Hear the borrowers before labelling them as "fraudulent": SC

The Supreme Court today said that the borrowers must be given a chance to be heard before their account is labelled as "fraudulent", and a clear and logical explanation must be provided if such an action is taken. 

Upholding a verdict from the Telangana High Court, Chief Justice D Y Chandrachud and the bench emphasized that categorizing accounts as fraudulent has serious civil consequences for borrowers, hence, they must be given an opportunity to present their case. 

Opportunity Of Hearing Must Be Given By Banks

"Opportunity of hearing must be given by the banks to the borrowers before classifying their accounts as fraud under the Master Directions on fraud," the bench said.

The bench stated that the banks must offer this opportunity to the borrowers before classifying their accounts as fraudulent under the Master Directions on fraud. 

Additionally, a well-reasoned order must follow the decision to classify an account as fraudulent. This decision was made in response to a plea by the State Bank of India.

The Bench also set aside an order of the Gujarat High Court which held to the contrary. 

Principles of Audi Alteram Partem Have To Be Applied 

“principles of audi alteram partem, however short, have to be applied before declaring a party as ‘a fraudulent account’, the Telangana High Court had held.

The RBI circular cites Indian Penal Code (IPC) provisions, including misappropriation, fraudulent transactions, cheating and forgery, for the classification of accounts as fraud.

The borrowers have been approaching various courts challenging the validity of the Reserve Bank of India circular. The borrowers have been saying that the grand objective behind the circular suffers from many issues, including the meaning and purport of the word ‘Fraud’.

Does Fraud Always Means A Crime?

The meaning of word ‘Fraud’ is essentially a crime, which remains undefined in the grand old Act on crimes, i.e., the Indian Penal Code 1860 (IPC). What is defined in the IPC is the word ‘Fraudulent’ in Section 25 as “A person is said to do a thing fraudulently if he does that thing with intent to defraud but not otherwise.” Section 421 of IPC deals with the crime of ‘Dishonest or fraudulent removal or concealment of property to prevent distribution among creditors”.

The RBI Circular does not define the word ‘Fraud’ or ‘Fraudulent’, nor does the RBI circular rely on any other act like IPC or Contract Act to decide on the ‘classification of the borrowers’ account as Fraud Account’. 

This has been a disadvantage for borrowers as the banks have the liberty to declare a particular loan account as a fraud at a stage, time and occasion they chose.

Even when a company’s account is declared as “fraud” or the company is declared as a holder of a fraudulent account, the company faces civil and criminal consequences. This hurts the company’s reputation and functioning and on top of that the penal provisions are applied to the board members such as promoters, executives and non-executive directors of the company. 

Despite having positive earnings before interest taxes, depreciation, and amortization (EBITDA), some companies may still become loss-making if they are unable to secure necessary financing to maintain their operations. Unfortunately, some loan accounts of such companies are also declared fraudulent without being granted a chance to present their case. 

Time and again companies too have been calling for a clear categorization of term ‘fraudulent’ and a fare chance of hearing before declaring an account as fraudulent.