Lenin
Supreme Court's significant judgment on Opportunity to be heard before their account is classified as fraud under RBI's Master Directions
Lenin Raj 11 Apr 2023

In a recent judgment titled State Bank of India & ors vs Rajesh Aggarwal, the Supreme Court of India has upheld the principles of natural justice and the rule of law. The case involved the classification of a borrower's account as fraudulent under the Master Directions on Frauds by the banks, which led to a credit freeze for the borrower, preventing them from accessing institutional finance for their business.

The borrowers argued that the classification of their account as fraud without being given an opportunity of being heard violated the principles of natural justice. On the other hand, the RBI and lender banks argued that the principles of natural justice could not be applied at the stage of reporting a criminal offence to investigating agencies.

The Supreme Court held that the principles of natural justice are not mere legal formalities but constitute substantive obligations that need to be followed by decision-making and adjudicating authorities. The principles of natural justice act as a guarantee against arbitrary action by judicial, quasi-judicial, and administrative authorities. The court further held that the rule of audi alteram partem applies to administrative actions, apart from judicial and quasi-judicial functions. It is also mandatory to provide for an opportunity of being heard when an administrative action results in civil consequences to a person or entity.

The court relied on previous judgments in the State of Orissa vs Dr (Miss) Binapani Dei and Maneka Gandhi vs Union of India, which held that any person prejudicially affected by a decision of the authority entailing civil consequences must be given an opportunity of being heard.

The Supreme Court further held that the classification of a borrower's account as fraud under the Master Directions on Frauds entails civil consequences to the borrower, leading to a credit freeze that could be fatal to the borrower and jeopardize their future business prospects. Therefore, the principles of natural justice necessitate giving an opportunity of 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 their right to reputation.

The apex court has clarified that no opportunity of being heard is required before an FIR is lodged and registered. However, it also highlighted that the classification of an account as fraud has serious penal and civil consequences against the borrowers, which demand the principles of natural justice to be followed.

The court emphasized that debarring the borrowers from accessing institutional finance under Clause 8.12.1 of the Master Directions on Frauds results in serious civil consequences for the borrower. Such a debarment is akin to blacklisting the borrowers for being untrustworthy and unworthy of credit by banks. Hence, an opportunity of hearing ought to be provided before a person is blacklisted.

The court also observed that the application of audi alteram partem cannot be excluded under the Master Directions on Frauds. It is reasonably practicable for the lender banks to provide an opportunity of hearing to the borrowers before classifying their account as fraud. Therefore, 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.

Moreover, the court held that the decision classifying the borrower’s account as fraudulent must be made by a reasoned order. 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 arbitrariness.

This judgment is a significant development in the protection of the rights of borrowers. The court has recognized the serious civil consequences of classifying a borrower’s account as fraud and has held that the principles of natural justice must be followed before such classification. The decision emphasizes the importance of providing a fair and reasonable opportunity of being heard to the borrowers before they are blacklisted from accessing institutional finance.

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