Lender Banks Must Furnish Copy Of Audit Reports Before Classifying Loan Account As Fraud: Gujarat High Court

Background Facts:

Amit Dineshchandra Patel (Petitioner) are the promoters, suspended directors, and shareholders of Syntex Industries Ltd. (Company). On 06.04.2021, the company was ordered into a Corporate Insolvency Resolution Process ('CIRP') under Insolvency and Bankruptcy, Code, 2016 ('IBC'). The company's loan accounts were declared as fraud by the consortium banks (Respondent).

Contention of the Petitioner:

The Petitioners argued that no opportunity has been offered to deal with the forensic audit report and/or the supplementary forensic audit report.

They contended the same is a mandate issued by the Supreme Court in State Bank of India and Others v. Rajesh Agarwal and Others (2023) and argued that pertinently, except for sharing the observations of the draft forensic audit report with the petitioners neither the copy of forensic audit report nor supplementary forensic audit report was provided to the petitioners.

Verdict of the Court:

The Gujarat High Court allowed the petition and held that the Lender Banks must provide a reasonable opportunity to the Borrower by furnishing a copy of the Audit Reports and allowing him to submit a representation before classifying the account as fraud.

The High Court placed reliance on the provisions of Master Directions of 2016 on frauds and observed that the Master Directions of 2016 on frauds and more particularly, Chapter VIII titled “Loan Frauds – New Framework” deals with the procedure to be followed while declaring the account as a fraud account.

Further, Clause 8.9.4 provides for the decision to classify any standard account or NPA account as RFA or Fraud at the individual level and the responsibility of the bank to report the RFA or Fraud status of the account on the CRILC platform so that other banks are alerted.

It also observed that Clause 8.9.5 envisages the completion of a forensic audit within a stipulated period. It also provides that in case the decision is to classify the account as a fraud, the RFA status shall be changed to fraud in all banks and to report to the Reserve Bank of India and on the CIRLC platform within a stipulated period.

The Court pointed out that the Supreme Court in State Bank of India & Ors. Vs. Rajesh Agarwal & Ors. (2023) answered the issue as to whether the principles of natural justice should be read into Master Directions of 2016 on frauds. It had held that the principles of natural justice and more particularly, rule of audi alteram partem has to be necessarily read into the Master Directions on frauds to save it from the vice of arbitrariness.

The Apex Court emphasized on the serious civil consequences of the classification of an account as fraud for the borrower, and thus, held that the directions must be construed reasonably by reading into them the requirement of observing the principles of natural justice.

“It provided that audi alteram partem, therefore, entails that an entity against whom evidence is collected must:

(i) be provided an opportunity to explain the evidence against it;

(ii) be informed of the proposed action, and

(iii) be allowed to represent why the proposed action should not be taken.”

The High Court noted that the Apex Court also emphasized that the mere participation of the borrower during the course of the preparation of a forensic audit report would not fulfill the requirements of natural justice.

The Gujarat High Court highlighted the Supreme Court's observations that there is an application of mind to the facts and law by the lender banks while deciding to classify an account as fraud. Further, the lender banks, either individually or through a Joint Lenders Forum have to decide whether a borrower has breached the terms and conditions of a loan agreement, and based upon such determination the lender banks can seek appropriate remedies.

The High Court noted that thus, the principles of natural justice provide for serving of notice to the borrower and an opportunity to explain and submit a representation must be given in light of the forensic audit report before classifying the loan account as fraud under the Master Directions on Frauds.

In conclusion, the Court ruled that presently the Respondent violated the principles of natural justice. Thus, it quashed and set aside the Respondent's decision declaring the account of the company as fraud. It remitted the matter and directed the Respondent to furnish the relevant copies of the forensic audit report and supplementary audit report giving reasonable opportunity to submit the representation.

Case Title: Amit Dineshchandra Patel vs. Reserve Bank of India

LL Citation: 2024 LiveLaw (Guj) 10

Case No.: R/Special Civil Application No. 19008 of 2022

Counsel for Petitioner: Mr. Mihir Thakore, Sr. Counsel with Ms. Rhea J. Sevak for Mr. Arjun R Sheth

Counsel for Respondent: Mr. Dhruvkumar S Chauhan, Mr. A J Saiyad, Mr. Amar N Bhatt, Mr. Anip A Gandhi, Mr. K I Kazi, Mr. Lalit M Patel, Mr. S. N. Soparkar, Sr. Counsel with Mr. Masoom K Shah, Ms. Ab Chaturvedi

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