State Bank of India & Ors Versus Rajesh Agarwal & Ors
State Bank of India & Ors Versus Rajesh Agarwal & Ors
Landmark Cases of India / सुप्रीम कोर्ट के ऐतिहासिक फैसले
1
Reportable
IN THE SUPREME COURT OF INDIA
CIVIL APPELLATE/ORIGINAL JURISDICTION
Civil Appeal No. 7300 of 2022
State Bank of India & Ors ... Appellants
Versus
Rajesh Agarwal & Ors …Respondents
With
Civil Appeal No. 7301 of 2022
With
Civil Appeal No. 7302 of 2022
With
Civil Appeal No. 7303 of 2022
With
Civil Appeal No. 7304 of 2022
With
Civil Appeal No. 7305 of 2022
With
Civil Appeal No. 7306 of 2022
2
With
Civil Appeal No. 7307 of 2022
And With
Writ Petition No. 138 of 2022
3
J U D G M E N T
Dr Dhananjaya Y Chandrachud, CJI
A. Background .............................................................................................................. 4
B. Facts......................................................................................................................... 5
C. Submissions............................................................................................................ 10
D. Analysis.................................................................................................................. 15
D.1 Regulatory Framework..................................................................................................... 15
D.2 Audi Alteram Partem ....................................................................................................... 25
D.3 No implied exclusion of audi alteram partem ................................................................... 39
D.4 Challenge to constitutional validity .................................................................................. 48
E. Conclusion .............................................................................................................. 57
4
A. Background
1. The civil appeals arise out of a challenge to the Reserve Bank of India
(Frauds Classification and Reporting by Commercial Banks and Select FIs)
Directions 2016.
1 Issued by the Reserve Bank of India2
, these directions
were challenged before different High Courts primarily on the ground that
no opportunity of being heard is envisaged to borrowers before classifying
their accounts as fraudulent. The High Court of Telangana has held in the
impugned judgment3 that the principles of natural justice must be read into
the provisions of the Master Directions on Frauds. The decision has been
assailed by the RBI and lender banks through these civil appeals.
2. In this background the court has to consider whether the principles of
natural justice should be read into the provisions of the Master Directions
on Frauds. For the reasons to follow, we hold that the principles of natural
justice, particularly the rule of audi alteram partem, has to be necessarily
read into the Master Directions on Frauds to save it from the vice of
arbitrariness. Since the classification of an account as fraud entails serious
civil consequences for the borrower, the directions must be construed
reasonably by reading into them the requirement of observing the
principles of natural justice.
1 “Master Directions on Frauds”
2 “RBI”
3 Writ Petition No. 19102 of 2019
5
B. Facts
I. SLP (C) No. 3931 of 2021; SLP (C) No. 4922 of 2021; SLP (C) No. 5056
of 2021
3. B S Limited is a company engaged in the business of power transmission
and distribution, passive telecom infrastructure, renewable energy, and
mineral resources. It availed loans amounting to Rs. 1406 crores from
various banks. The company failed to meet its payment obligations to
lender banks, thereby defaulting in repayment of credit facilities. In
accordance with the Master Directions on Frauds, all the lender banks
formed a Joint Lenders Forum4 with State Bank of India as the lead bank.
4. The JLF declared the company’s assets as Non-Performing Assets5 on 29
August 2016. The lender banks decided to adopt the Sustainable
Structuring of Stressed Assets Scheme6 and suggested a forensic audit
report and Techno Economic Viability7 study in its meeting held on 11 July
2016. Based on the conclusions of the forensic audit report, the JLF closed
the issue stating that there were no irregularities. However, based on the
TEV study it was concluded that the company was not eligible for the S4A
scheme and requested it to submit an alternative plan for regularization of
its account. In the meanwhile, IDBI Bank - one of the lender banks - redflagged the account of the company. Additionally, proceedings under the
4 “JLF”
5 “NPA”
6 “S4A Scheme”
7 “TEV”
6
Insolvency and Bankruptcy Code, 2016 were also initiated against the
company. On 15 February 2019, the JLF declared the account of the
company as fraud by invoking Clause 2.2.1(g) of the Master Directions on
Frauds. Subsequently, the Fraud Identification Committee8 passed a
resolution on 31 July 2019 identifying the company’s account as fraud. The
company filed a writ petition challenging both the decision of the JLF dated
15 February 2019 and the resolution of the FIC dated 31 July 2019 before
the High Court of Telangana.
5. By a judgment dated 10 December 2020, a Division Bench of the High
Court allowed the writ petition by holding that the principle of audi alteram
partem ought to be read into Clauses 8.9.4 and 8.9.5 of the Master
Directions on Frauds. The High Court further directed the lender banks: (i)
to give an opportunity of a hearing to the borrowers after furnishing a copy
of the forensic audit report; and (ii) to provide an opportunity of a personal
hearing to the borrower before classifying their account as fraud. The
judgment of the High Court was challenged in SLP (C) No. 3931 of 2021.
On 15 April 2021, this Court, while issuing notice, partially stayed the
directions issued by the Telangana High Court in the following terms:
“Meanwhile, the Minutes/Order dated 15.02.2019 passed by the
Joint Lenders Meeting is not to be acted upon. The High Court
insofar as it observed that a personal hearing be given is stayed.”
II. SLP (C) No. 762 of 2022; SLP (C) No. 873 of 2022; and SLP (C) No.
1514 of 2022
8 “FIC”
7
6. The appellant is a company involved in the manufacture of edible oils, fats,
rice and semolina products in the State of Telangana. From 2003 to 2015,
the appellant availed of credit facilities to the tune of Rs. 675 crores from a
consortium of banks led by the Andhra Bank (now merged with the Union
Bank of India). The appellant was declared as an NPA on 14 May 2018
with effect from 31 March 2018. Thereafter, the consortium of lenders in a
meeting of the JLF decided to conduct a forensic audit of the appellant for
the period till 31 March 2019. The appellant participated in the audit
process and submitted all the information required by the auditor from time
to time. In September 2019, the appellant learnt that its account has been
declared as fraud by the Union Bank of India (erstwhile Andhra Bank).
Aggrieved by that classification, the appellant filed a writ petition before the
High Court of Telangana. The High Court declined to deal with the issues
pertaining to the principles of natural justice and fair play considering the
fact that they were pending before this Court in SLP (C) No. 3931 of 2021.
By its judgment dated 22 December 2021, the High court dismissed the
writ petitions. The court held that the appellant’s account was rightly
classified as fraud because the forensic audit report contained adverse
findings against the appellant.
7. On 24 January 2022, this Court, while issuing notice in SLP (C) No. 762 of
2022, directed that the matter may not be reported to the Central Bureau of
Investigation9 for the time being. On 28 March 2022, this Court passed a
9 “CBI”
8
similar ad-interim order in SLP (C) No. 873 of 2022 and SLP (C) No. 1514
of 2022.
III. SLP (C) No. 2980 of 2022
8. The appellant is a promoter and director of Golden Jubilee Hotels Pvt
Ltd.10 GJHPL availed financial assistance from the respondent banks for
the construction and development of a hotel in Hyderabad. GJHPL’s
account was declared as NPA from 31 December 2015 because of its
inability to service its debts to the respondent banks. At its meeting on 21
April 2016, the JLF decided to carry out a special audit of the appellant’s
company. Thereafter, the appellant participated in a series of meetings
between the JLF and was consulted by the forensic auditor during the
preparation of the audit report. Bank of Baroda red-flagged the appellant’s
account on 03 May 2019 based on the observations in the forensic audit
report. The appellant’s account was classified as fraud on 14 August 2019.
A criminal complaint was also lodged with the CBI. The appellant came to
know about the classification of their account as fraud in 2021, when they
received a copy of the FIR. The appellant filed a writ petition before the
High Court of Telangana challenging the validity of the Master Directions
on Frauds. The High Court by its judgment dated 31 December 2021 held
that no relief could be granted to the appellant on the issue of personal
hearing since SLP (C) No. 3931 of 2021 was pending before this Court.
The High Court also held that the appellant’s account was rightly classified
as fraudulent in view of the adverse findings in the forensic audit report.
10 “GJHPL”
9
IV. Writ Petition (C) No. 138 of 2022 and SLP (C) No. 3388 of 2022
9. The appellant is one of the directors of a company called M/s Vimal Oil &
Foods Limited. The said company availed of loan facilities from various
financial institutions over a period of time. In 2015, the auditor of the
respondent bank flagged certain irregularities in the accounts of the
company. Based on a special audit, the respondent bank declared the
account of the company as NPA on 30 September 2015. Thereafter, on 05
July 2016, the company’s account was red-flagged by the respondent
bank. In the meantime, the Corporate Insolvency Resolution Process11
was initiated against the company on 19 December 2017 and the appellant
was suspended as Managing Director of the company. Upon suspension,
the appellant was not invited to attend the meetings of the JLF. The
appellant allegedly learnt that the respondent bank had classified their
account as fraud on 21 February 2018 though without any intimation.
Further, based on a letter addressed by the respondent bank to the CBI,
an FIR came to be registered against the appellant. The appellant alleges
that they acquired knowledge about their account being classified as fraud
and registration of the FIR only when a search was carried out at their
residential premises in pursuance of the FIR. The appellant filed a Special
Civil Application challenging the actions of the respondent bank, which was
dismissed by the Single Judge of the High Court of Gujarat. The Division
Bench partly allowed a Letters Patent Appeal by its judgment dated 23
December 2021 by permitting the appellant to address a representation to
11 “CIRP”
10
the respondent bank but declined to allow a personal hearing. The
appellant/ petitioner has also invoked the writ jurisdiction of this Court by
challenging the validity of the Master Directions on Frauds.
