Lok Adalat for Bank Recovery: Section 89 CPC Settlement Strategy and Borrower Negotiation Levers

A borrower facing recovery under the SARFAESI Act, 2002, the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (RDDB Act), or a plain civil suit, often discovers that contested litigation runs for 4 to 7 years, attracts compounding penal interest of around 2% per month over the contract rate, and ends with the secured asset auctioned at a 25% to 35% discount to fair market value. The Lok Adalat route, anchored in Section 89 of the Code of Civil Procedure, 1908 and Chapter VI of the Legal Services Authorities Act, 1987, is the only forum where a settlement is recorded as a civil court decree on the same day, with no appeal risk and substantial principal/interest waivers negotiated directly with the lender's recovery officer.

The National Legal Services Authority (NALSA) reported that the National Lok Adalat held on 14 December 2024 disposed of approximately 1.45 crore cases pan-India in a single day, of which a sizeable share were bank recovery matters. Public sector banks routinely sanction 25% to 50% waiver on overdue interest and unapplied charges in Lok Adalat one-time settlements (OTS), provided the borrower clears the negotiated principal in 60 to 90 days. This article walks through the statutory architecture, the step-by-step referral procedure, the negotiation levers available to a borrower, and the recent tribunal and High Court pronouncements on enforcement and challenge of a Lok Adalat award.

The Statutory Position

The Lok Adalat is not a court of law in the conventional sense. It derives its authority from the Legal Services Authorities Act, 1987 (Act 39 of 1987), which received Presidential assent on 11 October 1987 and was operationalised on 9 November 1995. Four sections do the heavy lifting:

Section 89 of the Code of Civil Procedure, 1908, inserted by the CPC (Amendment) Act, 1999 (Act 46 of 1999) effective 1 July 2002, formally recognises Lok Adalat as one of four alternate dispute resolution forums. Where it appears to the court that elements of a settlement exist, it must formulate the terms and refer the matter; Lok Adalat is the lowest-cost option because no court fee is payable and any pre-paid court fee is refundable in full under Section 16 of the Court Fees Act, 1870 once the award is passed.

For bank recovery, the Reserve Bank of India's Master Direction on Income Recognition, Asset Classification and Provisioning (IRACP) dated 1 October 2021 expressly permits scheduled commercial banks to compromise non-performing assets through Lok Adalat OTS, with the resulting waiver booked as a write-off against the bank's IRAC provisioning rather than as a fresh loss. This regulatory comfort is why public sector banks have a clear incentive to settle, especially for accounts already provisioned at 100% (loss assets per IRAC paragraph 4.1.3).

NALSA organises a National Lok Adalat once per quarter in coordination with State Legal Services Authorities; the calendar is published on nalsa.gov.in. Continuous Lok Adalats and Permanent Lok Adalats (Chapter VI-A, inserted by Act 37 of 2002 effective 11 June 2002) sit through the year, but Permanent Lok Adalats under Section 22B are reserved for public utility services, not bank recovery.

Procedure Step by Step

The procedural sequence below assumes the bank has classified the account as a non-performing asset (NPA) per RBI's 90-day rule under IRAC paragraph 2.1, and has issued either a SARFAESI Section 13(2) demand notice or filed an Original Application before the Debts Recovery Tribunal (DRT) under Section 19 of the RDDB Act, 1993.

1. Identify the right Lok Adalat. For accounts up to Rs 20 lakh, the District Legal Services Authority (DLSA) Lok Adalat is the correct forum. For higher-value matters and DRT-pending cases, request a DRT-organised Lok Adalat under DRT Regulations, 2003 read with Section 19A of the RDDB Act, 1993.

1. File a written application for referral. The borrower files Form A under State Legal Services Authority Rules, attaching the loan account statement, the Section 13(2) notice or DRT OA copy, and a proposed settlement figure. Filing fee is nil; affidavit attestation costs around Rs 50 to Rs 200.

1. Bank acceptance of reference. Under Section 20(1), the court or DRT can refer a case to Lok Adalat only if both parties agree or one party applies and the court is satisfied of settlement prospects. Public sector banks typically respond within 30 days through a designated recovery officer.

1. Pre-Lok Adalat negotiation meeting. Held usually 7 to 14 days before the hearing date. The bank tables its OTS offer (typically principal + simple interest at the contract rate, with penal interest waived); the borrower counter-offers based on settlement capacity. A signed memorandum of compromise is drawn up.

