The Reserve Bank of India ('RBI') updated its Master Directions on Frauds in 2016, to consolidate all earlier circulars on classification of fraud, reporting and monitoring.
In a case1 wherein a division bench of the Supreme Court heard various civil appeals that collectively challenged specific provisions of the Reserve Bank of India (Frauds Classification and Reporting by Commercial Banks and Select FIs) Directions, 2016 ('MFoF')2. All appellants in this case formed a Joint Lenders Forum ('JLF'), which included Union Bank, Andhra Bank, Bank of Baroda, etc. and was led by the State Bank of India ('SBI').
Background
The civil petition representing the grievances and frustration of various entities challenged the MDoF on the ground that borrowers whose accounts have been classified as 'fraudulent' were not given the opportunity to be heard, let alone defend. The subject companies involved have either defaulted on a payment of some credit facility or failed to meet a payment obligation and have been flagged by the lenders. As a result, proceedings under the Insolvency and Bankruptcy Code 2016 ('IBC') were initiated, and the company's account was identified as 'fraudulent'. Once classified, the borrower's account is blacklisted.
Participation of the borrower during the preparation of the forensic audit report does not itself fulfil the requirement of the principles of Natural Justice. Appellants emphasised that no notice was issued to the borrowing companies under MDoF before classifying an account as fraud. However, under the same MDoF, fraudulent accounts shall attract some serious civil consequences. The borrowing companies contended that the primary issue herein would be that, one of the most fundamental principles of natural justice, audi alteram partem, has been conveniently overlooked.
Issues for Consideration
The Court observed that MDoF deals with deterrent measures for defaulting borrowers. Once the account is classified as 'fraud', MDoF directs that no restructuring could be made to conclude a case for First Appeal. No compromise for settlement is allowed unless the conditions stipulate that the criminal complaint will be continued.
The objectives of the MDoF were for specific purposes, which can be broadly classified as - timely detection and reporting of fraud to investigative agencies and quicker dissemination of information pertaining to details of fraud or fraudulent borrowers to banks. Criminal proceedings shall be initiated after the regulators are alerted of a fraud account to the authorities.
The borrowers have challenged the constitutional validity of MDoF, arguing that it should be struck down as arbitrary and unconstitutional because it confers unfair powers on lender banks.
Analysis and Adjudication
With regard to adhering to the principles of Natural Justice, MDoF's stance can be inferred from the silence on the same as it does not contain any right for borrowers to be heard before action to classify their accounts as 'frauds'. It was also rebutted that the principles of Natural Justice do not apply when reporting an offence to any investigating agency. The Central Bureau of Investigation ('CBI') will act only when a criminal angle is involved, which can only be established after an account is classified as 'fraud'.
It was held that every authority with the power to take punitive actions also has the reasonable duty to give an opportunity to be heard. The principles of Natural Justice have universal application and constitute an integral part of our Constitution's fundamental structure. In this case, the audi alteram partem principle demands that the borrowing companies first be served notice and, secondly, be given a chance to represent themselves. The Court opined that the principles of audi alteram partem must be read into the MDoF to ensure its compliance with Natural Justice.
The Court finally concluded that lender banks must provide the borrower with the opportunity to present its case by furnishing a copy of the audit report and allowing time to submit a representation before classifying its account as 'fraud'. It has been reported that SBI might move to the Court again to seek further clarification on the ruling's retrospective applicability.
Footnotes
1. State Bank of India v. Rajesh Agarwal (2023) SCC OnLine SC 342
2. RBI Press Release - Master Directions on Frauds – Classification and Reporting by commercial banks and select FIs - RBI/DBS/2016-17/28 - DBS.CO.CFMC.BC.No.1/23.04.001/2016-17 - https://rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=10477
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