C. Submissions
10.On behalf of the borrowers, we have heard Dr Abhishek Manu Singhvi, Mr
Ranjit Kumar, Mr Dhruv Mehta, Mr Arunabh Chowdhury, Mr Navin Pahwa,
Senior Advocates and Mr Suraj Prakash, learned counsel. The counsel
submit that the procedure for classification of an account as fraud under
the Master Directions on Frauds suffers from illegalities because:
a. Under Clauses 8.9.4 and 8.9.5 of the Master Directions on
Frauds, no notice is given to the borrowing company or its
promoters, and directors including whole-time directors. They are
not given an opportunity to present a defense and even a copy of
the final decision is not provided to them.
b. The classification of the borrower’s bank accounts as fraud under
the Master Directions on Frauds carries serious civil
consequences. The penal provisions under Clause 8.12 of the
Master Directions on Frauds are also applicable to the promoters,
directors, and other whole-time directors. Once a bank account is
classified as fraudulent, it carries significant consequences
according to the Master Directions on Frauds such as filing of a
complaint with the CBI and debarment of the promoters and
directors from accessing institutional finance. Further, the action
11
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.
c. The Master Directions on Frauds are violative of Articles 14, 19,
and 21 of the Constitution of India as they debar a company and
its promoters and directors from accessing financial and credit
markets for a period of five years without even providing a show
cause notice or opportunity of being heard.
d. There are other facets to the principle of audi alteram partem
apart from a personal hearing. The Master Directions on Frauds
does not stand good on other facets of audi alteram partem such
as notice of allegations levelled and evidence collected, notice of
the penalty proposed, among others. According to the procedure
laid down under the Master Directions on Frauds, a company or
its promoters and directors are not even informed that they have
been classified as fraud and that a penalty has been imposed
upon them.
e. The Master Directions on Frauds are silent on whether or not the
borrower is entitled to an opportunity of being heard after the
receipt of forensic audit report and before deciding whether the
borrower’s account should be classified as fraud. Since the
12
decision to classify the account as fraud entails significant civil
consequences, principles of natural justice ought to be read into
the Master Directions on Frauds.
f. Clause 8.12.5 of the Master Directions on Frauds expressly
stipulates that an opportunity of hearing be provided to third
parties. The directions are manifestly arbitrary since on the one
hand they provide an opportunity of hearing to third parties, but
such an opportunity is denied to borrowers.
g. Although the purpose and object of the Master Directions on
Frauds is speedy detection and reporting of fraud to law
enforcement agencies, such exigencies cannot be a valid ground
to exclude the applicability of the principles of natural justice.
h. The decision of this Court in State Bank of India v. Jah
Developers12 read in the requirement of natural justice for the
purposes of declaring a borrower as a willful defaulter. The
principles laid down in Jah Developers (supra) would be squarely
applicable to the present matters.
i. The participation of the borrower during the preparation of the
forensic audit report does not in itself fulfil the requirement of the
principles of natural justice under the Master Directions on
Frauds. Those directions do not expressly provide for the
participation or inputs from a borrower during the preparation of
12 (2019) 6 SCC 787
13
the forensic audit report, giving rise to the possibility that in some
cases, the borrower is completely excluded from the forensic audit
process.
11.On behalf of the RBI and lender banks, we have heard Mr Tushar Mehta,
Solicitor General of India, Mr Gopal Jain, Senior Counsel and Mr Ramesh
Babu M R and Mr G N Reddy, learned counsel. Counsel submitted that
the challenge to the classification of a loan account as fraudulent on the
ground of a violation of the principles of natural justice is devoid of merit for
the following reasons:
a. The Master Directions on Frauds were necessitated to protect the
interests of depositors and banks from the growing instances of
frauds. RBI is duly empowered to take pre-emptive measures in
public interest to ensure that fraudulent borrowers are brought to
justice and loss caused to the banks is mitigated. The clauses of
the Master Directions on Frauds, therefore, must be interpreted in
light of their purpose and objective, that is, timely detection and
dissemination of information and reporting about the fraud.
b. The provisions of the Master Directions on Frauds must be
construed keeping in mind the following thresholds: (i) justness; (ii)
fairness towards the parties aggrieved; (iii) reasonability; and (iv)
proportionality between the mischief and the corrective measure.
Considering that the Master Directions on Frauds is an economic
14
policy decision, this Court must exercise greater latitude while
construing its provisions.
c. The procedure for classifying an account as fraud under the
Master Directions on Frauds is not arbitrary. The classification is
done only for reporting the matter to law enforcement agencies.
The banks already have in place a structured organizational setup
to identify and investigate fraudulent activities in bank accounts.
Banks file complaints before law enforcement agencies, who
conduct an investigation. The ultimate decision on fraud is
rendered by a competent court of law.
d. Principles of natural justice are not applicable at the stage of
setting the process of criminal law in motion. Since the lender
bank is an injured party in case of fraudulent accounts, it has the
right to report the crime to the law enforcement agencies without
giving an opportunity of being heard to the fraudulent borrower.
Issuing of a show cause notice to fraudulent borrowers may
forewarn them and hamper the investigation by law enforcement
agencies.
e. Debarring fraudulent borrowers from availing bank finances is a
preventive measure without which the Master Directions on
Frauds will be rendered toothless. Such a measure is necessary to
prevent a fraudulent borrower from committing frauds in other
banks.
15
f. The requirement of notice or prior hearing could be excluded if it
impedes the taking of prompt action. Further, it is not an inviolable
rule that personal hearing ought to be given in all cases.
g. The process for classification of a borrower as a willful defaulter
under the Master Circular on Willful Defaulters13 significantly
differs from the process of classification of an account as fraud
under the Master Directions on Frauds. Therefore, the decision of
this Court in Jah Developers (supra) will not be applicable to the
facts of the present appeal.
D. Analysis
D.1 Regulatory Framework
12.RBI is a statutory body constituted under Section 3 of the Reserve Bank of
India Act, 1934. The RBI has been constituted for the purpose of taking
over the management of currency from the Central Government, regulating
the issue of bank notes, keeping of reserves with a view to securing
monetary stability, and operating the currency and credit system of India.
RBI is entrusted with the statutory obligation of administering the
provisions of the Banking Regulation Act, 194914. The BR Act vests RBI
with various powers with respect to banking companies such as granting
licenses, conducting inspections and giving directions.
13 Master Circular on Wilful Defaulters, 2015
14 “BR Act”
16
13.Section 35A of the BR Act empowers RBI to issue directions to banking
companies. Such directions are statutory in nature. Section 35A is
extracted below:
“35A. Power of the Reserve Bank to give directions – (1)
Where the Reserve Bank is satisfied that –
(a) in the public interest; or
(aa) in the interest of banking policy; or
(b) to prevent the affairs of any banking company being conducted
in a manner detrimental to the interests of the depositors or in
a manner prejudicial to the interests of the banking company;
or
(c) to secure the proper management of any banking company
generally,
it is necessary to issue directions to banking companies generally
or to any banking company in particular, it may, from time to time,
issue such directions as it deems fit, and the banking companies or
the banking company, as the case may be, shall be bound to
comply with such directions.
(2) The Reserve Bank may, on representation made to it or on its
own motion, modify or cancel any direction issued under subsection (1), and in so modifying or cancelling any direction may
impose such conditions as it thinks fit, subject to which
modifications or cancellation shall have effect.”
14.RBI has been issuing ‘master directions’ on diverse issues since 2016.
These directions encompass the instructions on that particular subject. The
master directions are updated whenever there is a change in policy, and
such changes get reflected on RBI’s website. In exercise of the power
conferred by Section 35A, RBI issued the Master Directions on Frauds on
01 July 2016 to consolidate and update seven earlier circulars on
classification of fraud, reporting and monitoring issued between June 2009
and January 2016. The Master Directions on Frauds were updated on 03
July 2017. The purpose of the Master Directions is extracted below:
“1.3 Purpose
These directions are issued with a view to providing a framework
to banks to enable them to detect and report frauds early and
taking timely consequent actions like reporting to the Investigative
17
agencies so that fraudsters are brought to book early, examining
staff accountability and do effective fraud risk management. These
directions also aim to enable faster dissemination of information by
the Reserve Bank of India (RBI) to banks on the details of frauds,
unscrupulous borrowers and related parties, based on the banks’
reporting so that necessary safeguards / preventive measures by
way of appropriate procedures and internal checks may be
introduced and caution exercised while dealing with such parties
by banks.”
15.The above directions were issued to achieve specific purposes: (i) early
and timely detection and reporting of fraud; (ii) early and timely reporting of
fraud to investigative agencies; (iii) quicker dissemination of information
pertaining to details of fraud and fraudulent borrowers to banks; and (iv) to
facilitate the adoption of preventive measures by banks. These purposes
are reflected in Clause 2.1.1 of the Master Directions on Frauds:
“Clause 2.1.1 The Chairmen and Managing Directors/Chief
Executive Officers (CMD/CEOs) of banks must provide focus on
the “Fraud Prevention and Management Function” to enable,
among others, effective investigation of fraud cases and
prompt as well as accurate reporting to appropriate regulatory
and law enforcement authorities including Reserve Bank of
India.”
(emphasis supplied)
16. Clause 2.2.1 classifies frauds based on the provisions of the Indian Penal
Code, 1860:
“Clause 2.2.1 In order to have uniformity in reporting, frauds have
been classified as under, based mainly on the provisions of the
Indian Penal Code:
a. Misappropriation and criminal breach of trust
b. Fraudulent encashment through forged instruments,
manipulation of books of account or through fictitious accounts
and conversion of property.
c. Unauthorised credit facilities extended for reward or for illegal
gratification
d. Cash shortages.
e. Cheating and forgery
f. Fraudulent transactions involving foreign exchange
18
g. Any other type of fraud not coming under the specific heads as
above.”
17.Clause 3 advises banks to make full use of the Central Fraud Registry15 (a
database created by RBI to enable banks to share information on
fraudulent accounts) for timely identification, control, reporting, and
mitigation of risks associated with fraud. Clause 3.3 of the said directions
emphasizes the need to provide timely information on frauds and penalizes
banks for non-adherence to timelines:
“3.3.1 Banks should ensure that the reporting system is suitably
streamlines so that delays in reporting of frauds, submission of
delayed and incomplete fraud reports are avoided. Banks must fix
staff accountability in respect of delays in reporting fraud cases to
RBI.
