Give personal hearing before classifying borrowers’ account as fraud, SC tells banks

The Supreme Court on Monday declared that the banks are obligated to give a personal hearing to borrowers before classifying their account as fraudulent as per the RBI’s Master Circular of July 1, 2016, since such a decision is stigmatic, affecting their right to reputation.

A bench of Chief Justice Chandrachud and Justice Hima Kohli said the top court had consistently held that an opportunity for hearing ought to be provided before a person is blacklisted.

However, the court clarified that no opportunity of being heard is required before lodging an FIR.

The bench rejected appeals filed by both RBI and the SBI-led consortium of lenders and upheld Telangana High Court’s December 10, 2020 judgement which directed lenders to include principles of natural justice into the RBI’s ‘Master Direction on Frauds – Classification and Reporting by Commercial banks and select FIs’ so as to afford opportunity to the affected party/person to present their case.

The court said as per the principles of natural justice, the borrowers must be served notice, given an opportunity to explain the conclusions of the forensic audit report, and should be allowed to represent by the banks/joint lenders’ forum (JLF) before their account is classified as fraud.

In addition, the decision classifying borrower bank account as fraudulent must be made by a reasoned order as it carries serious civil consequences, it said.

The RBI and the lenders contended that giving such opportunity to the borrower before classifying and reporting loan frauds may defeat the very purpose of the 2016 circular, that is, early detection of fraud and prompt reporting.

Having noted that the penal provisions under the Master Directions on Frauds were also applicable to the promoters, directors, and other whole-time directors, the court said once a bank account is classified as fraudulent, it carries significant consequences such as filing a complaint with the CBI and debarment of the promoters and directors from accessing institutional finance.

“Further, the action of the banks of classifying an account as ‘fraud’ is stigmatic, akin to blacklisting the borrower, which affects their right to reputation. Thus, there is a direct impact on the fundamental rights of the individuals concerned, as a consequence of the classification of an account as fraud,” the court said.

The bench also pointed out classification of the borrower’s account as fraud virtually leads to a credit freeze for the borrower and the bar from raising finances could be fatal for the borrower leading to its ‘civil death’ in addition to the infraction of their rights under Article 19(1)(g) (right to profession, trade and business) of the Constitution.

It further said debarring the borrowers from accessing institutional finance results is “akin to blacklisting the borrowers for being untrustworthy and unworthy of credit by banks.”