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Business News/ News / India/  Borrowers must get chance to be heard before account is classified fraud: SC

Mumbai: The Supreme Court on Monday held that lenders must give borrowers an opportunity to be heard before classifying any account as fraud.

The apex court noted that classifying an account as fraud entails serious civil consequences for the borrower, and amounts to their blacklisting. 

“The principles of natural justice demand that the borrowers, must be served a notice giving an opportunity to explain the conclusion of the forensic audit report and be allowed to represent by banks and the joint lenders forum before their account is classified as fraud under the master directions on fraud. In addition, the decision classifying, the borrowers account as fraudulent, must be made by a reasoned order," a bench presided by Justice DY Chandrachud and Justice Hima Kohli said.

The rule of ‘audi alteram partem’ (let the other side be heard) is to be read into the provisions of the direction by the Reserve Bank of India (RBI) to save them from the vice of arbitrariness, the bench added.

The court also noted that under the central regulator’s master circular, debarring borrowers from accessing institutional finances causes a severe impact on them and is akin to their blacklisting, which affects credit score, the top court said.

The 2016 master circular by the RBI on ‘Frauds Classification and Reporting by Commercial Banks and Select FIs’ was challenged before various high courts. It had asked banks to be cautious with big loan defaulters.

The RBI had said that banks should declare such accounts as fraud if they are found to be suspicious.

The Telangana High Court in its order of 10 December 2020 had stated that the principle of audi alteram partem ought to be read into the master circular and directed the lender banks to give an opportunity of hearing to the borrowers after furnishing a copy of the audit report while also providing an opportunity of a personal hearing to the borrower before classifying their respective accounts as fraud. This was upheld by the top court.

While defending its circular, lenders argued that 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.

In one of the appeals before the Telangana High Court, B S Ltd, a power transmission and distribution company had availed loan of 1,406 crore from various banks. It, however, was unable to meet its payment obligations to lender banks thus defaulting on the repayment of credit facilities. As per the RBI circular, banks formed a joint lenders forum with the State Bank of India as the lead bank. In August 2016 it was declared as non-performing asset.

In 2016, corporate insolvency resolution proceedings under the IBC were initiated against the company. Thereafter in 2019, the lenders forum declared the account as fraud. The company then moved Telangana High Court challenging the decision.

Priyanka Gawande
Priyanka Gawande is a senior legal correspondent at Mint. She has worked as legal reporter for four years with both television and digital mediums. Based in Mumbai, she reports on disputes across sectors including banking, corporates and finance. This also includes insolvency and bankruptcy cases and intellectual property rights (IPR) litigation. Her focus also comprises tracking capital markets and disputes relating to securities law. Previously, Priyanka worked with Informist Media for 2.5 years covering major insolvency and bankruptcy cases and corporate developments. She started her career in journalism with Business Television India (BTVi) where she reported on primary markets, banking, finance and insurance companies.
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Updated: 27 Mar 2023, 05:21 PM IST
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