3.3.2. Delay in reporting of frauds and the consequent delay in
alerting other banks about the modus operandi and
dissemination of information through Caution Advice/ CFR
against unscrupulous borrowers could result in similar frauds
being perpetrated elsewhere. Banks should therefore, strictly
adhere to the timeframe fixed in this circular for reporting of fraud
cases to RBI failing which they would be liable for penal action
prescribed under Section 47(A) of the Banking Regulation Act,
1949.”
(emphasis supplied)
18.The Master Directions on Frauds provides a regulatory framework for four
types of frauds: (i) Chapter IV deals with attempted fraud; (ii) Chapter VII
deals with cheque related frauds; (iii) Chapter VIII deals with loan frauds;
and (iv) Chapter X deals with cases relating to theft, burglary, dacoity, and
bank robberies. The dispute in the present batch of cases is concerned
with Chapter VIII dealing with loan frauds.
15 “CFR”
19
19.Chapter VI states that as a general rule, cases involving fraud/
embezzlement should invariably be referred to the state police or CBI.
Chapter VIII provides for more robust safeguards which ensure that banks
report frauds to investigating agencies after forming an informed opinion.
The framework for dealing with loan frauds was put in place by a circular
dated 07 May 2015. The objective of the framework has been enumerated
in Clause 8.2:
“8.2 Objective of the framework
The objective of the framework is to direct the focus of banks on
the aspects relating to prevention, early detection, prompt reporting
to the RBI (for system level aggregation, monitoring &
dissemination) and the investigative agencies (for instituting
criminal proceedings against fraudulent borrowers) and timely
initiation of the staff accountability proceedings (for determining
negligence or connivance, if any) while ensuring that the normal
conduct of business of the banks and their risk taking ability is not
adversely impacted and no new and onerous responsibilities are
placed on the banks. In order to achieve this objective, the
framework has stipulated time lines with the action incumbent on a
bank. The time lines / stage wise actions in the loan life-cycle are
expected to compress the total time taken by a bank to identify a
fraud and aid more effective action by the law enforcement
agencies. The early detection of Fraud and the necessary
corrective action are important to reduce the quantum of loss
which the continuance of the Fraud may entail.”
20.Clause 8.3 deals with Early Warning Signals16 and Red Flagged
Accounts.17 Under Clause 8.3.1, a RFA is one where a suspicion of
fraudulent activity is thrown up by the presence of one or more EWS. EWS
which should alert bank officials about wrongdoings in a loan account are
set out in Annexure II. Some of those enumerated are set out below:
16 “EWS”
17 “RFA”
20
i. a. Default in undisputed payment to statutory bodies as declared
in the annual report;
b. Dishonour of high value cheques;
ii. Delay in payment of outstanding dues;
iii. Funds coming from other banks to liquidate the outstanding loan
amount except in the normal course;
iv. Exclusive collateral charged to a number of lenders without NOCs
of existing charge holders;
v. Dispute on title to collateral securities; and
vi. Critical issues in the stock audit report.
21.EWS provide indications of wrongdoing which may later turn out to be
frauds. A bank is put on alert by the presence of EWS and must use them
to trigger a detailed investigation into the concerned bank account.
According to Clause 8.3.5, the officer responsible for operations in the
account should promptly report any manifestation of EWS to the Fraud
Monitoring Group18 constituted by the bank. The clause directs banks to
take cognizance of EWS and launch a detailed investigation into an RFA.
22.Clause 8.8 deals with situations where a bank is the sole lender. In such
situations, the FMG is entrusted with the responsibility to take a call on
whether a bank account in which EWS are observed should be classified
18 “FMG”
21
as RFA. The bank is permitted to use external auditors before taking a final
call on RFA status. However, within six months the bank is required to
either lift the RFA status or classify the account as fraud in accordance
with the investigation or forensic audits.
23.Clause 8.9 deals with lending under consortium or multiple banking
arrangements19. Clause 8.9.2 provides that all banks which have financed
a borrower under an MBA should take coordinated action based on a
commonly agreed strategy for subsequent legal actions, follow-ups,
exchange of details and information on a consistent basis. Clauses 8.9.4
and 8.9.5 provide the procedure for classification of a borrower’s account
as fraud:
“8.9.4 The initial decision to classify any standard account or NPA
account as RFA or Fraud will be at the individual level and it would
be the responsibility of this bank to report the RFA or Fraud status
of the account on the CRILC platform so that other banks are
alerted. In case it is decided at the individual bank level to classify
the account as fraud straightaway at this stage itself, the bank shall
then report the fraud to RBI within 21 days of detection and also
report the case to CBI/Police, as it is being done hitherto. Further,
within 15 days of RFA/Fraud classification, the bank which has red
flagged the account or detected the fraud would ask the
consortium leader or the largest lender under MBA to convene a
meeting of the JLF to discuss the issue. The meeting of the JLF
so requisitioned must be convened within 15 days of such a
request being received. In case there is a broad agreement,
the account should be classified as fraud; else based on the
majority rule of agreement amongst bank with at least 60%
share in the total lending, the account should be red flagged
by all the banks and subjected to a forensic audit
commissioned or initiated by the consortium leader or the
largest lender under MBA. All banks, as part of the consortium of
multiple-banking arrangement, shall share the costs and provide
the necessary support for such an investigation.
19 “MBA”
22
8.9.5 The forensic audit must be completed within a maximum
period of three months from the date of the JLF meeting
authorizing the audit. Within 15 days of the completion of the
forensic audit, the JLF shall reconvene and decide on the status of
the account, either by consensus or the majority rule as specified
above. In case the decision is to classify the account as a
fraud, the RFA status shall be changed to Fraud in all banks
and reported to RBI and on the CRILC platform within a week
of the said decision. Besides, within 30 days of the RBI
reporting, the bank commissioning/ initiating the forensic
audit should lodge a complaint with the CBI on behalf of all
banks in the consortium/MBA. For this purpose, if the bank
initiating the forensic audit is a private sector bank, the
complaint shall be lodged with the CBI by the PSU bank with
the largest exposure to the account in the consortium/MBA. If
there is no PSU bank in the consortium/MBA or it is a solo
bank lending by a private sector bank/ foreign bank, the
private bank/foreign bank shall report to the Police as per
extant instructions. This would be in addition to the complaint
already lodged by the first bank which had detected the fraud and
informed the consortium/MBA.”
(emphasis supplied)
24. Clause 8.9.4 stipulates that the initial decision to classify an account as
RFA or fraud vests with the individual bank. Once the bank classifies the
account as fraud, it is the responsibility of that bank to report the RFA or
fraud status on the account on the Central Repository of Information on
Large Credits20 platform to alert other banks. In case the individual bank
decides to straightaway classify the account as fraud, it is obligated to
report the fraud to RBI within 21 days of detection and also report the case
to CBI/Police. Further, within 15 days the individual bank could ask the
consortium leader or the largest lender under the MBA to convene a
meeting of the JLF to discuss the issue. The meeting of the JLF has to be
convened within 15 days of the request being received. The JLF can
classify an account as fraud in case there is a broad consensus.
20 “CRILC”
23
Otherwise, the clause indicates that based on an agreement amongst
banks with at least a 60 percent share in total lending, the account should
be red-flagged by all banks and subjected to forensic audit commissioned
or initiated by the consortium leader or the largest lender under MBA.
25.Clause 8.9.5 states that the forensic audit has to be completed within 3
months from the date of the JLF meeting authorizing the audit. Within 15
days of the completion of the audit, the JLF has to decide to classify the
account as fraud and report it to the RBI. The clause also requires the
bank commissioning the audit to lodge a complaint with CBI on behalf of all
banks in the consortium within 30 days of reporting to RBI.
26.Clause 8.11 deals with the filing of complaints to law enforcement
agencies. Clause 8.11.1 requires banks to lodge complaints with law
enforcement agencies immediately on detecting fraud. The clause enjoins
banks to avoid delay in filing a complaint as it may result in loss of
documents, unavailability of witnesses, absconding borrowers, loss of
money trail and asset tripping by fraudulent borrowers.
27.The penal measures for fraudulent borrowers are set out in Clause 8.12
which reads as follows:
8.12 Penal measures for fraudulent borrowers
8.12.1 In general, the penal provisions as applicable to wilful
defaulters would apply to the fraudulent borrowers including
the promoter director(s) and other whole time directors of the
company insofar as raising of funds from the banking system
or from capital markets by companies with which they are
associated is concerned, etc. In particular, borrowers who
have defaulted and have also committed a fraud in the
account would be debarred from availing bank finance from
24
Scheduled Commercial Banks, Development Financial
Institutions, Government owned NBFCs, Investment
Institutions, etc., for a period of five years from the date of full
payment of the defrauded amount. After this period, it is for
individual institutions to take a call on whether to lend to such a
borrower. The penal provisions would apply to non-whole time
directors (like nominee directors and independent directors) only in
rarest of cases based on conclusive proof of their complicity.
8.12.2 No restructuring or grant of additional facilities may be
made in the case of RFA or fraud accounts. However, in cases
of fraud/malfeasance where the existing promoters are replaced by
new promoters and the borrower company is totally delinked from
such erstwhile promoters/management, banks and JLF may take a
view on restructuring of such accounts based on their viability,
without prejudice to the continuance of the criminal actions against
the erstwhile promoters/management.
8.12.3 No compromise settlement involving a fraudulent borrower
is allowed unless the conditions stipulate that the criminal
complaint will be continued.
8.12.4 In addition to above borrower – fraudsters, third parties
such as builders, warehouse/ cold storage owners, motor vehicle/
tractor dealers, travel agents, etc. and professionals such as
architects, valuers, chartered accountants, advocates, etc. are also
held accountable if they play a vital role in credit sanction/
disbursement or facilitated the perpetration of frauds. Banks are
advisable to report to Indian Banks Association (IBA) the details of
such parties involved in frauds.
