The Lender Banks Must Give an Opportunity of Hearing to the Borrower Companies before Classifying their Accounts as Frauds

In a recent case before the Supreme Court (“SC”), the Reserve Bank of India (Frauds Classification and Reporting by Commercial Banks and Select FIs) Directions 2016 (“Master Directions on Frauds”) was challenged primarily on the ground that no opportunity of being heard is envisaged to borrowers before classifying their accounts as fraudulent.

Since the classification of an account as fraud entails serious civil consequences for the borrowers, the SC has held that the principles of natural justice, particularly the rule of ‘audi alteram partem’ (i.e., hear the other side), are to be necessarily read into the Master Directions on Frauds to save it from the vice of arbitrariness.

In the present case, the lender banks did not provide an opportunity of hearing to the borrowers before classifying their accounts as fraud, hence such classification has been held by the SC as violative of principles of Natural Justice.

The SC has further directed that, consistent with the principles of natural justice, the lender banks should:

1. provide an opportunity to a borrower by furnishing a copy of the audit reports and
2. allow the borrower a reasonable opportunity to submit a representation before classifying the account as fraud and
3. subsequently, issue a reasoned order considering the objections raised by the borrower.

Source: Supreme Court