Supreme Court: Borrowers Have Right to be Heard Before their Accounts are Classified as Fraud

Supreme Court: Borrowers Have Right to be Heard Before their Accounts are Classified as Fraud

The Supreme Court by its division bench comprising of Chief Justice of India DY Chandrachud and Justice Hima Kohli, while upholding the judgment passed by the Telangana High Court, observed that, even though Master Directions on Frauds do not expressly exclude a right of hearing to the borrowers before action to class their account as frauds is initiated. The principles of natural justice can 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.

The Apex Court was hearing the civil appeals arising out of a challenge to the Reserve Bank of India (Frauds Classification and Reporting by Commercial Banks and Select FIs) Directions 2016. These directions were challenged before different High Courts primarily on the ground that no opportunity of being heard was envisaged by borrowers before classifying their accounts as fraudulent.

The High Court of Telangana had observed in its impugned judgment that the principles of natural justice must be read into the provisions of the Master Directions on Frauds. The decision was assailed by the Reserve Bank of India (RBI) and lender banks through these civils appeals.

The Apex Court was of the view that the classification of accounts as frauds 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.

The bench pertinently noted that, “classification of a borrower’s account as fraud has the effect of preventing the borrower from accessing institutional finance for the purpose of business. It also entails significant civil consequences as it jeopardizes the future of the business of the borrower. Therefore, the principles of natural justice necessitate giving an opportunity of a hearing before debarring the borrower from accessing institutional finance under Clause 8.12.1 of the Master Directions on Frauds. The action of classifying an account as fraud not only affects the business and goodwill of the borrower, but also the right to reputation.”

The Apex Court while emphasizing on the principle of ‘audi alteram partem,’ 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 Apex Court further directed that the reasons to be recorded need not placed on the same pedestal as a judgment of a court. The reasons may be brief but they must comport with fairness by indicating a due application of mind.

The Apex Court laid the following conclusions:

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 frame contemplated under the Master Directions on Frauds as well as the nature of the procedure adopted, it is reasonably practicable for the lender banks to provide an opportunity of a hearing to the borrowers before classifying their account as fraud.

6. The principles of natural justice demand that the borrowers must be served a notice, given an opportunity to explain the conclusions of the forensic audit report, and be allowed to represent by the banks/ JLF before their account is classified as fraud under the Master Directions on Frauds. In addition, the decision classifying the borrower’s account as fraudulent must be made by a reasoned order.

7. Since the Master Directions on Frauds do not expressly provide an opportunity of hearing to the borrowers before classifying their account as fraud, audi alteram partem has to be read into the provisions of the directions to save them from the vice of arbitrariness.