Bombay High Court Stays Bank Action After SC Rules Opportunity Of Hearing To Borrowers Before Classifying Their Accounts As 'Fraud' Mandatory

Granting relief to certain borrowers in a batch of petitions, the Bombay High Court has stayed till September 11 the action taken by various banks after declaring their accounts as “fraudulent accounts” without prior notice and a hearing.

A division bench of Justice GS Patel and Neela Gokhale relied on the Supreme Court’s order in State Bank of India & Ors v. Rajesh Agarwal & Ors. that read the principles of natural justice into the RBI’s master directions on fraud.

This meant accounts couldn’t be declared as fraudulent accounts sans a hearing and notice.

“….We will have to issue Rule and grant stay against further actions based on the decision taken by the banks under the Master Circular in question.”

The bench clarified that the banks were at liberty to rescind, withdraw or cancel any orders already passed under the Master Circular declaring accounts as fraudulent accounts without hearing and to re-initiate the process in line with the SC’s decision.

“We have not stayed the operation of the Master Circular (which has not been struck down by the Supreme Court decision). The Supreme Court has only read certain requirements into the Master Circular. It follows, therefore, that actions under the Master Circular consistent with the Supreme Court judgment and decision may undoubtedly proceed.”

The petitions filed before the Bombay High Court assailed actions taken by various banks under directions issued by the Reserve Bank of India called the Frauds (Classification and Reporting by Commercial Banks and Select FI) Directions, 2016.

In State Bank of India & Ors v. Rajesh Agarwal & Ors.1 the SC was dealing with a challenge to an order passed by the Telangana High Court against the RBI’s directions empowering banks to categorise a borrowers account as ‘fraudulent account’ without a hearing.

The SC noted that classification of an account as fraud resulted in debarring the borrowers from accessing institutional finance under Clause 8.12.1 of the Master Directions on Frauds, and was akin to blacklisting the borrowers for being untrustworthy and unworthy of credit by banks.

“This Court has consistently held that opportunity of hearing ought to be provided before a person is blacklisted…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 lenders banks to provide an opportunity of a hearing to the borrowers before classifying their account as fraud.”

Moreover, principles of natural justice demanded that the borrowers must be served a notice, given an opportunity to explain and classifying the borrower’s account as fraudulent must be made by a reasoned order, the SC held.

Justice Patel’s bench noted that they would have to consider each of the petitions but since all Petitions complained of a violation of the principles of natural justice, including not being afforded an opportunity of a hearing and not being given copies of the material relied upon against the Petitioner, they would have to issue Rule and stay further actions based on the Master Circular.

The court said it would take up the entire group of pleas for final disposal on 7th and 8th September 2023.

Case Title: S S Hemani v. Reserve Bank of India & Ors

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