8.12.5 Before reporting to IBA, banks have to satisfy themselves of
the involvement of third parties concerned and also provide them
with an opportunity of being heard. In this regard the banks should
follow normal procedures and the processes followed should be
suitably recorded. On the basis of such information, IBA would, in
turn, prepare caution lists of such third parties for circulation
among the banks.”
(emphasis supplied)
28. Clause 8.12.1 provides that the penal provisions as applicable to willful
defaulters would apply to fraudulent borrowers as regards the raising of
funds from the banking system and financial institutions. Importantly, under
the clause, fraudulent borrowers include promoters, directors, and other
whole-time directors of the borrowing company. It debars fraudulent
25
borrowers from availing banking finance from scheduled commercial
banks, development financial institutions, government owned NBFCs,
investment institutions, etc. for a period of five years from the date of full
payment of the defrauded amount. Even after the completion of the fiveyear period, it is for the individual financial institutions to decide whether to
lend to fraudulent borrowers, including directors and promoters of the
borrowing company. Additionally, under Clause 8.12.2, fraudulent
borrowers are denied restructuring or grant of additional facilities by banks
and other such financial institutions.
D.2 Audi Alteram Partem
29.We need to bear in mind that the principles of natural justice are not mere
legal formalities. They constitute substantive obligations that need to be
followed by decision-making and adjudicating authorities. The principles of
natural justice act as a guarantee against arbitrary action, both in terms of
procedure and substance, by judicial, quasi-judicial, and administrative
authorities. Two fundamental principles of natural justice are entrenched in
Indian jurisprudence: (i) nemo judex in causa sua, which means that no
person should be a judge in their own cause; and (ii) audi alteram partem,
which means that a person affected by administrative, judicial or quasijudicial action must be heard before a decision is taken. The courts
generally favor interpretation of a statutory provision consistent with the
principles of natural justice because it is presumed that the statutory
authorities do not intend to contravene fundamental rights. Application of
26
the said principles depends on the facts and circumstances of the case,
express language and basic scheme of the statute under which the
administrative power is exercised, the nature and purpose for which the
power is conferred, and the final effect of the exercise of that power.21
30.While the borrowers argue that the actions of banks in classifying borrower
accounts as fraud according to the procedure laid down under the Master
Directions on Frauds is in violation of the principles of natural justice, the
RBI and lender banks argue that these principles cannot be applied at the
stage of reporting a criminal offence to investigating agencies. At the
outset, we clarify that principles of natural justice are not applicable at the
stage of reporting a criminal offence, which is a consistent position of law
adopted by this Court. In Union of India v. W N Chadha, a two-judge
bench of this Court held that that providing an opportunity of hearing to the
accused in every criminal case before taking any action against them
would “frustrate the proceedings, obstruct the taking of prompt action as
law demands, defeat the ends of justice and make the provisions of law
relating to the investigation lifeless, absurd, and self-defeating.”22 Again, a
two-judge bench of this Court in Anju Chaudhary v. State of UP23 has
reiterated that the Code of Criminal Procedure, 1973 does not provide for
right of hearing before the registration of an FIR.
31.Chapter VIII of the Master Directions on Fraud provides detailed
procedures to be followed by the banks before forming an opinion to
21 Union of India v. Col. J N Sinha, (1970) 2 SCC 458
22 1993 Supp (4) SCC 260
23 (2013) 6 SCC 384
27
proceed with a criminal complaint against the borrowers. Under the said
chapter, the lender banks have to report a borrower to the CBI after
classifying the borrower’s account as fraudulent. However, the
classification of the borrower’s account does not simpliciter lead to
reporting of criminal complaint with the enforcement authorities; it also
entails penal consequences for the borrowers as laid down under Clause
8.12.
32.The process of forming an informed opinion under the Master Directions
on Frauds is administrative in nature. This has also been acceded to by
RBI and lender banks in their written submissions. It is now a settled
principle of law that the rule of audi alteram partem applies to
administrative actions, apart from judicial and quasi-judicial functions.
24 It is
also a settled position in administrative law that it is mandatory to provide
for an opportunity of being heard when an administrative action results in
civil consequences to a person or entity.
33.In State of Orissa v. Dr (Miss) Binapani Dei25, a two-judge bench of this
Court held that every authority which has the power to take punitive or
damaging action has a duty to give a reasonable opportunity to be heard.
This Court further held that an administrative action which involves civil
consequences must be made consistent with the rules of natural justice:
“9. […] The rule that a party to whose prejudice an order is
intended to be passed is entitled to a hearing applies alike to
24 A K Kraipak v. Union of India, (1969) 2 SCC 262; Governing Body, St Anthony’s College, Shillong
and Ors v. Rev. Fr. Paul Petta of Shillong, (1988) Supp SCC 676; Uma Nath Pandey and Ors v. State
of Uttar Pradesh, (2009) 12 SCC 40.
25 AIR 1967 SC 1269
28
judicial tribunals and bodies of persons invested with authority to
adjudicate upon matters involving civil consequences. It is one of
the fundamental rules of our constitutional set-up that every citizen
is protected against exercise of arbitrary authority by the State or
its officers. Duty to act judicially would therefore arise from the very
nature of the function intended to be performed: it need not be
shown to be super-added. If there is power to decide and
determine to the prejudice of a person, duty to act judicially is
implicit in the exercise of such power. If the essentials of justice be
ignored and an order to the prejudice of a person is made, the
order is a nullity. That is a basic concept of the rule of law and
importance thereof transcends the significance of a decision in any
particular case.”
34.In Maneka Gandhi v. Union of India26, a seven-judge bench of this court
held that any person prejudicially affected by a decision of the authority
entailing civil consequences must be given an opportunity of being heard.
This has been reiterated in a catena of decisions of this Court. In view of
the settled position of law, the next question that arises before us is the
scope and definition of the phrase ‘civil consequences’.
35.In Mohinder Singh Gill v. Chief Election Commissioner, New Delhi27, a
Constitution Bench of this Court held that ‘civil consequences’ cover
infraction of not merely property or personal rights but of civil liberties,
material deprivations, and non-pecuniary damages. In that case, the Court
held that denial of a democratic right to cast a vote inflicts civil
consequences. In D K Yadav v. J M A Industries28, a three-judge bench
of this Court observed that “everything that affects a citizen in his civil life
inflicts a civil consequence.”
26 (1978) 1 SCC 248
27 (1978) 1 SCC 405
28 (1993) 3 SCC 259
29
36.In Canara Bank v. V K Awasthy29, a two-judge bench of this Court
succinctly summarized the history, scope, and application of the principles
of natural justice to administrative actions involving civil consequences in
the following terms:
14. Concept of natural justice has undergone a great deal of
change in recent years. Rules of natural justice are not rules
embodied always expressly in a statute or in rules framed
thereunder. They may be implied from the nature of the duty to be
performed under a statute. What particular rule of natural justice
should be implied and what its context should be in a given case
must depend to a great extent on the fact and circumstances of
that case, the framework of the statute under which the enquiry is
held. The old distinction between a judicial act and an
administrative act has withered away. Even an administrative
order which involves civil consequences must be consistent
with the rules of natural justice. The expression “civil
consequences” encompasses infraction of not merely
property or personal rights but of civil liberties, material
deprivations and non-pecuniary damages. In its wide umbrella
comes everything that affects a citizen in his civil life.
(emphasis supplied)
There is a consistent pattern of judicial thought that civil consequences
entail infractions not merely of property or personal rights, but also of civil
liberties, material deprivations, and non-pecuniary damages. Every order
or proceeding which involves civil consequences or adversely affects a
citizen should be in accordance with the principles of natural justice.
37.The next question that requires our consideration is whether the
classification of a borrower’s account as fraudulent under the Master
Directions on Frauds entails civil consequences to borrowers.
29 (2005) 6 SCC 321
30
38.The RBI and lender banks have argued that the civil consequences
contemplated in Clause 8.12.1 of the Master Directions on Frauds are
reasonable. Under the said clause, the borrower, including the promoters
and directors of the company, are barred from availing credit from financial
markets and credit markets for a period of five years, and possibly even
beyond. According to RBI and lender banks, such a restriction has to be
perceived from the perspective of public interest. While acknowledging that
the procedure which has been laid down in the Master Directions on
Frauds is conceived in public interest, to protect the banking system, we
cannot ignore the serious civil consequences which emanate to the
borrowers.
39.Clause 8.12 of the Master Directions on Frauds deals with the penal
measures for borrowers. Clause 8.12.1 provides that penal provisions as
applicable to wilful defaulters would apply to fraudulent borrowers,
including the promoters and directors of the borrower company. The
consequences that apply to a wilful defaulter under the Master Circular on
Wilful Defaulters have been culled out in Jah Developers (supra):
“9. […] serious consequences follow after a person has been
classified as a wilful defaulter. These consequences are as follows:
(a) No additional facilities to be granted by any bank/financial
institution [para 2.5(a)].
(b) Entrepreneurs/Promoters would be barred from institutional
finance for a period of 5 years [para 2.5(a)].
(c) Any legal proceedings can be initiated, including criminal
complaints [para 2.5(b)].
(d) Banks and financial institutions to adopt proactive approach in
changing the management of the wilful defaulter [para 2.5(c)].
(e) Promoter/Director of wilful defaulter shall not be inducted by
another borrowing company [para 2.5(d)].
31
(f) As per Section 29-A of the Insolvency and Bankruptcy Code,
2016, a wilful defaulter cannot be a resolution applicant.”
40.In addition to the above consequences, borrowers are also liable to suffer
the following consequences under the Master Directions on Frauds:
a) No restructuring may be made in the case of an RFA or fraud accounts
(clause 8.12.2)
b) No compromise on settlement involving a fraudulent borrower is
allowed unless the conditions stipulate that the criminal complaint will
be continued (clause 8.12.3)
The above consequences show that the classification of a borrower’s
account as fraud under the Master Directions on Frauds has difficult civil
consequences for the borrower. The classification of an account as fraud
not only results in reporting the fact to investigating agencies, but has other
penal and civil consequences as specified in Clauses 8.12.1 and 8.12.3.
