and is consistent with the principles of fairness.
What Legal Options Do You Have If a Bank Refuses Loan Settlement?
Engaging with a bank in an appropriate manner through effective communication should be the first step.
The majority of disputes that arise from borrower and lender relationships are due to incomplete settlement proposals or lack of supporting documentation for the claim of financial hardship from the borrower. Providing the bank with detailed representations regarding the borrower’s financial condition, including all of the appropriate supporting documentation, will often increase the likelihood of the institution reconsidering its prior decision.
If the branch where the borrower has been trying to negotiate a settlement turns down the request, the borrower will have the option of escalating the dispute to another level within the institution, such as the regional office, zonal office, grievance redressal officer, or nodal officer.
If the internal process is unsuccessful, the borrower may wish to contact the Reserve Bank of India (RBI) and inquire about the RBI’s Integrated Ombudsman Scheme regarding matters in which they believe they have experienced unfair treatment, a deficiency of service, or procedural irregularities.
The Ombudsman does not have the authority to formally direct a bank to accept a borrower’s settlement proposal; however, it does have the authority to review and ensure that the bank is treating its customer fairly and in accordance with applicable regulations.
Recovery Proceedings Under the SARFAESI Act
One of the primary reservations of borrowers, upon receipt of debt collection demand from a lender but not yet receiving an approved settlement offer, is the commencement of recovery procedures pursuant to the Security Interest (Enforcement) Act or SARFAESI Act.
The SARFAESI Act allows lenders (or ‘financial institutions’) to enforce a security interest without getting a separate court order confirming the validity of the security interest prior to enforcement.
Because of this, a lender can take possession of a borrower’s secured property by:
- Taking possession of the secured asset;
- Selling the secured asset;
- Recovering the amounts owed by enforcing the security interests.
The vast majority of borrowers think they have no legal defence to an enforcement of a security interest after SARFAESI proceedings have been commenced. This is absolutely incorrect.
The SARFAESI Act expressly provides legal remedies and/or protection to borrowers facing enforcement proceedings pursuant to the SARFAESI Act.
Where a borrower is subjected to unlawful recovery proceedings pursuant to the SARFAESI Act, the borrower can challenge those proceedings before the Debt Recovery Tribunal (in India) pursuant to Section 17 of the SARFAESI Act.
The types of defences that generally may arise in an enforcement proceeding include, but are not limited to, the following:
- Violation of the statutory process;
- Illegal repossession of the secured property;
- Illegally served notices;
- Valuation issues;
- Illegal auction details.
The Role of the Debt Recovery Tribunal (DRT)
The main forum for resolving disputes arising from bank recovery actions is the Debt Recovery Tribunal, or DRT.
Borrowers often mistakenly think that the DRT can direct banks to agree to settlements; in reality, however, the Tribunal’s authority is more narrowly focused.
The DRT focuses exclusively on verifying whether recovery actions were carried out legally. It checks for compliance with statutory requirements and assesses whether or not the borrower’s legal rights have been violated.
The Tribunal doesn’t typically have the authority to require a bank to accept a settlement proposal, however, in situations in which recovery actions violate applicable laws, the Tribunal may provide valuable relief to a borrower.
As a result, borrowers who are subject to SARFAESI actions should be vigilant regarding all notices and timelines they receive during the recovery process, as well as contacting an attorney for legal advice as soon as possible.
Can You Approach the High Court?
Uncommon situations require High Court’s interference via writs under Article 226 of the Constitution of India for borrowers. Generally speaking, High Court’s do not typically interfere with commercial decisions regarding loans being settled.
Courts have reiterated that borrowers must first apply all available statutory remedies (SARFAESI Act and DRT). However, there may be instances where the courts are able to intervene when there is clear arbitrariness, a breach of natural justice, procedural injustice or a disregard for a statute.
If so, the Court may direct a reconsideration of the settlement proposal, as well as to review the legality of the settlement decision-making process.
Important Supreme Court Judgments on Loan Settlement
The most important judgment on this issue is the Supreme Court decision in Bijnor Urban Cooperative Bank Ltd. v. Meenal Agarwal & Others (2021).
