SUPREME COURT UPHOLDS THAT BORROWERS MUST BE HEARD BEFORE BANKS CLASSIFY THEM AS FRAUDULENT

A Two Judge Bench of the Supreme Court comprising of Chief Justice Dr. DY Chandrachud and Justice Hima Kohli passed a Judgment in ‘State Bank of India and Others vs Rajesh Agarwal and Others, Civil Appeal No. 7300 of 2022’ and upheld that banks must give an opportunity to be heard to its borrowers before declaring them fraudulent.

Facts:

i) In the present case, lending banks such as State bank of India, Union Bank of India, Bank of Baroda have declared a borrower company named BS Limited (a Company dealing in business of power transmission), as fraudulent and red flagged their accounts on default of credits payments by them.

ii) The lending Banks formed a Joint Lenders Forum (JLF) with State Bank of India as the lead bank and classified the borrower as fraud by following the provisions laid down by the Reserve Bank of India (RBI) in the ‘Master Directions on Frauds’ (Master Circular).

iii) The borrower company filed a Writ Petition No 19102 of 2019 in the High Court of Telangana challenging the decision of JLF, which classified their company as fraud.

iv) The borrower company in their Writ Petition contented that the JLF failed to follow the Principals of Natural Justice (Audi Alteram Partem in specific) prior to lisitng them as wilful defaulters and frauds.

v) It also contended that the non-inclusion of principals of natural justice in the Master Directions on Fraud make the said directions arbitrary to borrowers.

vi) The lending banks contented that the Master Circular is drafted with an intent to protect the interests of depositors and banks from growing instances of fraud.

vii) They further contended that the principals of natural justice are not applicable at the stage of setting the process of criminal law in motion i.e. before filing an FIR or a complaint before law enforcing departments.

High Court

The High Court of Telangana after hearing the parties vide its Judgment dated 10.12.2020 allowed the Petition and held that the principal of Audi Alteram Partem (Right to be heard or listened to) has to be read as part of the Master Circular. Thereby, informing the bank that it could not take any action against the borrower without giving an opportunity to explain themselves.

Aggrieved by the Judgment dated 10.12.2020, the lending banks (Appellants) filed a Civil Appeal No. 7300 of 2022 in the Supreme Court of India.

Supreme Court Analysis:

1. After hearing the Counsels representing both the parties, the Apex Court held that
2. RBI is a statutory body constituted for administering the provisions of the Banking Regulation Act, 1949 (BR Act). The BR Act vests RBI with various powers with respect to banking companies such as granting licenses, conducting inspections and giving directions. The Master Circular is one such direction that allows banking companies to delist borrowers with fraudulent intentions.
3. The principals of natural justice are not mere legal formalities but constitute substantive obligations that are to be followed by decision-making and adjudicating authorities. They act as a guarantee against arbitrary action by judicial, quasi-judicial, and administrative authorities. One of the fundamental principles of natural justice is ‘Audi Alteram Partem’, which provides for a person affected by administrative, judicial or quasi-judicial action to be heard before a decision is taken.
4. The Master Directions on Frauds do not expressly exclude a right of hearing to the borrowers before an action to class their accounts as fraud. The principles of natural justice must be read into a statute or a notification where it is silent on granting an opportunity of a hearing to a party whose rights and interests are likely to be affected by the orders that may be passed.
5. The classification of an account as fraud entails serious civil consequences for the borrower; hence, the directions must be construed reasonably by reading into them the requirement of observing the principles of natural justice.

Conclusion:

The Apex Court vide its Judgment dated 27.03.2023 dismissed the Civil Appeal No 7300 of 2022 and upheld the High Court Judgment dated 10.12.2020 stating that the principals of natural justice demand that the borrowers be served a notice and be given an opportunity to be heard before their account is classified as fraud under the Master Directions on Fraud.

Editor’s Comments:

In the recent past, there have been several frauds played upon the banks that now banks are quick to jump to the conclusion that every borrower who is not paying is guilty of fraud. However, this may not be true in every case as there are instances where a borrower may be genuine and yet is unable to repay the loan. In such a situation, the borrower would obviously request for some time as the intention to repay is there. It is one of the first principals of law that a court, tribunal or authority cannot decide against a person without such a person being given the opportunity to be heard. Hence, Audi Alteram Partem is a principal that must be complied in all matters in order to enable a court, tribunal or authority to do justice.

Shalini Donthi

Legal Associate

The Indian Lawyer

Edited by:

Sushila Ram Varma

Chief Consultant

The Indian Lawyer