Banks Must Give Opportunity Of Hearing To Borrowers Before Classifying Their Accounts As Fraud

Cause Title : State Bank of India & Ors vs Rajesh Agarwal & Ors, Civil Appeal No. 7300 of 2022, Supreme Court Of India

Date of Judgment/Order : 27/3/2023

Corum : Dr Dhananjaya Y Chandrachud, CJI & Hima Kohli, J

Citied: 

1. State Bank of India v. Jah Developers, (2019) 6 SCC 787
2. Union of India v. W N Chadha, 1993 Supp (4) SCC 260
3. Anju Chaudhary v. State of UP, (2013) 6 SCC 384
4. State of Orissa v. Dr (Miss) Binapani Dei, AIR 1967 SC 1269
5. Maneka Gandhi v. Union of India, (1978) 1 SCC 248 27 
6. Mohinder Singh Gill v. Chief Election Commissioner, New Delhi, (1978) 1 SCC 405 28
7. D K Yadav v. J M A Industries,  (1993) 3 SCC 259
8. Canara Bank v. V K Awasthy, (2005) 6 SCC 321
9. Erusian Equipment & Chemicals Ltd v. State of West Bengal, (1975) 1 SCC 70
10. Joseph Vilangandan v. Executive Engineer, (1978) 3 SCC 36
11. Raghunath Thakur v. State of Bihar, (1989) 1 SCC 229
12. Gorkha Security Services v. Govt (NCT of Delhi), (2014) 9 SCC 105
13. State of Maharashtra v. Public Concern for Governance Trust, (2007) 3 SCC 587 37
14. Peerless General Finance and Investment Co. Ltd v. Reserve Bank of India, (1992) 2 SCC 343 38 AIR 
15. Joseph Kuruvilla Vellukunnel v. Reserve Bank of India, 1962 SC 1371 39
16. Internet and Mobile Association of India v. Reserve Bank of India, (2020) 10 SCC 274
17. Swadeshi Cotton Mills v. Union of India, (1981) 1 SCC 664
18. Mangilal v. State of Madhya Pradesh, (2004) 2 SCC 447
19. Ajit Kumar Nag v. General Manager (PJ), Indian Oil Corp. Ltd, (2005) 7 SCC 764 44
20. Union of India v. Tulsiram Patel,  (1985) 3 SCC 398 45
21. K I Shephard v. Union of India, (1987) 4 SCC 431
22. Keshav Mills Co. Ltd. v. Union of India, (1973) 1 SCC 380
23. Delhi Cloth Mills & General Mills v. Union of India, (1983) 4 SCC 166
24. E P Royappa v. State of Tamil Nadu, (1974) 4 SCC 3
25. Cantonment Board v. Taramani Devi, 1992 Supp (2) SCC 501 52
26. Delhi Transport Corporation v. DTC Mazdoor Congress, 1991 Supp (1) SCC 600
27. Olga Tellis v. Bombay Municipal Corporation, (1985) 3 SCC 545
28. Union of India v. Col. J N Sinha, (1970) 2 SCC 458 55
29. C B Gautam v. Union of India, (1993) 1 SCC 78
30. Sahara India (Firm), Lucknow v. Commissioner of Income Tax, Central-I, (2008) 14 SCC 151 57 
31. Kesar Enterprises Ltd v. State of Uttar Pradesh, (2011) 13 SCC 733

Background

This civil appeals arise out of a challenge to the Reserve Bank of India (Frauds Classification and Reporting by Commercial Banks and Select FIs) Directions 2016.1 Issued by the RBI, these directions were challenged before different High Courts primarily on the ground that no opportunity of being heard is envisaged to borrowers before classifying their accounts as fraudulent. The High Court of Telangana has held in the impugned judgment that the principles of natural justice must be read into the provisions of the Master Directions on Frauds. The decision has been assailed by the RBI and lender banks through these civil appeals.

The objections of the borrowers were :-

• no notice is given to the borrowing company or its promoters, and directors including whole-time directors
• They are not given an opportunity to present a defense and even a copy of the final decision is not provided to them.
• there is a direct impact on the fundamental rights of the individuals concerned, as a consequence of the classification of an account as fraud.
• Master Directions on Frauds are violative of Articles 14, 19, and 21 of the Constitution of India as they debar a company and its promoters and directors from accessing financial and credit markets for a period of five years without even providing a show cause notice or opportunity of being heard.

Judgment

The question before the court was whether the principles of natural justice should be read into the provisions of the Master Directions on Frauds.

The court observed that the two fundamental principles of natural justice are entrenched in Indian jurisprudence are: (i) nemo judex in causa sua, which means that no person should be a judge in their own cause; and (ii) audi alteram partem, which means that a person affected by administrative, judicial or quasi- judicial action must be heard before a decision is taken.

It is now a settled principle of law that the rule of audi alteram partem applies to administrative actions, apart from judicial and quasi-judicial functions. It is also a settled position in administrative law that it is mandatory to provide for an opportunity of being heard when an administrative action results in civil consequences to a person or entity.

The court held that the principles of natural justice, particularly the rule of audi alteram partem, has to be necessarily read into the Master Directions on Frauds to save it from the vice of arbitrariness. Since the classification of an account as fraud entails serious civil consequences for the borrower, the directions must be construed reasonably by reading into them the requirement of observing the principles of natural justice.

The court summarised its conclusions as below:

• No opportunity of being heard is required before an FIR is lodged and registered;
• Classification of an account as fraud not only results in reporting the crime to investigating agencies, but also has other penal and civil consequences against the borrowers;
• Debarring the borrowers from accessing institutional finance under Clause 8.12.1 of the Master Directions on Frauds results in serious civil consequences for the borrower;
• Such a debarment under Clause 8.12.1 of the Master Directions on Frauds is akin to blacklisting the borrowers for being untrustworthy and unworthy of credit by banks. This Court has consistently held that an opportunity of hearing ought to be provided before a person is blacklisted;
• The application of audi alteram partem cannot be impliedly excluded under the Master Directions on Frauds. In view of the time frame contemplated under the Master Directions on Frauds as well as the nature of the procedure adopted, it is reasonably practicable for the lender banks to provide an opportunity of a hearing to the borrowers before classifying their account as fraud;
• The principles of natural justice demand that the borrowers must be served a notice, given an opportunity to explain the conclusions of the forensic audit report, and be allowed to represent by the banks/ JLF before their account is classified as fraud under the Master Directions on Frauds. In addition, the decision classifying the borrower’s account as fraudulent must be made by a reasoned order; and
• Since the Master Directions on Frauds do not expressly provide an opportunity of hearing to the borrowers before classifying their account as fraud, audi alteram partem has to be read into the provisions of the directions to save them from the vice of arbitrariness.