‘Lender must hear borrower before listing a/c as fraud’

Bankers are, however, worried that the order will only lengthen the process of declaring a fraud account.

The apex court also said since the classification of a fraud account entails serious civil consequences for the borrower, the directions must be construed reasonably and follow the principles of natural justice. The Telangana high court had directed lenders to hear borrowers out after they furnish a copy of the audit report and then offer a personal hearing before classifying accounts as fraud.

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

The rule of Listen to the other sidemeaning let the other side be heard, is to be read into the provisions of direction by the Reserve Bank of India to save them from arbitrariness. A 2016 master circular from RBI on “Frauds Classification and Reporting by Commercial Banks and Select FIs” was challenged before various high courts. The circular asked banks to be cautious with big loan defaulters and said banks should declare such accounts as fraud if found to be suspicious.

“This is an order which will add one more process to declaration of fraud. Usually, a bank is already in consultation with the borrower, borrowers’ books are examined by forensic auditors, issues are discussed in the consortium, and various decisions are taken based on the replies filed by the borrower,” said Sunil Mehta, chief executive of Indian Banks’ Association.

Banks do not take a suo motu decision on fraud. There is no legal process of issuing a show-cause notice, taking replies and passing an order, and this can now be formalized, Mehta said.

Under RBI’s master circular, debarring borrowers from accessing institutional finance severely impacts them and is akin to blacklisting, and affects credit score, the court observed.

Legal experts, however, welcomed the apex court’s decision. Fereshte Sethna, senior partner, DMD Advocates, said the court stipulated a requirement to ensure, as a precursor to reporting under the aegis of the RBI framework, and due observance of principles of natural justice. “Lenders’ fraud identification committees have previously relied upon reports of forensic auditors. Adverse civil consequences, including debarment from availing of institutional finance, which impacts fundamental rights of individuals, has long warranted judicial interference.”

If a bank classifies a borrower as fraud, it appears in the registry, and nobody will lend to that borrower, said a banker on condition of anonymity.

“Post this judgment, the individual borrower gets a chance to present his case, and it may delay in fraud reporting but not detection.”

Gopika Gopakumar in Mumbai contributed to this story.