Gujarat High Court: Lender Banks Must Provide Borrowers Audit Reports And Opportunity To Clarify Before Terming Account Illegal

Gujarat High Court: Lender Banks Must Provide Borrowers Audit Reports And Opportunity To Clarify Before Terming Account Illegal

The promoters, suspended directors and shareholders of Syntex Industries had appealed against the decision of the moneylenders

The Gujarat High Court has partly allowed a special civil application, while addressing the lender banks to realize the importance of providing borrowers the opportunity to review audit reports and present their case before categorizing an account as fraudulent.

The bench stressed the need for lenders to allow a rational window for borrowers to submit their representations. It mandated that the banks must issue a reasoned order addressing any objections raised by the debtors.

The petitioners had appealed before the court due to the decision of the respondent banks taken during the Joint Lenders Meeting on 29 September 2020, declaring the account of Syntex Industries Limited as counterfeit.

The petitioners, including promoters, suspended directors and shareholders, were involved in a case, wherein via the 06 April 2021 order, the company was placed under Corporate Insolvency Resolution Process (CIRP) as per the Insolvency and Bankruptcy Code, 2016.

On 04 July 2020, the company became aware that the South Indian Bank, one of the consortium banks, initiated action to declare the loan account of the company as sham.

During the meetings held on 18 August and 29 September 2020, discussions were held regarding forensic audit reports of 11 August and 18 September, along with other issues, including the declaration of fraud concerning the company's account by the South Indian Bank.

On 29 September, based on the forensic audit reports, the company's account was declared illegal. Subsequently, the petitioners learned about similar declarations by other banks including the Punjab National Bank, Punjab & Sind Bank, and Karnataka Bank Limited.

Thereafter, the petitioners filed writ petitions challenging the banks' actions before the Delhi High Court, which issued a stay order.

Later, the petitioners withdrew all proceedings, preserving their rights to pursue other legal remedies, without conceding their stance. They contended not being provided the opportunity to address the forensic audit report findings and the supplementary version, as mandated by the recent judgment in the State Bank of India and Others v. Rajesh Agarwal and Others case.

The Gujarat High Court bench acknowledged that apart from sharing the draft forensic audit report's observations with the petitioners, neither the actual forensic audit report nor its supplementary version was provided to them. The respondents, particularly the respondent lender banks, had not disputed the point. Hence, the writ petition deserved to be allowed.

The court highlighted the Master Directions of 2016 concerning frauds, specifically Chapter VIII titled ‘Loan Frauds – New Framework’, which outlines the procedure for declaring an account as fraudulent.

The bench noted Clause 8.9.4, which specifies the decision-making process for classifying any standard account or Non-Performing Asset (NPA) account as Red Flagged Account (RFA) or fraudulent. The Clause placed the responsibility on the bank to report such status on the Central Repository of Information on Large Credits (CRILC) platform to alert other banks.

It also observed Clause 8.9.5 that mandated the completion of forensic audits within a specified period. This meant that if the decision was to classify the account as fake, the RFA status had to be updated across all banks. The Reserve Bank of India (RBI) and the CRILC platform were also required to be reported within a designated timeframe.

The bench noticed that the Master Directions were challenged before various high courts on the ground that no opportunity of being heard was envisaged to the borrowers before classifying the account as deceptive.

In fact, the Telangana High Court judgment was challenged before the Supreme Court, which held that the principles of natural justice must be read into the provisions of the Master Directions.

The apex court had observed and held that the principles of natural justice, particularly the rule of audi alteram partem had to be necessarily read into the Master Directions on frauds to save it from the vice of arbitrariness. It stated that classification of an account as fraudulent entailed serious civil consequences for the borrower. Therefore, the ruling must be construed reasonably by reading into the provisions and requirements of natural justice for all.

The top court had ruled that it meant the entity against whom the evidence was 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.

It had added that mere participation of the borrower during the preparation of a forensic audit report did not fulfil the requirements of natural justice. The decision to classify an account as scam involved due application of mind to the facts and law by the lender banks. The banks, either individually, or through a Joint Lenders Forum (JLF) must decide whether a borrower breached the terms and conditions of a loan agreement. Based on that, they could seek appropriate remedies against the borrowers.

The Supreme Court had also stated that the principles of natural justice demanded that the borrowers had to be served a notice and provided an opportunity to explain the findings in the forensic audit report. All this was to be carried out before the account was classified as fraudulent under the Master Directions.

Thus, the Gujarat High Court held, “Clearly, the rule of audi alteram partem has been read into Clauses 8.9.4 and 8.9.5 of the Master Directions of 2016 on frauds. The apex court has also directed that consistent with the principles of natural justice, the lender banks should provide an opportunity to a borrower by furnishing a copy of the audit report and allow the borrower a reasonable opportunity to submit a representation before classifying the account as fraud coupled with passing of a reasoned order on the objections addressed by the borrower.”

The bench added, “Undisputedly, no such steps were taken by the respondent lender banks. Therefore, on this limited ground of violation of principles of natural justice, the decision of the respondent banks declaring the account of the company as fraud is hereby quashed and set aside.”

While remitting the matter, the court directed the respondents to furnish the copies of the forensic audit report and supplementary forensic audit report to the borrowers. It advised the banks to provide a reasonable opportunity to the petitioners to submit the representation and complete the proceedings by passing the order.

The bench ordered, “The aforesaid exercise shall be undertaken in conformity with the principles laid down by the apex court in the above referred judgment and within a period of six months from the date of receipt of this order’s copy. We have not expressed any opinion regarding the criminal proceedings, if any.”