SC tells RBI to ensure banks follow rules on loan recovery, vehicle repossession

The Supreme Court on Wednesday said banks and finance companies cannot use strong-arm tactics to recover loans or treat a default as “a licence” to forcibly seize a borrower’s assets, even if the loan agreement permits repossession.

The court directed the Reserve Bank of India (RBI) to ensure “genuine compliance” with its guidelines, master circulars and clarifications by non-banking financial companies (NBFCs) and scheduled commercial banks so that borrowers are not dispossessed of their livelihoods “in the dead of night, without notice and without recourse”.

“Where a financier steps outside that framework, breaks open a lock in the dead of night, takes possession without notice and without a signed memorandum, and thereafter treats the borrower merely as a source of residual liability, it forfeits the protection that the contract and the law would otherwise have afforded it,” the court said.

The observations were made by Justice Alok Aradhe, who was hearing an appeal filed by Hari Dutta Sharma challenging an April 2025 order of the Allahabad High Court.

Sharma had taken a commercial vehicle loan worth around ₹10 lakh from a finance company to buy a truck. When he defaulted on the instalments, the company sent “four unidentified men” at around 1 am. They broke the truck’s steering lock and drove it away without any prior notice to Sharma. The company then took possession of the vehicle and sold it.

Sharma approached the Allahabad High Court, which dismissed his plea, saying he had approached it belatedly since the vehicle had already been sold. It also noted the default in payment of the loan instalments and dismissed the writ petition.

He had argued before the Supreme Court that the company had repossessed his vehicle in violation of the loan agreement, which required seven days’ prior notice. He also argued that a financier could not exercise its right to self-help repossession through force or deceit, or contrary to the terms of the agreement.

The company, meanwhile, argued that it had resorted to taking the vehicle back because Sharma had a history of defaulting on repayment instalments.

The Supreme Court, however, said that while a repossession clause in a loan agreement was meant to protect the interests of the lending company and make it more feasible for it to extend credit to borrowers, such a right does not operate without limits.

“Precisely because this right operates as an alternative to recovery through courts or tribunals, outside the supervision of a court at the first instance, it must be construed with great circumspection,” the court said. “Left unchecked, it is capable of being read as an unbridled licence to seize property by stealth, by force or in the dead of night, converting a facility meant to promote financial inclusion into an instrument of oppression against the very class it was designed to serve,” it said.

The court also examined the loan agreement and held that it was contrary to the RBI guidelines and the provisions of the Indian Contract Act, 1872.

It found that the clause left the borrower entirely at the financier’s unilateral discretion regarding whether to issue notice and the manner and timing of the sale. The court held that the clause did not conform to the RBI guidelines or the contractual requirement of fairness.

The court also referred to its earlier judgments, which had stressed that India is governed by the rule of law and that banks and financial institutions must recover loans and seize vehicles only through legal means. The judgments had specifically rejected the use of musclemen or “goondas” to take possession of vehicles by force.

The earlier judgments had also referred to RBI guidelines issued in 2005 for the recovery of loans and seizure of vehicles. The court noted that, despite the passage of more than two decades, those guidelines and subsequent directions had effectively remained “only on paper” without effective implementation.

It directed the RBI to take effective steps to ensure genuine compliance with the guidelines.