The borrowers have placed reliance on Jah Developers (supra) to submit
that debarring them from accessing institutional finance under Clause
8.12.1 of the Master Directions affects the fundamental right of the
borrower to carry on business. On the other hand, the RBI and lender
banks have argued that reliance on the observations in Jah Developers
(supra) is misplaced because the decision dealt with the classification of a
borrower as wilful defaulter, whereas the present batch of appeals deal
with the classification of a borrower’s account as fraud.
32
41.The question in Jah Developers (supra) was whether a person who is
declared to be a wilful defaulter according to the procedure laid down in
the Master Circular on Wilful Defaulters is entitled to be represented by a
lawyer of their choice before such a declaration is made. The Court held
that a borrower does not have the right to be represented by a lawyer in
the course of in-house proceedings envisaged in Paragraph 3 of the
Master Circular on Wilful Defaulters. Paragraph 3 of the Master Circular on
Wilful Defaulters provides a two-tier process for identification of a wilful
defaulter. At the first stage, a First Committee headed by an Executive
Director or equivalent and consisting of two other senior officers of the
bank must, after examining the evidence of wilful default and concluding
that wilful default has occurred, issue a show-cause notice to the
concerned borrowers and promoters/ whole-time directors calling for their
submissions. The First Committee has to consider the submissions before
recording the fact of wilful default with reasons. If the Committee deems it
necessary, it could also provide a personal hearing to the borrower and the
promoter/ whole-time director of the borrowing company. The second
stage is that the order of the First Committee is reviewed by another
Committee, known as the Review Committee. Thus, it is clear that the
procedure for declaration of a borrower as a wilful defaulter is different
from the procedure envisaged under the Master Directions on Frauds for
classifying a borrower’s account as fraud. However, by virtue of Clause
8.12.1 of the Master Directions on Frauds, the penal provisions applicable
to wilful defaulters also apply to fraudulent borrowers. Thus, although the
33
procedure adopted for declaration of a wilful defaulter is different from that
envisaged for classifying the borrower’s account as fraud, they will face
similar consequences. In fact, as mentioned above, the borrowers’
accounts classified as fraud under the Master Directions on Frauds will
face certain additional consequences which have been laid down in
Clauses 8.12.2 and 8.12.3. Since the consequences flowing from the two
circulars are similar, the observations in Jah Developers (supra) on the
effect of declaring a borrower as wilful defaulter will be squarely applicable
to the present case. The observations of the Court are extracted below:
24. However, we are of the view that Article 19(1)(g) is
attracted in the facts of the present case as the moment a
person is declared to be a wilful defaulter, the impact on its
fundamental right to carry on business is direct and
immediate. This is for the reason that no additional facilities
can be granted by any bank/financial institutions, and
entrepreneurs/promoters would be barred from institutional
finance for five years. Banks/financial institutions can even
change the management of the wilful defaulter, and a
promoter/director of a wilful defaulter cannot be made
promoter or director of any other borrower company. Equally,
under Section 29-A of the Insolvency and Bankruptcy Code, 2016,
a wilful defaulter cannot even apply to be a resolution applicant.
Given these drastic consequences, it is clear that the Revised
Circular, being in public interest, must be construed
reasonably.
(emphasis supplied)
In Jah Developers (supra), this Court construed the Master Circular on
Wilful Defaulters by harmonizing it with the principles of natural justice.
Particularly, it was directed that: (i) the First Committee must give its order
to the borrower as soon as possible; (ii) the Borrower, thereafter, can file a
written representation against the order of First Committee to the Review
34
Committee; and (iii) the Review Committee must pass a reasoned order
which must be provided to the borrower.
42.Classification of the borrower’s account as fraud under the Master
Directions on Frauds virtually leads to a credit freeze for the borrower, who
is debarred from raising finance from financial markets and capital
markets. 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) of the Constitution. Since debarring disentitles a person or
entity from exercising their rights and/or privileges, it is elementary that the
principles of natural justice should be made applicable and the person
against whom an action of debarment is sought should be given an
opportunity of being heard. Indeed, debarment is akin to blacklisting a
borrower from availing credit. Black’s Law Dictionary30 explains the term
‘blacklist’ has been defined in the following terms:
“A list of persons marked out for special avoidance, antagonism, or
enmity on the part of those who prepare the list or those among
whom it is intended to circulate; as where a trades-union
“blacklists” workmen who refuse to conform to its rules, or where a
list of insolvent or untrustworthy persons is published by a
commercial agency or mercantile association.”
(emphasis supplied)
Similarly, P Ramanatha Aiyar’s Law Lexicon31 defines the term “blacklist”
as follows:
“Black List is a list of persons or firms against whom its compiler
would warn the public, or some section of the public; a list of
persons unworthy of credit, or with whom it is not advisable
30 Black’s Law Dictionary, 5th edn (1979)
31 P Ramanatha Aiyar, ‘The Law Lexicon: The Encyclopedic Law Dictionary’ (1997 edn)
35
to make contracts. Thus the official list of defaulters on the Stock
Exchange is a black list. To put a man’s name on such a black list
without lawful cause is actionable; and the further publication of
such a list will be restrained by injunction.”
(emphasis supplied)
43.A blacklist is: (i) a list of insolvent or untrustworthy persons published by a
commercial agency or mercantile association; and (ii) a list of persons
unworthy of credit, or with whom it is not advisable to make contracts.
Before this Court, the RBI and lender banks have submitted that debarring
borrowers from accessing institutional finance is necessary to not only
prevent the same persons from committing frauds in other banks, but also
to proscribe banks from dealing with unscrupulous borrowers in public
interest. Debarring a borrower under Clause 8.12.1 of the Master
Directions on Frauds is akin to blacklisting the borrower for being
untrustworthy and unworthy of credit by the banks. This Court has
consistently held that an opportunity of a hearing ought to be provided
before a person is put on a blacklist.
44.In Erusian Equipment & Chemicals Ltd v. State of West Bengal32, the
issue before this Court was whether a person is entitled to a notice to be
heard before being blacklisted by the government. This Court held that
since blacklisting affects the privileges of the blacklisted person,
fundamentals of fair play require that such a person be provided an
opportunity of being heard:
“20. Blacklisting has the effect of preventing a person from the
privilege and advantage of entering into lawful relationship with the
32 (1975) 1 SCC 70
36
Government for purposes of gains. The fact that a disability is
created by the order of blacklisting indicates that the relevant
authority is to have an objective satisfaction. Fundamentals of fair
play require that the person concerned should be given an
opportunity to represent his case before he is put on the blacklist.”
45.In Joseph Vilangandan v. Executive Engineer33, the issue before the
two-judge pertained to debarment of a government contractor from seeking
any further contract with the government without providing an opportunity
of being heard. The material sentence of the notice there read as follows:
“You are therefore requested to show cause ... why the work may
not be arranged otherwise at your risk and loss, through other
agencies after debarring you as a defaulter....”
(emphasis original)
This Court applied the position of law in Erusian Equipment & Chemicals
Ltd (supra) to hold that the Executive Engineer ought to have given the
contractor adequate opportunity to represent against the proposed action
of debarment.
46.In Raghunath Thakur v. State of Bihar34, a two-judge bench of this Court
held that since blacklisting entails civil consequences an order of
blacklisting should be issued only after following the principles of natural
justice:
“4. […] Insofar as the contention that there is no requirement
specifically of giving any notice is concerned, the respondent is
right. But it is an implied principle of the rule of law that any order
having civil consequence should be passed only after following the
principles of natural justice. It has to be realised that blacklisting
any person in respect of business ventures has civil consequence
for the future business of the person concerned in any event. Even
if the rules do not express so, it is an elementary principle of
33 (1978) 3 SCC 36
34 (1989) 1 SCC 229
37
natural justice that parties affected by any order should have right
of being heard and making representations against the order. […]”
47. In Gorkha Security Services v. Govt (NCT of Delhi)35, the issue before
this Court pertained to the form and content of a show-cause notice that is
required to be served before blacklisting the noticee. A two-judge bench of
this Court observed that that an order blacklisting a person is stigmatic.
The relevant observation is extracted below:
16. It is a common case of the parties that the blacklisting has to
be preceded by a show-cause notice. Law in this regard is firmly
grounded and does not even demand much amplification. The
necessity of compliance with the principles of natural justice by
giving the opportunity to the person against whom action of
blacklisting is sought to be taken has a valid and solid rationale
behind it. With blacklisting, many civil and/or evil
consequences follow. It is described as “civil death” of a
person who is foisted with the order of blacklisting. Such an
order is stigmatic in nature and debars such a person from
participating in government tenders which means precluding
him from the award of government contracts.
(emphasis supplied)
48.Classification of a borrower’s account as fraud has the effect of preventing
the borrower from accessing institutional finance for the purpose of
business. It also entails significant civil consequences as it jeopardizes the
future of the business of the borrower. Therefore, the principles of natural
justice necessitate giving an opportunity of a hearing before debarring the
borrower from accessing institutional finance under Clause 8.12.1 of the
Master Directions on Frauds. The action of classifying an account as fraud
not only affects the business and goodwill of the borrower, but also the
right to reputation.
35 (2014) 9 SCC 105
38
49.In State of Maharashtra v. Public Concern for Governance Trust36, a
two-judge bench of this Court held that a decision taken by any authority
affecting the right to reputation of an individual has civil consequences.
Therefore, in such situations the principles of natural justice would come
into play. The Court held that any order or decision of the authority
adversely affecting the personal reputation of an individual must be taken
after following the principles of natural justice:
“41. It is thus amply clear that one is entitled to have and preserve
one's reputation and one also has a right to protect it. In case any
authority in discharge of its duties fastened upon it under the law,
travels into the realm of personal reputation adversely affecting
him, it must provide a chance to him to have his say in the matter.
In such circumstances, right of an individual to have the safeguard
of the principles of natural justice before being adversely
commented upon is statutorily recognised and violation of the
same will have to bear the scrutiny of judicial review.”
