STATE BANK OF INDIA & Ors. v. RAJESH AGARWAL & Ors.

476 [2023] 7 S.C.R. STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS (Civil Appeal No. 7300 of 2022) MARCH 27, 2023 [DR. DHANANJAYA Y CHANDRACHUD, CJI AND HIMA KOHLI, J.] Reserve Bank of India Act, 1934 – Banking Regulation Act, 1949 – Reserve Bank of India (Frauds Classification and Reporting by Commercial Banks and Select FIs) Directions 2016 – Master Directions on Frauds – Principle of Natural Justice – Rule of Audi Alteram Partem – The civil appeals arise out of a challenge to the Reserve Bank of India (Frauds Classification and Reporting by Commercial Banks and Select FIs) Directions 2016 – These directions were challenged before different High Courts primarily on the ground that no opportunity of being heard is envisaged to borrowers before classifying their accounts as fraudulent – Whether the principles of natural justice should be read into the provisions of the Master Directions on Frauds – Held : The principles of natural justice demand that the borrowers must be served a notice, given an opportunity to explain the conclusions of the forensic audit report, and be allowed to represent by the banks/ JLF before their account is classified as fraud under the Master Directions on Frauds – In addition, the decision classifying the borrower’s account as fraudulent must be made by a reasoned order; and since the Master Directions on Frauds do not expressly provide an opportunity of hearing to the borrowers before classifying their account as fraud, audi alteram partem has to be read into the provisions of the directions to save them from the vice of arbitrariness.

Reserve Bank of India Act, 1934 – Banking Regulation Act, 1949 – Reserve Bank of India (Frauds Classification and Reporting by Commercial Banks and Select FIs) Directions 2016 – Principle of Natural Justice – Civil consequences to borrowers – Whether the classification of a borrower’s account as fraudulent under the Master Directions on Frauds entails civil consequences to borrowers – Held: Clause 8.12 of the Master Directions on Frauds 476 STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS 477 deals with the penal measures for borrowers – Clause 8.12.1 provides that penal provisions as applicable to wilful defaulters would apply to fraudulent borrowers, including the promoters and directors of the borrower company – In addition, borrowers are also liable to suffer the following consequences under the Master Directions on Frauds : a) No restructuring may be made in the case of an RFA or fraud accounts (clause 8.12.2); b) No compromise on settlement involving a fraudulent borrower is allowed unless the conditions stipulate that the criminal complaint will be continued (clause 8.12.3) – The classification of a borrower’s account as fraud under the Master Directions on Frauds has difficult civil consequences for the borrower – Classification of the borrower’s account as fraud under the Master Directions on Frauds virtually leads to a credit freeze for the borrower, who is debarred from raising finance from financial markets and capital markets – The bar from raising finances could be fatal for the borrower leading to its ‘civil death’ in addition to the infraction of their rights under Article 19(1)(g) of the Constitution – Since, debarring disentitles a person or entity from exercising their rights and/or privileges, it is elementary that the principles of natural justice should be made applicable and the person against whom an action of debarment is sought should be given an opportunity of being heard.

Reserve Bank of India Act, 1934 – Banking Regulation Act, 1949 – Reserve Bank of India (Frauds Classification and Reporting by Commercial Banks and Select FIs) Directions 2016 – No implied exclusion of audi alteram partem – The RBI and the lender banks have contended that the Master Directions on Frauds impliedly exclude the right to be heard – Held: The Master Directions on Frauds 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. Principles/Doctrines – Principles of natural justice – 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 – The courts generally favor interpretation of a statutory provision consistent with the principles of natural justice because it is presumed that the statutory authorities do not intend to contravene fundamental rights. Disposing of the appeals, the Court HELD: Audi Alteram Partem

The principles of natural justice are not mere legal formalities. They constitute substantive obligations that need to be followed by decision-making and adjudicating authorities. The 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. The courts generally favor interpretation of a statutory provision consistent with the principles of natural justice because it is presumed that the statutory authorities do not intend to contravene fundamental rights. Application of the said principles depends on the facts and circumstances of the case, express language and basic scheme of the statute under which the administrative power is exercised, the nature and purpose for which the power is conferred, and the final effect of the exercise of that power. [Para 29][502-E-G]

Chapter VIII of the Master Directions on Fraud provides detailed procedures to be followed by the banks before forming an opinion to proceed with a criminal complaint against the borrowers. Under the said chapter, the lender banks have to report a borrower to the CBI after classifying the borrower’s account as fraudulent. However, the classification of the borrower’s account does not simpliciter lead to reporting of criminal complaint with the enforcement authorities; it also entails penal consequences for the borrowers as laid down under Clause 8.12. The process of forming an informed opinion under the STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS 479 Master Directions on Frauds is administrative in nature. This has also been acceded to by RBI and lender banks in their written submissions. It is now 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 also a settled position in administrative law that it is mandatory to provide for an opportunity of being heard when an administrative action results in civil consequences to a person or entity. [Paras 31, 32][503-D- G]

The RBI and lender banks have argued that the civil consequences contemplated in Clause 8.12.1 of the Master Directions on Frauds are reasonable. Under the said clause, the borrower, including the promoters and directors of the company, are barred from availing credit from financial markets and credit markets for a period of five years, and possibly even beyond. According to RBI and lender banks, such a restriction has to be perceived from the perspective of public interest. While acknowledging that the procedure which has been laid down in the Master Directions on Frauds is conceived in public interest, to protect the banking system, it cannot be ignore the serious civil consequences which emanate to the borrowers. [Para 38][505-G; 506-A-B]

Classification of the borrower’s account as fraud under the Master Directions on Frauds virtually leads to a credit freeze for the borrower, who is debarred from raising finance from financial markets and capital markets. The bar from raising finances could be fatal for the borrower leading to its ‘civil death’ in addition to the infraction of their rights under Article 19(1)(g) of the Constitution. Since debarring disentitles a person or entity from exercising their rights and/or privileges, it is elementary that the principles of natural justice should be made applicable and the person against whom an action of debarment is sought should be given an opportunity of being heard. Indeed, debarment is akin to blacklisting a borrower from availing credit. [Para 42][509-A-C] No implied exclusion of audi alteram partem

The Master Directions on Frauds do not expressly exclude a right of hearing to the borrowers before action to class H 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. [Para 53][513-E]

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. Hence, the mere participation of the borrower during the course of the preparation of a forensic audit report would not fulfil the requirements of natural justice. The decision to classify an account as fraud involves due application of mind to the facts and law by the lender banks. The lender banks, either individually or through a JLF, have to decide whether a borrower has breached the terms and conditions of a loan agreement, and based upon such determination the lender banks can seek appropriate remedies. Therefore, principles of natural justice 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 Master Directions on Frauds. [Para 65][520-F-H]

The conclusions are summarized as follows: i. No opportunity of being heard is required before an FIR is lodged and registered; ii. Classification of an account as fraud not only results in reporting the crime to investigating agencies, but also has other penal and civil consequences against the borrowers; iii. Debarring the borrowers from accessing institutional finance under Clause 8.12.1 of the Master Directions on Frauds results in serious civil consequences for the borrower; iv. Such a debarment under Clause 8.12.1 of the Master Directions on Frauds is akin to blacklisting the borrowers for being untrustworthy and unworthy of credit by banks. This Court has consistently held that an opportunity of hearing ought to be provided before a person is blacklisted; v. The application of audi STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS 481 alteram partem cannot be impliedly excluded under the Master Directions on Frauds.