Supreme Court says borrowers should be heard before banks classify accounts as fraud

The judgment also notes that the banks must pass a reasoned order

Borrowers have the right to be heard before banks classify their accounts as fraud, the Supreme Court ruled on March 27, adding the principles of natural justice must be followed and read into the Reserve Bank of India's master circular on fraud.

The court held that when an account is classified as fraud, it results in civil and criminal consequences for the borrower. It amounts to "blacklisting" a borrower from availing any credit, hence a hearing must be granted under the Master Directions on Fraud, the country's top court said.

In 2016, the RBI issued a circular allowing banks to unilaterally classify accounts of wilful defaulters as fraudulent, a move that was challenged in several high courts.

The Supreme Court, however, said the borrower need not be given an opportunity of being heard before registering of an FIR. The judgment also notes that the banks must pass a reasoned order on their decision to classify an account as fraudulent, to avoid arbitrariness.

The court was hearing a bunch of petitions that challenged the RBI circular. The leading case in the judgment was an appeal against a 2020 order of the Telangana High Court.

The high court directed the RBI to ensure that principles of natural justice be read into the clauses in the master circular issued for detecting frauds in the banking sector. Natural justice meant everyone had the right to be heard before a decision was passed against them, the court said.

The high court directed the Joint Lenders Forum (JLF) to give an opportunity of hearing to the petitioner before taking a and to complete the exercise within three months. The subsequent exercise by Fraud Identification Committee (FIC) should be carried out within two months, it said.

The RBI and State Bank of India challenged the order in the Supreme Court, which decided to bunch together appeals against judgments of various high courts in similar cases.

Supreme Court’s conclusions:

1. No opportunity of being heard is required before an FIR is lodged and registered;
2. Classification of an account as fraud not only results in reporting the crime to investigating agencies, but also has other penal and civil consequences against the borrowers;
3. Debarring the borrowers from accessing institutional finance under clauses of the Master Directions on Frauds results in serious civil consequences for the borrower;
4. Such a debarment is akin to blacklisting the borrowers for being untrustworthy and unworthy of credit by banks. The court has consistently held that an opportunity to be heart must be provided before a person is blacklisted;
5. In view of the time frame contemplated under the Master Directions on Frauds as well as the nature of the procedure adopted, it is reasonable for the lender banks to provide an opportunity of a hearing to the borrowers before classifying their account as fraud;
6. The borrower should be 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;
7. Since the Master Directions on Frauds do not expressly provide an opportunity of hearing to the borrowers before classifying their account as fraud, it has to be read into the provisions of the directions to save them from the vice of arbitrariness