50.The RBI and lender banks have relied on Peerless General Finance and
Investment Co. Ltd v. Reserve Bank of India37, Joseph Kuruvilla
Vellukunnel v. Reserve Bank of India38, and Internet and Mobile
Association of India v. Reserve Bank of India39 to submit that the
Master Directions on Frauds are akin to a statutory regulation and a
decision on economic policy, which must be accorded a level of deference.
51. The competence of the RBI to issue the Master Directions on Frauds is
not a bone of contention in these appeals. The RBI, in its estimation, has
the power to determine and frame economic measures in the public
interest to ensure the proper management of banking companies. The
36 (2007) 3 SCC 587
37 (1992) 2 SCC 343
38 AIR 1962 SC 1371
39 (2020) 10 SCC 274
39
point however is that the implementation of a decision to secure the health
of banking companies must comport with the due process of law. The civil
consequences which follow upon a classification of a borrower’s account
as fraud are serious and prejudicial to the interests of a borrower.
Principles of fair play require that borrower ought to be given an
opportunity of being heard before classifying the account as fraud in
accordance with the procedure laid down under the Master Directions on
Frauds.
D.3 No implied exclusion of audi alteram partem
52. The RBI and the lender banks have contended that the Master Directions
on Frauds impliedly exclude the right to be heard. The objective of the
Master Directions on Frauds is to ensure timely detection and reporting of
cases of fraud to alert other banks and initiate criminal proceedings. The
Directions contemplate an opportunity of hearing to a third party who is
involved in the commission of fraudulent activity, but do not explicitly
provide for hearing to a borrower. Thus, it is urged that hearing to the
borrowers is excluded by necessary implication.
53.The Master Directions on Frauds do not expressly exclude a right of
hearing to the borrowers before action to class their account as frauds is
initiated. The principles of natural justice can be read into a statute or a
notification where it is silent on granting an opportunity of a hearing to a
party whose rights and interests are likely to be affected by the orders that
may be passed.
40
54.In a decision of a three-judge bench of this Court in Swadeshi Cotton
Mills v. Union of India40, the issue was whether the Central government
was required to comply with the requirements of audi alteram partem
before it took over the management of an industrial undertaking under
Section 18-AA(1)(a) of the Industries (Development and Regulation) Act,
195141. R S Sarkaria, J speaking for the majority consisting of himself and
D A Desai, J laid down the following principles of law:
44. In short, the general principle — as distinguished from an
absolute rule of uniform application — seems to be that where a
statute does not, in terms, exclude this rule of prior hearing but
contemplates a post-decisional hearing amounting to a full review
of the original order on merits, then such a statute would be
construed as excluding the audi alteram partem rule at the predecisional stage. Conversely, if the statute conferring the
power is silent with regard to the giving of a pre-decisional
hearing to the person affected and the administrative decision
taken by the authority involves civil consequences of a grave
nature, and no full review or appeal on merits against that
decision is provided, courts will be extremely reluctant to
construe such a statute as excluding the duty of affording
even a minimal hearing shorn of all its formal trappings and
dilatory features at the pre-decisional stage, unless, viewed
pragmatically, it would paralyse the administrative progress or
frustrate the need for utmost promptitude. In short, this rule of
fair play “must not be jettisoned save in very exceptional
circumstances where compulsive necessity so demands”.
The court must make every effort to salvage this cardinal rule
to the maximum extent possible, with situational
modifications. But, to recall the words of Bhagwati, J., the core of
it must, however, remain, namely, that the person affected must
have reasonable opportunity of being heard and the hearing must
be a genuine hearing and not an empty public relations exercise.
(emphasis supplied)
55.The main point for consideration before this Court in Swadeshi Cotton
Mills (supra) was whether the use of the phrase “immediate action is
40 (1981) 1 SCC 664
41 “IDR Act, 1951”
41
necessary” under Section 18-AA(1)(a) of the IDR Act impliedly excluded
the application of the audi alteram partem rule. Sarkaria, J held that the
expression “immediate action”, construed in light of the overall context,
object and reasons of the legislation, did not necessarily indicate an
intention to exclude the requirement of prior hearing. The Court held that
the use of the phrase does not exclude the duty to comply with the audi
alteram partem rule:
“77. The second reason — which is more or less a facet of the first
— for holding that the mere use of the word “immediate” in the
phrase “immediate action is necessary”, does not necessarily
and absolutely exclude the prior application of the audi
alteram partem rule, is that immediacy or urgency requiring
swift action is a situational fact having a direct nexus with the
likelihood of adverse effect on fall in production. And, such
likelihood and the urgency of action to prevent it, may vary
greatly in degree. The words “likely to affect. . .production”
used in Section 18-AA(1)(a) are flexible enough to
comprehend a wide spectrum of situations ranging from the
one where the likelihood of the happening of the apprehended
event is imminent to that where it may be reasonably
anticipated to happen sometime in the near future. Cases of
extreme urgency where action under Section 18-AA(1)(a) to
prevent fall in production and consequent injury to public interest,
brooks absolutely no delay, would be rare. In most cases, where
the urgency is not so extreme, it is practicable to adjust and strike
a balance between the competing claims of hurry and hearing.”
(emphasis supplied)
Sarkaria, J observed that that the owner of an undertaking is entitled to a
fair hearing at the pre-decisional stage because the power of the Central
government under Section 18AA-(1)(a) to take over is far-reaching and
adversely affects the rights and interests of owners.
42
56.In Mangilal v. State of Madhya Pradesh42, a two-judge bench of this
Court held that the principles of natural justice need to be observed even if
the statute is silent in that regard. In other words, a statutory silence should
be taken to imply the need to observe the principles of natural justice
where substantial rights of parties are affected:
10. Even if a statute is silent and there are no positive words
in the Act or the Rules made thereunder, there could be
nothing wrong in spelling out the need to hear the parties
whose rights and interest are likely to be affected by the
orders that may be passed, and making it a requirement to
follow a fair procedure before taking a decision, unless the
statute provides otherwise. The principles of natural justice
must be read into unoccupied interstices of the statute,
unless there is a clear mandate to the contrary. No form or
procedure should ever be permitted to exclude the
presentation of a litigant's defence or stand. Even in the
absence of a provision in procedural laws, power inheres in every
tribunal/court of a judicial or quasi-judicial character, to adopt
modalities necessary to achieve requirements of natural justice
and fair play to ensure better and proper discharge of their duties.
Procedure is mainly grounded on the principles of natural justice
irrespective of the extent of its application by express provision in
that regard in a given situation. It has always been a cherished
principle. Where the statute is silent about the observance of
the principles of natural justice, such statutory silence is
taken to imply compliance with the principles of natural
justice where substantial rights of parties are considerably
affected. The application of natural justice becomes
presumptive, unless found excluded by express words of
statute or necessary intendment. Its aim is to secure justice or
to prevent miscarriage of justice. Principles of natural justice
do not supplant the law, but supplement it. These rules operate
only in areas not covered by any law validly made. They are a
means to an end and not an end in themselves. […]
(emphasis supplied)
57.As a counter to the above legal position, the RBI and lender banks have
contended that the principles of natural justice could be excluded in cases
where there is a requirement of promptitude or exigent action. In support of
42 (2004) 2 SCC 447
43
the submission, the RBI and banks have relied upon Ajit Kumar Nag v.
General Manager (PJ), Indian Oil Corp. Ltd43, which in turn relied on the
Constitution Bench decision of this Court in Union of India v. Tulsiram
Patel.
44 In Tulsiram Patel (supra), this Court observed that a right to a
prior notice and an opportunity to be heard could be excluded if allowing
for such a right would obstruct the taking of prompt action:
101. […] So far as the audi alteram partem rule is concerned, both
in England and in India, it is well established that where a right to a
prior notice and an opportunity to be heard before an order is
passed would obstruct the taking of prompt action, such a right can
be excluded. This right can also be excluded where the nature of
the action to be taken, its object and purpose and the scheme of
the relevant statutory provisions warrant its exclusion; nor can the
audi alteram partem rule be invoked if importing it would have the
effect of paralysing the administrative process or where the need
for promptitude or the urgency of taking action so demands, […]
58. The borrowers have dwelt on Clause 8.9.6 of the Master Directions on
Frauds according to which the entire exercise commencing from the
detection of fraud by an individual bank upto the declaration of fraud by the
JLF is to be completed within six months. Clause 8.9.6 provides thus:
“8.9.6 It may be noted that the overall time allowed for the entire
exercise to be completed is six months from the date when the first
member bank reported the account as RFA or Fraud on the CRILC
platform.”
59.In K I Shephard v. Union of India45, this Court was called upon to decide
the validity of amalgamation schemes drawn by the RBI, whereunder three
private banks were amalgamated with nationalized banks. At the time of
merger, some employees of the private banks were excluded from
43 (2005) 7 SCC 764
44 (1985) 3 SCC 398
45 (1987) 4 SCC 431
44
employment as their services were not taken over by the transferee banks
in view of allegations of misconduct against them. While noting the fact
that the entire process of amalgamation was statutorily required to be
completed within 6 months, this Court held that the said time frame
provides scope for granting an opportunity of hearing to the affected
employees:
15. […] We do not think in the facts of the case there is any
justification to hold that rules of natural justice have been ousted
by necessary implication on account of the time frame. On the
other hand we are of the view that the time limited by statute
provides scope for an opportunity to be extended to the intended
excluded employees before the scheme is finalised so that a
hearing commensurate to the situation is afforded before a section
of the employees is thrown out of employment.
