Summary
Lender banks and the Reserve Bank of India appealed against a Telangana High Court judgment reading the rule of audi alteram partem into the RBI Master Directions on Frauds, 2016, under which lenders had classified borrowers' accounts as fraud on forensic audit reports without notice to the borrowers. A three-Judge Bench upheld that view. Though no hearing is required before an FIR is lodged, classification as fraud also debars the borrower and its promoters and directors from institutional finance for five years, a civil consequence akin to blacklisting that engages Article 19(1)(g) and the right to reputation. The six-month timeline makes a hearing practicable, so natural justice is not impliedly excluded and must be read in to save the Directions from arbitrariness under Article 14. Borrowers must receive the audit report, an opportunity to represent and a reasoned order.
Issues
- Whether the principles of natural justice, in particular the rule of audi alteram partem, must be read into Clauses 8.9.4 and 8.9.5 of the Reserve Bank of India (Frauds Classification and Reporting by Commercial Banks and Select FIs) Directions, 2016 before a borrower's account is classified as fraud.
- Whether the Master Directions on Frauds impliedly exclude a prior hearing by reason of the need for prompt detection and reporting of fraud, or whether the borrower's participation in the forensic audit suffices.
- Whether the Master Directions on Frauds are unconstitutional for conferring unguided power and for granting a hearing to third parties but not to borrowers.
Provisions considered
- Section 35A, Banking Regulation Act, 1949Empowers the RBI to issue binding directions to banking companies; the Master Directions on Frauds issued under it are statutory in nature and the RBI's competence to issue them was not in dispute, but their implementation must comport with due process. (¶¶ 13, 14, 51)
- Clauses 8.9.4, 8.9.5 and 8.9.6, RBI Master Directions on Frauds, 2016Prescribe the procedure for red-flagging, forensic audit and classification of an account as fraud by the individual bank or joint lenders' forum within an overall six-month timeframe; the rule of audi alteram partem is read into these clauses, and the timeframe leaves ample room for notice and representation. (¶¶ 23, 24, 25, 58, 60, 79)
- Clauses 8.12.1 to 8.12.5, RBI Master Directions on Frauds, 2016Apply the penal consequences for wilful defaulters to fraudulent borrowers including promoters and whole-time directors, debar them from bank finance for five years from full repayment, and bar restructuring and compromise; these are serious civil consequences akin to blacklisting. The hearing given to third parties under Clause 8.12.5 does not make the Directions arbitrary since borrowers and facilitators stand on different footings. (¶¶ 27, 28, 39, 40, 42, 43, 80)
- Article 14, Constitution of IndiaViolation of natural justice by State action is a violation of Article 14; where a rule is silent, audi alteram partem is read in to render it non-arbitrary, as done in C.B. Gautam, Sahara India and Kesar Enterprises. (¶¶ 68, 69, 70, 71, 74, 75, 76, 77)
- Article 19(1)(g), Constitution of IndiaFollowing Jah Developers, debarment from institutional finance has a direct and immediate impact on the right to carry on business, amounting to a credit freeze or civil death of the borrower. (¶¶ 41, 42, 48)
Held
- Principles of natural justice do not apply at the stage of reporting a criminal offence or registering an FIR. But classification of an account as fraud under the Master Directions does not merely lead to a criminal complaint; it is an administrative determination entailing penal and civil consequences under Clause 8.12, and administrative action with civil consequences must comply with audi alteram partem. (¶¶ 30, 31, 32, 33, 34, 36, 81)
- Since Clause 8.12.1 applies to fraudulent borrowers the same consequences as to wilful defaulters, the observations in Jah Developers apply; debarment from institutional finance is akin to blacklisting for being unworthy of credit, which Erusian Equipment, Raghunath Thakur and Gorkha Security hold cannot be imposed without a hearing, and the classification also affects the borrower's reputation. (¶¶ 41, 42, 43, 44, 46, 47, 48, 49)
- The Directions do not expressly exclude a hearing, and following Swadeshi Cotton Mills, Mangilal and K.I. Shephard the Court leans towards reading natural justice into a regulatory silence; the Tulsiram Patel exception for promptitude does not apply because the six-month timeline makes it reasonably practicable to serve notice and hear the borrower without obstructing prompt action. (¶¶ 53, 54, 56, 57, 59, 60)
- Mere participation of the borrower in preparing the forensic audit report does not satisfy natural justice; audi alteram partem requires that the borrower be given an opportunity to explain the evidence, be informed of the proposed action and be allowed to represent against it, and the decision must be by a reasoned order, since reasons permit challenge and check arbitrariness. (¶¶ 61, 62, 63, 64, 65, 78)
- Lender banks must furnish a copy of the audit report, allow a reasonable opportunity to make a representation before classifying the account as fraud, and pass a reasoned order on the objections. As no such opportunity was given, the impugned classifications are vitiated, but the banks are at liberty to take fresh steps in accordance with the judgment. (¶¶ 79, 81)
Result
Appeals and writ petition disposed of; judgment of the Telangana High Court dated 10.12.2020 reading audi alteram partem into Clauses 8.9.4 and 8.9.5 of the Master Directions on Frauds upheld; judgments of the Telangana High Court dated 22.12.2021 and 31.12.2021 and of the Gujarat High Court dated 23.12.2021 set aside; classifications of the borrowers' accounts as fraud held vitiated for breach of natural justice, with liberty to the banks to take fresh steps; no order as to costs.