Borrowers must be given opportunity to explain before their account is classified as fraud: Supreme Court

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Synopsis

Supreme Court has further held that a reasoned order has to be issued on the objections addressed by the borrower, as a reasoned order allows an aggrieved party to demonstrate that the reasons which persuaded the authority to pass an adverse order against the interests of the aggrieved party are extraneous or perverse; and the obligation to record reasons acts as a check on the arbitrary exercise of the powers.

The Supreme Court today held that borrowers must be given an opportunity to explain before their account is classified as fraud under the Reserve Bank of India (Frauds Classification and Reporting by Commercial Banks and Select FIs) Directions 2016 ["Master Directions"] on Frauds.

"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...", a bench of CJI DY Chandrachud and Justice Hima Kohli has held.

Court has further clarified that 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.

These observations have been made by the Top Court while upholding a December 2020 judgment of the Telangana High Court whereby it held that the principles of natural justice must be read into the provisions of the Master Directions on Frauds.

The High Court's decision was assailed by the RBI and lender banks through the instant civil appeals.

"Since the classification of an account as fraud entails serious civil consequences for the borrower, the directions must be construed reasonably by reading into them the requirement of observing the principles of natural justice....", the Top Court has held.

While holding 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, the bench has added,

"Such a debarment under Clause 8.12.1 of the Master Directions on Frauds is akin to blacklisting the borrowers for being untrustworthy and unworthy of credit by banks. This Court has consistently held that an opportunity of hearing ought to be provided before a person is blacklisted"

Case Title: State Bank of India & Ors vs. Rajesh Agarwal & Ors