Under Section 35-A of the Banking Regulation Act,1949, the Master Directions on Frauds was brought to protect the interest of depositors and banks from the growing instances of frauds. The Master circular classifies fraud based on Indian Penal Code. Whenever such an inquiry against a fraud account is initiated, Central Fraud Registry (CFR), is available to the banks to share information with respect thereto. Eventually, after following the procedure envisaged under the Master Circular the Banks are required to declare the account fraud and lodge a complaint with the law enforcement agencies.
Pertinently, the decision to classify an account as fraud entails significant adverse civil consequences which jeopardizes the business of the borrower including:
a)The promoters and directors, are barred from availing credit from financial and credit markets at least for a period of five years;
b)No restructuring is permissible,
c)No settlement with a fraudulent borrower is allowed unless the conditions stipulate that the criminal complaint will be continued.The Master Circular does not provide any provision for issuance of show cause notice or affording a hearing to the affected party before the classification as fraud. ‘Audi alteram partem’ is one of the principles of natural justice which means that no person should be judged without the opportunity of being heard. ‘Notice’ and ‘hearing’ are the two key criteria of ‘audi alteram partem.’The issue of lack of opportunity of hearing to the affected person in Master Circular was initially dealt by a division bench of High Court of Telangana which held that the principle of ‘audi alteram partem’ must be read in Clause 8.9.4 and 8.9.5 of the Master Circular. Similar issues were also raised before other high courts. Notably the High Court of Gujarat declined to allow a personal hearing to the affected person.
Eventually, the issue whether the principles of natural justice should be read into the provisions of the Master Directions on Fraudsreached before the Supreme Court of India in SBI vs Rajesh Agarwal and other connected matters, wherein the said respective decisions of High Court of Telangana and Gujarat High Court were challenged.
The Supreme Court after considering the grave penal and civil consequences of the declaration of fraud held that the principle of natural justice has to be read in to the Master Circular and passed the following directions:
a)Lender banks must provide an opportunity of hearing to the borrowers before classifying the account as fraud.
b)The decision classifying the borrower’s account as fraudulent must be made by reasoned order.
Earlier also RBI’s Master Circular on wilful defaulter was met with the same fate and found to be in violation of the principles of natural justice. However, this time the decision of the Supreme Court has left the banks in a big conundrum.
Giving prior notice and providing the opportunity of hearing to the borrower is not a mere formality, Banks cannot avoid providing the evidence to the borrower upon which they are planning to rely along with an opportunity to explain the evidence against it. The borrower will be allowed to represent why the proposed action should not be taken against it. The lender has the right to report the crime to the law enforcement agencies.
However, providing an opportunity to the borrower may forewarn the defaulters and hamper the investigation by law enforcement agencies by way of disclosure of confidential and/or critical information. The opportunity of hearing may be interpreted as a personal hearing, further delaying the entire process.
The circular came into force in 2016 and the retrospective effect of the decision of the Supreme Court may also be misused in digging up old graves. Financial Institutions again approached the Supreme Court seeking clarification of the decision passed by the Supreme Court, however, no substantial relief could be obtained by the financial institutions in the garb of clarification. It will be interesting to see if the financial institutions again approach the Supreme Court by filing a review and if the Court takes into consideration the consequences of its decision.
Understandably, the purpose of the Master Circular is a preemptive measure to detect fraud in the banking system, as expeditiously as possible, and to report the same both to RBI and law enforcement agencies. However, the declaration of fraud under Master Circular carries grave civil consequences which may adversely impact the fundamental rights of the affected person including to carry on a trade or a business, as such the above exigencies cannot be a valid ground to exclude the applicability of the principles of natural justice from the Master Circular.
The author is Designated Partner, Litigation at S&A Law Offices.
