Supreme Court: The division bench of Dr DY Chandrachud*, CJ. and Hima Kohli, J., contemplated various civil appeals challenging the Reserve Bank of India (Frauds Classification and Reporting by Commercial Banks and Select FIs) Directions, 2016 and held that principles of Natural Justice, particularly the rule of Audi Alteram Partem, has to be necessarily read into the Master Directions on Frauds (hereinafter ‘MDoF’) to save it from the vice of arbitrariness. The Court affirmed the decision of the High Court of Telangana and set aside the contrary view of the High Court of Gujarat.
Background:
Various companies challenged directions issued by Reserve Bank of India, before different High Courts primarily on the ground that no opportunity of being heard was envisaged to borrowers before classifying their accounts as fraudulent. In some cases, Joint Lender Forum (JLF) or the lending bank declared company’s assets as Non-Performing Assets (NPA). These companies either failed to meet its payment obligations to lender banks, thereby defaulting in repayment of credit facilities or the accounts were red flagged by any of the lenders. In other cases, the lenders adopted Sustainable Structuring of Stressed Assets Scheme (S4A Scheme) and suggested a forensic audit report and Techno Economic Viability however, the companies were not eligible for the same.
Eventually, proceedings under the Insolvency and Bankruptcy Code, 2016 (IBC) were initiated, which resulted in identifying the company’s accounts as fraud, in view of the adverse findings in the forensic audit report.
Analysis
• Regulatory Framework
The Supreme Court discussed the regulatory framework and observed, that RBI has been issuing ‘master directions’ on diverse issues since 2016. Directions were issued to achieve specific purposes such as: (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. Subsequently, Clause 8.3 deals with Early Warning Signals (EWS) and Red Flagged Accounts (RFA). 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.
• Rule of Audi Alteram Partem
The entire contention of the appellants is based on the fact that under clauses of the MDoF, ‘no notice’ was issued to the borrowing companies or its promoters, and directors including whole-time directors. Hence, no opportunity to present a defense and even a copy of the final decision was not provided to them. Further contended that classification of the borrower’s bank accounts as fraud under the MDoF carries serious ‘civil consequences’.
Borrowers argued 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.
Emphasising to the main issue of Audi Alteram Partem the Court opined, that such principles of Natural Justice are not mere legal formalities. The Court held, that 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 quasi-judicial action must be heard before a decision is taken. 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.
The Court held, that process of forming an informed opinion under the Master Directions on Frauds is administrative in nature. It is a settled principle of law that the rule of audi alteram partem applies to administrative actions, apart from judicial and quasi-judicial functions. It is mandatory to provide for an opportunity of being heard when an administrative action results in civil consequences to a person or entity.
• Issues: Whether the classification of a borrower’s account as fraudulent under the MDoF entails civil consequences to borrowers
The Court observed, that MDoF deals with the penal measures for borrowers. MDoF provides that no restructuring may be made in the case of an RFA or fraud accounts and no compromise on settlement involving a fraudulent borrower is allowed unless the conditions stipulate that the criminal complaint will be continued.
Hence, it was held that classification of a borrower’s account as fraud under the MDoF has difficult civil consequences for the borrower it not only results in reporting the fact to investigating agencies but has other penal and civil consequences.
• Implied exclusion of Audi Alteram Partem
RBI and the lender banks have contended that the MDoF impliedly exclude the right to be heard. The objective of the MDoF is to ensure timely detection and reporting of cases of fraud to alert other banks and initiate criminal proceedings.
Court opined, that the MDoF 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.
It was further observed, that, 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. 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.
• Challenge to constitutional validity
Borrowers have argued that the MDoF will have to be struck down as arbitrary and unconstitutional for conferring unguided and unbridled powers on banks.
The Court while considering the constitutional validity of MDoF observed that, RBI has right to take all such measures as are necessary to protect the health of the banking system. Hence, MDoF 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. 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.
• Conclusion
The principles of Natural Justice have a universal application and constitute an important facet of procedural propriety envisaged under Article 14. Therefore, these principles 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 MDoF.
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 Court further concluded that, the MDoF do not expressly provide the borrowers an 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. Hence, 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.
Hence, the lender banks have to provide opportunity of hearing to borrowers before classifying their account as fraud; Audi alteram partem has to be read into provisions of RBI’s Master Directions on Frauds, 2016.
[State Bank of India v. Rajesh Agarwal, 2023 SCC OnLine SC 342, decided on 27-03-2023]
*Judgment authored by CJI Dr. DY Chandrachud
Advocates who appeared in this case:
For the Appellant: Dr Abhishek Manu Singhvi, Ranjit Kumar, Dhruv Mehta, Arunabh Chowdhury, Navin Pahwa, Senior Advocates and Suraj Prakash, Advocate;
For the Respondent: Tushar Mehta, Solicitor General of India, Gopal Jain, Senior Advocate and Ramesh Babu M R and G N Reddy, Advocates.