1. Hearing before the Lok Adalat bench. A two-member bench (a serving or retired judicial officer plus a member of the legal profession) verifies that the compromise is voluntary and that no party is acting under coercion, then passes the award in open hearing.

1. Compliance with award terms. The borrower deposits the agreed sum within the timeline (usually 60 to 90 days; some banks allow 180 days with interest at base rate plus 1%). The bank issues a no-dues certificate, files satisfaction of charge with the Registrar of Companies under Section 82 of the Companies Act, 2013, and updates CIBIL/CRIF Highmark with status code 'Settled' or 'Closed (written off and settled)'.

1. Execution if borrower defaults. Failure to comply triggers Section 21(2): the award is executable as a decree of the civil court that referred the matter, under Order XXI CPC. The bank can attach immovable property, garnish salary, or proceed with auction without re-litigating the debt.

Borrower Defences Available

A borrower entering a Lok Adalat does not surrender substantive defences merely because the forum is conciliatory. Six negotiation levers carry real weight at the bargaining table.

Lever 1: IRAC asset classification. If the account is already a 'loss asset' under IRAC paragraph 4.1.3 (100% provisioning), the bank has no incremental capital cost in writing off up to 100% of unapplied interest. The difference between sub-standard (15%), doubtful-1 (25%), doubtful-2 (40%), doubtful-3 (100% on unsecured portion) and loss (100%) directly shapes the bank's flexibility.

Lever 2: Reversal of penal and overdue interest. RBI's circular dated 18 August 2023 (DOR.MCS.REC.28/01.01.001/2023-24), effective 1 January 2024, mandates that penal charges levied on default must be in the nature of penal charges and not penal interest. Any penal interest capitalised after that date is contestable, and full reversal is regularly secured at Lok Adalat negotiations.

Lever 3: Section 35A Banking Regulation Act, 1949 and the Fair Practices Code. The RBI Master Circular on Customer Service in Banks (1 July 2015, periodically updated) requires lenders to disclose all charges and to offer compromise settlement on transparent criteria. Undisclosed processing fee, foreclosure charge or insurance premium booked to the loan can be challenged.

Lever 4: SARFAESI Section 13(3A) reply. If the borrower has filed a representation under Section 13(3A) within 60 days of the Section 13(2) notice and the bank failed to issue a reasoned reply within 15 days, the entire enforcement process is procedurally tainted, as held in Mardia Chemicals Ltd v Union of India (Supreme Court of India, 8 April 2004, AIR 2004 SC 2371).

Lever 5: Limitation under Article 36 of the Limitation Act, 1963. A bank's claim on a loan is time-barred 3 years from the date of default acknowledgement (Section 18 read with Article 36). If the bank's last acknowledgement is older than 3 years, the suit itself is barred, and any Lok Adalat compromise should reflect that weakness.

Lever 6: Income tax treatment of write-off. Under Section 41(4) of the Income Tax Act, 1961, interest waived by the lender is not taxable in the hands of an individual not carrying on business. For business borrowers, the waived amount is taxable as remission of trading liability under Section 41(1), which must be modelled into the settlement figure.

Recent Tribunal/HC Position

The judicial position on Lok Adalat awards in bank recovery has been refined through three lines of authority that any borrower or counsel must be alive to.

Finality of the award. The Supreme Court in State of Punjab v Jalour Singh (4 February 2008, (2008) 2 SCC 660) held that an award passed by Lok Adalat under Section 21 is final and binding; the only remedy is to invoke Article 226/227 of the Constitution where the award is the result of fraud, misrepresentation or coercion. A fresh civil suit on the same cause of action is barred.

Writ jurisdiction as the sole challenge route. In Bhargavi Constructions v Kothakapu Muthyam Reddy (Supreme Court, 5 September 2017, (2018) 13 SCC 480) the court reiterated that a Lok Adalat award is amenable to writ jurisdiction under Article 227 only on limited grounds of jurisdictional error or fraud. Substantive disagreement with the settlement amount is not a ground.

DRT-Lok Adalat interplay. The Bombay High Court in Bank of Maharashtra v Pandurang Ganpat Lavate (29 January 2024, Writ Petition 4527 of 2023) held that where a DRT has organised a Lok Adalat and the bank's recovery officer has signed compromise terms, the bank cannot subsequently resile and proceed with auction under SARFAESI; the auction would be void and the borrower entitled to specific performance of the OTS terms.