In this case, borrowers sought directions compelling the bank to consider and accept a One-Time Settlement proposal. The Supreme Court rejected the attempt to force the bank into a settlement arrangement and held that a borrower cannot claim OTS as a matter of right.
The Court further observed that commercial decisions regarding recovery and settlement primarily fall within the domain of banks and financial institutions. Judicial interference should remain limited unless there is clear illegality.
This judgment is significant because it directly answers the question that most borrowers ask when a bank refuses a settlement proposal.
In Transcore v Union of India and Authorized Officer, State Bank of Travancore v Mathew K.C., the Supreme Court reaffirmed that the principle of exhausting available specialized remedies before utilizing extraordinary judicial jurisdiction remains firmly established.
Collectively, these four cases create an overarching statutory framework for the resolution of disputes arising from settlements and recovery actions in India.
When Can a Bank’s Refusal Become Legally Vulnerable?
The bank’s refusal to grant a settlement to a borrower may become open to legal challenge (e.g., for being an arbitrary, correspondingly inconsistent decision, or a mala fide decision).
In this example, the borrower that is denied consideration for settlement benefits but has sufficiently similar characteristics to other borrowers who have received settlement benefits may have grounds for appealing the bank’s decision.
If the bank has ignored its own settlement guidelines and/or has not followed mandatory procedures, the borrower may have grounds to challenge the bank’s decision-making process.
In general, the courts have focussed on ensuring there is a fair and lawful result, rather than replacing the bank’s business judgment with the courts’.
Impact of Loan Settlement on Credit Score
Before pursuing this option, borrowers need to thoroughly assess the impact of the settlement method.
The majority of borrowers only consider immediate relief from their debt without taking into account what will happen to their credit history when settling their debt will be reported as a “settled,” “partially settled,” or “written off.”
Borrowers should compare their settlement options to a restructuring or full repayment option before making any decisions regarding their Settlement. Borrowers need to understand that having their debt settled will show up in their credit report as “settled,” “partially settled,” or “written off” and will affect any future credit applications, credit cards, or any future financing.
What You Should Practically Do Right Now
If your bank has refused a loan settlement proposal:
- Do not ignore recovery notices.
- Keep all communications in writing.
- Obtain written reasons for rejection wherever possible.
- Review whether any OTS scheme is currently available.
- Gather the documents proving the financial hardship.
- Monitor the SARFAESI and DRT proceedings very carefully.
- Seek professional legal advice before responding to the recovery action.
Many borrowers lose valuable legal opportunities simply because they delay taking action after receiving notices from banks.
How We Help Borrowers in Loan Settlement and Recovery Matters
We assist our clients in reviewing offers of settlement, replying to communications from a bank, negotiating with banks & financial institutions, countering invalid SARFAESI actions and representing clients in Debt Recovery Tribunals, and defending borrowers against unreasonable or arbitrary collection initiatives.
We focus on providing practical, legally viable solutions for our clients and ensuring that they know their legal rights and obligations as a borrower.
One can talk to lawyer from Lead India for any kind of legal support. In India, free legal advice online can be obtained at Lead India. Along with receiving free legal advice online, one can also ask questions to the experts online free through Lead India.
FAQs
1. Can a bank legally refuse a loan settlement proposal?
Yes. Banks are generally not legally required to accept settlement requests because settlement is considered a commercial decision.
2. Can a court force a bank to accept a One-Time Settlement?
Generally, no. Courts have consistently held that OTS cannot be claimed as a matter of right.
3. What happens if at all my settlement proposal gets rejected?
The bank may continue recovery proceedings, including SARFAESI action, DRT proceedings, or other recovery measures.
4. Will loan settlement affect my CIBIL score?
Yes. Settlement may negatively impact your credit history and future borrowing capacity.
5. Can I approach the DRT after a settlement rejection?
You may approach the DRT to challenge unlawful recovery actions, although the Tribunal generally cannot compel a bank to approve a settlement.
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