Audi Alteram Partem In RBI Master Circulars On Wilful Defaulter And Fraud

The RBI Master Circular, dated July 01, 2015, in clause 2.1.3 states certain circumstances, the occurring of which result in the identification of a unit as a willful defaulter, which are as follows:

a) The unit has defaulted in meeting its payment / repayment obligations to the lender even when it has the capacity to honour the said obligations.

b) The unit has defaulted in meeting its payment / repayment obligations to the lender and has not utilised the finance from the lender for the specific purposes for which finance was availed of but has diverted the funds for other purposes.

c) The unit has defaulted in meeting its payment / repayment obligations to the lender and has siphoned off the funds so that the funds have not been utilized for the specific purpose for which finance was availed of, nor are the funds available with the unit in the form of other assets.

d) The unit has defaulted in meeting its payment / repayment obligations to the lender and has also disposed off or removed the movable fixed assets or immovable property given for the purpose of securing a term loan without the knowledge of the bank / lender…"

The circular further states that for the default to be categorized as willful, it must be intentional, deliberate and calculated and should not have been an isolated incident. The circular in Clause 3 provides for the mechanism for identification of willful defaulters wherein in sub clause (b), a show cause notice needs to be given to be given to the concerned borrower and on the basis of the reply the identification for willful defaulter needs to be done and on case-to-case basis even personal hearing can be given to the borrower.

On the other hand, classification of an account as 'fraud' is dealt with by the Master Directions on Frauds dated 01.07.2016. Clause 2.2 of these directions, which defines and deals with the classification of frauds, based on the provisions of the Indian Penal Code, states that:

a. Misappropriation and criminal breach of trust.

b. Fraudulent encashment through forged instruments, manipulation of books of account or through fictitious accounts and conversion of property.

c. Unauthorised credit facilities extended for reward or for illegal gratification.

d. Cash shortages.

e. Cheating and forgery.

f. Fraudulent transactions involving foreign exchange.

g. Any other type of fraud not coming under the specific heads as above.

As regards cases under d) and f) above, cash shortages resulting from negligence and fraudulent forex transactions involving irregularities / violation of regulations have also to be reported as fraud if the intention to cheat/defraud is suspected or proved. Notwithstanding the above, the following cases shall be treated as fraud and reported accordingly:

a. cases of cash shortage more than ₹ 10,000/-, (including at ATMs) and

b. cases of cash shortage more than ₹ 5,000/- if detected by management / auditor/ inspecting officer and not reported on the day of occurrence by the persons handling cash.

However, to identify a unit as 'fraud' no opportunity of hearing is available in the circular even though the latter is a much more serious matter.

Consequences under willful defaulter vs. Consequences under Fraud

Under the master circular on willful defaulters, the basic purpose is to ensure that basic bank finance is not available to them as emphatically stated under the head of purpose. The penal measures in the willful defaulter circular provided in Clause 2.5 state that a) no additional facilities should be given to the willful defaulter, b) legal process to recover the dues should initiated against the willful defaulter and criminal action may be initiated wherever necessary, c) Banks/FIs should adopt a proactive approach to change the management of the borrower and d) the loan agreements should have a clause that companies should not have on its board persons who have been declared to be willful defaulters and in case such a person is found to be on the board, it would take steps for its removal. Moreover, under clause 4.2 (iii), the banks and the FIs have been advised to initiate criminal action against the willful defaulters under the existing law and in specific cases under Section 403 and 405 of the IPC.

On the other hand, the prime purpose under the fraud circular as expressed in clause 1.3 is to discover a fraud being committed on a bank so as to alert the other banks to take necessary action against such parties who may be declared as a fraud and also to kickstart investigations by the investigative agencies. According to Clause 8.12 of the Master Circular, the borrower and all the working Directors would be debarred from raising funds from the banking system for a period of five years. In addition, they will be debarred from seeking additional funds or seeking restructuring and cannot even enter into a compromise or settlement. Thus, once labelled as a 'fraud' the, the stigma will haunt for a considerable time and will have very grave civil consequences as well apart from the criminal prosecution that will entail.

Audi Alteram Partem

The issue of Audi Alteram Partem in the RBI circular on fraud has come under immense judicial scrutiny.

The Telangana High Court in the case of Rajesh Agarwal vs. Reserve Bank of India and Ors has upheld the principle of audi alteram partem to be read into Clause 8.9.4 and 8.9.5 of the Master Circular as doing it otherwise will result into vagueness because while under Clause 8.9.4 and 8.9.5 the opportunity to be heard has been denied whereas under Clause 8.12.1 it has been provided that the procedure for declaring a borrower as a wilful defaulter has to be followed. The Court applied the consequences of the decision test to read the principle of natural justice into the Master Circular of fraud as the declaration of fraud would entail according to Clause 8.12 with very harsh consequences for the borrower and it's promoter/director with debarment from banking system for 5 years which would be violative of Article 19 1 (g) and Article 21 without the succour of natural justice. In the same breadth it was observed that subsequent to the detection of an account as fraud, the Master Circular imposes a duty on the Bank to lodge a complaint with the CBI/criminal investigating agency in a short span of time which would have a disastrous consequence for the company and its promoter in facing the criminal prosecution by the State. The Court also held that without the principle of natural justice being read into Clause 8.9.4 and 8.9.5 of the Master Circular, the Bank would have absolute power which is antithetical to the concept of Rule of Law and fair play in governance demands that the person/entity is given one hearing before making an opinion.

The Delhi High Court in the case of Apple Sponge And Power Ltd and Ors v. Reserve Bank of India and Anr, in the order dated 15.02.2019, granted stay against any subsequent/ further actions pursuant to the account being declared fraud. It was observed by the Court that declaration of fraud in the civil law framework by an administrative decision would require the principles of natural justice i.e., audi alteram partem to be followed but a bank can certainly report fraudulent transactions under the criminal law to law enforcement agencies. Moreover, the High Court remarked that for an account to be declared as a fraud would happen on an egregious default and would be much more than the account holder being just a willful defaulter and thus the fraud would entail an element of criminality based on some substantive material which ought to be produced to the account holder with the spirit of audi alteram partem. The Delhi High Court has relied on the order dated 15.02.2019 in subsequent Writ Petitions and granted a stay against any adversarial action by the bank pursuant to such declaration. All the subsequent Writ Petitions have been tagged with the Apple Sponge case and are pending final adjudication before the Delhi High Court.

The Supreme Court of India has refused to stay the judgment of the Telangana High Court but notices have been issued and the matter is now listed on 13^th July, 2021 for arguments.

In order to harmonize the provisions of the Circulars on fraud and willful defaulter, the declaration of account as a fraud resulting in both civil and criminal consequences must happen only after furnishing the documents before the borrower/promoter and giving them one opportunity to explain the same in compliance with the principle of natural justice.

It is imperative that the master Circulars are synchronized and the errant borrowers face the strong arm of the law by the Supreme Court of India. In light of the ongoing corona pandemic, RBI should bring greater clarity on the One Time Settlement (OTS) policy for the banks in light of the KV Kamath Panel report by extending it to even for those businesses which have been NPA's before the onset of the pandemic so that borrowers have greater clarity and settlements can take place in a transparent manner.

Views are personal.

The Author is an Advocate based in New Delhi.