Insolvency overlap. The National Company Law Appellate Tribunal in Anand Varma v Reliance Capital Ltd (NCLAT, 17 April 2024, Company Appeal AT (Ins) 471/2024) noted that a Lok Adalat OTS executed before a Section 7 admission under the Insolvency and Bankruptcy Code, 2016 is enforceable as a creditor admission of the settled amount; later admission of the corporate debtor does not unravel the OTS, although unpaid amounts crystallise as financial debt before the Resolution Professional.

No pre-deposit. Unlike an appeal before the Debts Recovery Appellate Tribunal under Section 18 of the SARFAESI Act, 2002 (50% of the demanded amount, reducible to 25% on application), no pre-deposit is required to access a Lok Adalat. This is one of the strongest practical reasons a borrower with limited liquidity should attempt the Lok Adalat route before exhausting tribunal appeals.

For deeper context on the tribunal escalation pathway, borrowers should review our explainer at /learn/glossary/drt and the SARFAESI primer at /learn/glossary/sarfaesi. Where the property is mortgaged, the foreclosure calculator helps model the exit cost against the OTS figure being negotiated.

Practical Negotiation Workbook

Before walking into a pre-Lok Adalat meeting, prepare these five numbers, each verifiable from the loan account statement that the bank must provide under the RBI Master Direction on Customer Protection dated 6 July 2017:

The bank's opening offer typically equals (1) + (2) + 50% of (3). The borrower's counter-offer should target (1) + 70% of (2), with full waiver of (3) and (4). For the underlying charge-priority logic, our recent piece on SARFAESI Section 23 and CERSAI registration is the relevant primer; for harassment remedies overlapping with Lok Adalat referrals, see the RBI Fair Practice Code piece.

FAQ

Can I approach a Lok Adalat before any case is filed against me?

Yes. Section 19(5) of the LSA Act 1987 permits pre-litigation reference. The borrower files Form A with the DLSA, the DLSA issues notice to the bank, and if both parties agree, the matter is taken up at the next sitting. The award has the same finality as a post-litigation award under Section 21.

What is the total cost to access a Lok Adalat?

Court fees are nil. Any pre-paid court fee in a referred suit is refunded in full under Section 16 of the Court Fees Act, 1870. Affidavit and notarial costs typically range from Rs 50 to Rs 500. Legal representation is optional; many borrowers appear in person for accounts under Rs 20 lakh.

Can the bank refuse to come to Lok Adalat?

In theory, yes, since Section 20(1) requires both parties to agree. In practice, public sector banks rarely refuse because the RBI IRAC Master Direction (1 October 2021) and the Department of Financial Services framework on bad loan resolution actively encourage compromise settlements. Private banks and Asset Reconstruction Companies are also typically open, especially for accounts older than 2 years.

What happens if I default on the Lok Adalat award?

Section 21(2) of the LSA Act 1987 makes the award a decree of the civil court that referred the case. The bank can execute under Order XXI of the CPC, 1908 by attaching property, garnishing salary, or proceeding with auction. Critically, the bank cannot re-open the substantive debt; the award amount becomes the new principal.

Will an OTS hurt my CIBIL score and for how long?

Yes. Under the RBI Master Direction on Credit Information Companies (1 January 2014, periodically updated), the account is reported as 'Settled' or 'Closed (written off and settled)' for 7 years from the award date. The 'Settled' tag typically reduces the credit score by 75 to 150 points, and most lenders treat it as a negative marker for fresh loans for 3 to 5 years. Some banks accept payment of the waived portion later to upgrade the status to 'Closed'.

Is a Lok Adalat award the same as a One-Time Settlement under bank policy?

They overlap but are not identical. An OTS is a contractual compromise sanctioned under the bank's internal recovery policy and executed on a memorandum of agreement; it does not automatically have the status of a decree. A Lok Adalat OTS is the same compromise, but recorded as a Lok Adalat award, giving it Section 21 finality. Borrowers should always insist that the OTS be recorded at a Lok Adalat sitting rather than through a private agreement, because the decree status protects both sides from later challenge.

Subodh Bajpai is a tax and corporate law commentator. He writes on financial regulation, tribunal practice and borrower remedies. Nothing in this article constitutes legal advice; readers should consult their own counsel before acting on any procedural step described above.