60.The decision of this Court in Swadeshi Cotton Mills (supra) and K I
Shephard (supra) demonstrates that the exigency of a situation is
contextual. The Court must lean in favour of reading in the principles of
natural justice when faced with a regulatory silence. Any exclusion must be
confined to the narrowest possible limits. The application of the
requirement of a prior hearing could be excluded only in situations where
importing it would have the effect of paralyzing the entire process. As
mentioned above, Clause 8.9.6 of the Master Directions on Frauds
contemplates that the procedure for the classification of an account as
fraud has to be completed within six months. The procedure adopted
under the Master Directions on Frauds provides enough time to the banks
to deliberate before classifying an account as fraud. During this interval,
the banks can serve a notice to the borrowers, and give them an
opportunity to submit their reply and representation regarding the findings
45
of the forensic audit report. Given the wide time frames contemplated
under the Master Directions on Frauds as well as the nature of the
procedure adopted, it is reasonably practicable for banks to provide an
adequate opportunity of a hearing to the borrowers before classifying their
account as fraud. The exclusion contemplated in the decision of this Court
in Tulsiram Patel (supra) would not be applicable because giving an
opportunity of a hearing to the borrowers will not obstruct the taking of
prompt action under the Master Directions on Frauds.
61.The RBI and lender banks have further submitted that the requirement of
natural justice is already fulfilled under the Master Directions on Frauds as
the borrower is allowed to participate during the preparation of the forensic
audit report. On the other hand, the borrowers have submitted that the
Master Directions do not expressly provide for participation of the
borrowers during forensic audit report. It was also submitted that merely
seeking inputs of borrowers during the preparation of the forensic audit
report does not satisfy the requirements of the principles of natural justice
as the borrowers should also be heard before classifying them as fraud.
62.In Keshav Mills Co. Ltd. v. Union of India46, this Court was dealing with
the issue of a takeover of a company by the government under the IDR
Act, 1951 after completion of a full investigation into the affairs of the
company. The issue was whether the report of an investigating body
appointed by an administrative authority should be made available to the
person concerned before the authority takes a decision upon that report.
46 (1973) 1 SCC 380
46
While deciding to lay down a general principle, this Court observed that
there may be certain situations where an investigation report is required to
be furnished to the concerned party to make an effective representation
about the proposed action:
21. In our opinion it is not possible to lay down any general
principle on the question as to whether the report of an
investigating body or of an inspector appointed by an
administrative authority should be made available to the persons
concerned in any given case before the authority takes a decision
upon that report. The answer to this question also must always
depend on the facts and circumstances of the case. It is not at
all unlikely that there may be certain cases where unless the
report is given the party concerned cannot make any effective
representation about the action that Government takes or
proposes to take on the basis of that report. Whether the
report should be furnished or not must therefore depend in
every individual case on the merits of that case. We have no
doubt that in the instant case non-disclosure of the report of the
Investigating Committee has not caused any prejudice whatsoever
to the appellants.
(emphasis supplied)
63.In Swadeshi Cotton Mills (supra), this Court held that a company is
entitled to an opportunity to explain the evidence collected against it and
represent why the proposed action should not be taken:
85. The contention does not appear to be well founded. Firstly, this
documentary evidence, at best, shows that the Company was in
debt and the assets of some of its “units” had been hypothecated
or mortgaged as security for those debts. Given an opportunity the
Company might have explained that as a result of this
indebtedness there was no likelihood of fall in production, which is
one of the essential conditions in regard to which the Government
must be satisfied before taking action under Section 18A-A(1)(a).
Secondly, what the rule of natural justice required in the
circumstances of this case, was not only that the Company
should have been given an opportunity to explain the
evidence against it, but also an opportunity to be informed of
the proposed action of take over and to represent why it be
not taken.
47
(emphasis supplied)
64.Audi alteram partem has several facets, including the service of a notice to
any person against whom a prejudicial order may be passed and providing
an opportunity to explain the evidence collected. In Tulsiram Patel
(supra), this Court explained the wide amplitude of audi alteram partem:
96. The rule of natural justice with which we are concerned in
these appeals and writ petitions, namely, the audi alteram
partem rule, in its fullest amplitude means that a person
against whom an order to his prejudice may be passed should
be informed of the allegations and charges against him, be
given an opportunity of submitting his explanation thereto,
have the right to know the evidence, both oral or
documentary, by which the matter is proposed to be decided
against him, and to inspect the documents which are relied
upon for the purpose of being used against him, to have the
witnesses who are to give evidence against him examined in
his presence and have the right to cross-examine them, and
to lead his own evidence, both oral and documentary, in his
defence. The process of a fair hearing need not, however,
conform to the judicial process in a Court of law, because judicial
adjudication of causes involves a number of technical rules of
procedure and evidence which are unnecessary and not required
for the purpose of a fair hearing within the meaning of audi alteram
partem rule in a quasi-judicial or administrative inquiry. […]
(emphasis supplied)
65.Audi alteram partem, therefore, entails that an entity against whom
evidence is collected must: (i) be provided an opportunity to explain the
evidence against it; (ii) be informed of the proposed action, and (iii) be
allowed to represent why the proposed action should not be taken. Hence,
the mere participation of the borrower during the course of the preparation
of a forensic audit report would not fulfil the requirements of natural justice.
The decision to classify an account as fraud involves due application of
mind to the facts and law by the lender banks. The lender banks, either
48
individually or through a JLF, have to decide whether a borrower has
breached the terms and conditions of a loan agreement, and based upon
such determination the lender banks can seek appropriate remedies.
Therefore, principles of natural justice demand that the borrowers must be
served a notice, given an opportunity to explain the findings in the forensic
audit report, and to represent before the account is classified as fraud
under the Master Directions on Frauds.
D.4 Challenge to constitutional validity
66.The borrowers have argued that the Master Directions on Frauds will have
to be struck down as arbitrary and unconstitutional for conferring unguided
and unbridled powers on banks. To counter the submission, the RBI and
lender banks have relied upon the decision in Delhi Cloth Mills & General
Mills v. Union of India47 to submit that the provisions of the Master
Directions on Frauds are not arbitrary as they have a reasonable nexus to
the object sought to be achieved. It was further argued that the Courts
should not interfere with and supplant their wisdom in an economic policy
decision unless there is blatant perversity, arbitrariness, or mala fides.
67.The RBI has the right to take all such measures as are necessary to
protect the health of the banking system. Hence, the Master Directions on
Frauds lay down the procedure for banks, who in case of a breach of loan
agreements by borrowers, can seek appropriate remedies by approaching
law enforcement agencies and debarring borrowers from accessing further
47 (1983) 4 SCC 166
49
institutional finance. However, any policy decision which contemplates
serious civil consequences for any person will be open to challenge for
being arbitrary if the principles of natural justice are not applied during the
process.
68.In E P Royappa v. State of Tamil Nadu48, this Court held that an arbitrary
state action is violative of Article 14 of the Constitution. Again, in Maneka
Gandhi (supra) this court reiterated that the principle of non-arbitrariness
pervades Article 14. An administrative action can be tested for
constitutional infirmities under Article 14 on four grounds: (i)
unreasonableness or irrationality; (ii) illegality; (iii) procedural impropriety;
49
and (iv) proportionality. However, the scope of such judicial review is
limited to ascertaining the deficiency in the decision-making process, and
not the correctness of the choice made by the administrator.50
69.Fairness in action requires that procedures which permit impairment of
fundamental rights ought to be just, fair, and reasonable. The principles of
natural justice have a universal application and constitute an important
facet of procedural propriety envisaged under Article 14. The rule of audi
alteram partem is recognized as being a part of the guarantee contained in
Article 14. A Constitution Bench of this Court in Tulsiram Patel (supra)
has categorically held that violation of the principles of natural justice is a
violation of Article 14. The court held that any state action in breach of
natural justice implicates a violation of Article 14:
48 (1974) 4 SCC 3
49 State of AP v. McDowell, (1996) 3 SCC 709; Om Kumar v. Union of India, (2001) 2 SCC 386
50 Chairman and Managing Director, United Commercial Bank v. P C Kakkar, (2003) 4 SCC 364
50
“95. The principles of natural justice have thus come to be
recognized as being a part of the guarantee contained in Article 14
because of the new and dynamic interpretation given by this Court
to the concept of equality which is the subject-matter of that article.
Shortly put, the syllogism runs thus: violation of a rule of natural
justice results in arbitrariness which is the same as discrimination;
where discrimination is the result of State action, it is a violation of
Article 14: therefore, a violation of a principle of natural justice
by a State action is a violation of Article 14. Article 14,
however, is not the sole repository of the principles of natural
justice. What it does is to guarantee that any law or State
action violating them will be struck down. The principles of
natural justice, however, apply not only to legislation and
State action but also where any tribunal, authority or body of
men, not coming within the definition of State in Article 12, is
charged with the duty of deciding a matter. In such a case, the
principles of natural justice require that it must decide such matter
fairly and impartially.”
(emphasis supplied)
70.In Cantonment Board v. Taramani Devi51, a two-judge bench of this
Court held that the rule of audi alteram partem is a part of Article 14.
Similarly, in Delhi Transport Corporation v. DTC Mazdoor Congress52,
this Court observed that the rule of audi alteram partem enforces the
equality clause in Article 14. Therefore, any administrative action which
violates the rule of audi alteram partem is arbitrary and violative of Article
14.
71.Administrative proceedings which entail significant civil consequences
must be read consistent with the principles of natural justice to meet the
requirement of Article 14. Where possible, the rule of audi alteram partem
ought to be read into a statutory rule to render it compliant with the
principles of equality and non-arbitrariness envisaged under Article 14. The
Master Directions on Frauds do not expressly provide the borrowers an
51 1992 Supp (2) SCC 501
52 1991 Supp (1) SCC 600
51
opportunity of being heard before classifying the borrower’s account as
fraud. Audi alteram partem must then be read into the provisions of the
Master Directions on Frauds.
72.In Olga Tellis v. Bombay Municipal Corporation53, a Constitution Bench
of this Court was called upon to adjudge the validity of Section 314 of the
Bombay Municipal Corporation Act, 1888. The provision enabled the
Municipal Commissioner to remove, without notice, any object, structure or
fixture which was set up in or upon any street. Chief Justice Y V
Chandrachud delivering the judgment of the Constitution Bench held that
the impugned provision must be construed to ensure that the procedure
contemplated is fair and reasonable. It was further held:
44. […] What Section 314 provides is that the Commissioner may,
without notice, cause an encroachment to be removed. It does not
command that the Commissioner shall, without notice, cause an
encroachment to be removed. Putting it differently, Section 314
confers on the Commissioner the discretion to cause an
encroachment to be removed with or without notice. That
discretion has to be exercised in a reasonable manner so as
to comply with the constitutional mandate that the procedure
accompanying the performance of a public act must be fair
and reasonable. We must lean in favour of this interpretation
because it helps sustain the validity of the law. Reading
Section 314 as containing a command not to issue notice
before the removal of an encroachment will make the law
invalid.
