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

In a significant verdict, the Supreme Court on Monday held that borrowers must be heard before their accounts are classified as fraud. The Court held that the principles of "audi alteram partem" must be read into the Circular issued by the Reserve Bank of India on the classification of bank accounts as fraud accounts.

The bench noted that classification of accounts as fraud results in serious criminal and civil consequences for borrowers; it amounts to "blacklisting" of borrowers; hence opportunity of hearing must be granted for the borrowers under the Master Directions on Fraud.

Also, such decision must be made by a reasoned order.  It cannot be presumed that the Master Circular excludes the principles of natural justice.

A bench comprising Chief Justice of India DY Chandrachud and Justice Hima Kohli upheld the judgment passed by the Telangana High Court in December 2020 which held the same. The bench also set aside a judgment of the Gujarat High Court which held to the contrary.

Requirement of reasoned order will act as a check on arbitrary exercise of power

Apart from the principle of "audi alteram partem", the Court held that the requirement of passing a reasoned order must be read into the Master circular, as it will act as a "check on the arbitrary exercise of powers".

"The reasons to recorded need not be placed on the same pedestal as a judgment of the Court. The reasons may be brief but they must conform to fairness by indicating due application of mind", the judgment stated.

Conclusions of the judgment :

CJI Chandrachud read out the conclusions of the judgment as follows :

1. No opportunity of being heard is required before an FIR is lodged and registered.

2. 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.

3. Debarring the borrowers from accessing institutional finance results in serious civil consequences for the borrowers.

4. Such a debarment is akin to blacklisting the borrowers for being untrustworthy and unworthy of credits by banks. This Court has consistently held that an opportunity of hearing must be provided for a person blacklisted.

5. The application of audi alteram partem cannot be impliedly excluded from the Master Directions on Frauds. In view of the time line in the Master Directions on Frauds, as well as the nature of proceedings, it is reasonably practicable for the lender banks to provide an opportunity of hearing to the borrowers before classifying their accounts as fraud.

6. The principles of natural justice demand that the borrowers must be served an notice, given an opportunity to explain the conclusions in the forensic audit report and be allowed to represent the banks and joint lenders forum before their accounts are classified as fraud. In addition, the decision to classify the account as fraudulent must be made by a reasoned order.

7. Since the Master Directions do not expressly provide for an opportunity of hearing to the borrower, audi alteram partem must be read into the provisions to save them from the vice of arbitrariness.

Case Title : State Bank of India vs Rajesh Agarwal and connected cases