(emphasis supplied)
53 (1985) 3 SCC 545
52
73.In Union of India v. Col. J N Sinha54, a two-judge bench of this Court held
that an endeavor must be made to interpret a statutory provision consistent
with the principles of natural justice:
8. […] It is true that if a statutory provision can be read
consistently with the principles of natural justice, the courts
should do so because it must be presumed that the
Legislatures and the statutory authorities intend to act in
accordance with the principles of natural justice. But if on the
other hand a statutory provision either specifically or by necessary
implication excludes the application of any or all the principles of
natural justice then the court cannot ignore the mandate of the
Legislature or the statutory authority and read into the concerned
provision the principles of natural justice. Whether the exercise of a
power conferred should be made in accordance with any of the
principles of natural justice or not depends upon the express words
of the provision conferring the power, the nature of the power
conferred, the purpose for which it is conferred and the effect of
the exercise of that power.
(emphasis supplied)
74.In C B Gautam v. Union of India55, the question before a Constitution Bench
of this Court was whether a show cause notice must be issued to an intending
purchaser and seller of property before making a compulsory purchase under
Section 269-UD(1) of Chapter XX-C of the Income Tax Act, 1961. Chief
Justice M H Kania speaking for the Constitution Bench held that where the
validity of a provision would be open to serious challenge for want of an
opportunity of being heard, Courts have read such a requirement into the
provision. In C B Gautam (supra), this Court read the principles of natural
justice into the provisions of Chapter XX-C to save them from the vice of
arbitrariness. The Constitution Bench held:
54 (1970) 2 SCC 458
55 (1993) 1 SCC 78
53
30. […] Again, there is no express provision in Chapter XX-C
barring the giving of a show-cause notice or reasonable
opportunity to show cause nor is there anything in the language of
Chapter XX-C which could lead to such an implication. The
observance of principles of natural justice is the pragmatic
requirement of fair play in action. In our view, therefore, the
requirement of an opportunity to show cause being given before an
order for purchase by the Central Government is made by an
appropriate authority under Section 269-UD must be read into the
provisions of Chapter XX-C. There is nothing in the language of
Section 269-UD or any other provision in the said Chapter
which would negate such an opportunity being given.
Moreover, if such a requirement were not read into the
provisions of the said Chapter, they would be seriously open
to challenge on the ground of violations of the provisions of
Article 14 on the ground of non-compliance with principles of
natural justice. The provision that when an order for purchase is
made under Section 269-UD — reasons must be recorded in
writing is no substitute for a provision requiring a reasonable
opportunity of being heard before such an order is made.
(emphasis supplied)
75.In Sahara India (Firm), Lucknow v. Commissioner of Income Tax,
Central-I
56, a two-judge bench of this Court was called upon to decide
whether an opportunity of being heard has to be granted to an assesee
before any direction could be issued under section 142(2-A) of the Income
Tax Act, 1961 for special audit of the accounts of the assessee. This Court
held that since the exercise of power under section 142(2-A) of the Income
Tax Act leads to serious civil consequences for the assesee, the
requirement of observing the principles of natural justice is to be read into
the said provision.
76. In Kesar Enterprises Ltd v. State of Uttar Pradesh57, the Court dealt
with a challenge to the validity of Rule 633(7) of the Uttar Pradesh Excise
Manual which allowed the imposition of a penalty for breach of the
56 (2008) 14 SCC 151
57 (2011) 13 SCC 733
54
conditions of a bond without expressly issuing a show-cause notice. D K
Jain, J speaking on behalf of the two-judge bench held that a show-cause
notice should be issued and an opportunity of being heard should be
afforded before an order under Rule 633(7) is made. The Court held that
the rule would be open to challenge for being violative of Article 14 of the
Constitution unless the requirement of an opportunity to show cause is
read into it. The Court observed:
30. Having considered the issue, framed in para 16, on the
touchstone of the aforenoted legal principles in regard to the
applicability of the principles of natural justice, we are of the
opinion that keeping in view the nature, scope and
consequences of direction under sub-rule (7) of Rule 633 of
the Excise Manual, the principles of natural justice demand
that a show-cause notice should be issued and an opportunity
of hearing should be afforded to the person concerned before
an order under the said Rule is made, notwithstanding the fact
that the said Rule does not contain any express provision for
the affected party being given an opportunity of being heard.
[…]
32. In our view, therefore, if the requirement of an opportunity
to show cause is not read into the said Rule, an action
thereunder would be open to challenge as violative of Article
14 of the Constitution of India on the ground that the power
conferred on the competent authority under the provision is
arbitrary.
(emphasis supplied)
77.It has been elucidated in the preceding paragraphs that the classification of
a borrower’s account as fraud in accordance with the procedure laid down
in the Master Directions on Frauds entails significant civil consequences
for the borrower. Since the Master Directions on Frauds do not expressly
provide an opportunity of being heard to the borrower before classifying an
55
account as fraud, the rule of audi alteram partem has to be read into the
provisions of the said directions to save them from the vice of arbitrariness.
78.Before concluding, we also want to address the argument by the borrowers
that the requirement of passing a reasoned order must be read into the
Master Directions on Frauds. The borrowers also relied on Jah
Developers (supra) where it was held that a final decision of the Review
Committee declaring the borrower as a ‘wilful defaulter’ must be made by a
reasoned order. We agree with this contention of the borrowers because:
(i) a reasoned order allows an aggrieved party to demonstrate that the
reasons which persuaded the authority to pass an adverse order against
the interests of the aggrieved party are extraneous or perverse; and (ii) the
obligation to record reasons acts as a check on the arbitrary exercise of
the powers.
58 The reasons to be recorded need not be placed on the same
pedestal as a judgment of a court. The reasons may be brief but they must
comport with fairness by indicating a due application of mind
79.In light of the legal position noted above, we hold that the rule of audi
alteram partem ought to be read in Clauses 8.9.4 and 8.9.5 of the Master
Directions on Fraud. Consistent with the principles of natural justice, the
lender banks should provide an opportunity to a borrower by furnishing a
copy of the audit reports and allow the borrower a reasonable opportunity
to submit a representation before classifying the account as fraud. A
reasoned order has to be issued on the objections addressed by the
borrower. On perusal of the facts, it is indubitable that the lender banks did
58 Kranti Associates (P) Ltd. v. Masood Ahmed Khan, (2010) 9 SCC 496
56
not provide an opportunity of hearing to the borrowers before classifying
their accounts as fraud. Therefore, the impugned decision to classify the
borrower account as fraud is vitiated by the failure to observe the rule of
audi alteram partem. In the present batch of appeals, this Court passed an
ad-interim order restraining the lender banks from taking any precipitate
action against the borrowers for the time being. In pursuance of our
aforesaid reasoning, we hold that the decision by the lender banks to
classify the borrower accounts as fraud, is violative of the principles of
natural justice. The banks would be at liberty to take fresh steps in
accordance with this decision.
80.Lastly, the borrowers have argued that the Master Directions on Frauds
suffer from manifest arbitrariness because they stipulate an opportunity of
a hearing to third parties, while denying the same to borrowers, who face
significant civil consequences. Clause 8.12.5 of the Master Directions on
Frauds provides that banks have to satisfy themselves of the involvement
of third parties and provide them with an opportunity of being heard before
reporting them to Indian Banks’ Association. We are unable to accept this
argument of the borrowers in light of the fact that the borrowers and the
third parties stand on a different footing because: (i) the borrowers are the
main perpetrators of fraud, while the third parties are merely facilitators;
and (ii) it is the borrowers who face the significant civil consequences
stipulated under clauses 8.12.1 and 8.12.2, while the third party service
providers are merely referred to the Indian Banks’ Association which
maintains a caution list of such service providers. However, this view does
57
not affect our conclusions in view of the discussion in the preceding
paragraphs.
E. Conclusion
81.The conclusions are summarized below:
i. No opportunity of being heard is required before an FIR is lodged
and registered;
ii. 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;
iii. Debarring the borrowers from accessing institutional finance under
Clause 8.12.1 of the Master Directions on Frauds results in
serious civil consequences for the borrower;
iv. Such a debarment under Clause 8.12.1 of the Master Directions
on Frauds is akin to blacklisting the borrowers for being
untrustworthy and unworthy of credit by banks. This Court has
consistently held that an opportunity of hearing ought to be
provided before a person is blacklisted;
v. The application of audi alteram partem cannot be impliedly
excluded under the Master Directions on Frauds. In view of the
time frame contemplated under the Master Directions on Frauds
as well as the nature of the procedure adopted, it is reasonably
58
practicable for the lender banks to provide an opportunity of a
hearing to the borrowers before classifying their account as fraud;
vi. The principles of natural justice demand that the borrowers must
be served a notice, 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; and
vii. Since the Master Directions on Frauds do not expressly provide an
opportunity of hearing to the borrowers before classifying their
account as fraud, audi alteram partem has to be read into the
provisions of the directions to save them from the vice of
arbitrariness.
82.In the result, the judgment of the Division Bench of the High Court of
Telangana dated 10 December 2020 is upheld. The judgments of the High
Court of Telangana dated 22 December 2021 and 31 December 2021, and
of the High Court of Gujarat dated 23 December 2021 are accordingly set
aside. The Civil Appeals are disposed of. Writ Petition (C) No. 138 of 2022
is also disposed of in above terms. There shall be no order as to costs.
59
83.Pending application(s), if any, shall stand disposed of.
…………………………………………CJI
[Dr Dhananjaya Y Chandrachud]
….…………………………………………J
[Hima Kohli]
New Delhi;
March 27, 2023
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