Opportunity should be granted by the Bank To Borrowers Before Declaring the Accounts As Fraud : Supreme Court

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE/ORIGINAL JURISDICTION

DR. DHANANJAYA Y. CHANDRACHUD; CJI.,

HIMA KOHLI; J.

Civil Appeal No. 7300 of 2022;

March 27, 2023

State Bank of India & Ors Versus Rajesh Agarwal & Ors.

J U D G M E N T

Dr Dhananjaya Y Chandrachud, CJI

A. Background

1. 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 2016.1 Issued by the Reserve Bank of India , 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. The High Court of Telangana has held in the impugned judgment3 that the principles of natural justice must be read into the provisions of the Master Directions on Frauds. The decision has been assailed by the RBI and lender banks through these civil appeals.

2. In this background the court has to consider whether the principles of natural justice should be read into the provisions of the Master Directions on Frauds. For the reasons to follow, we hold that the principles of natural justice, particularly the rule of audi alteram partem, has to be necessarily read into the Master Directions on Frauds to save it from the vice of arbitrariness. Since the classification of an account as fraud entails serious civil consequences for the borrower, the directions must be construed reasonably by reading into them the requirement of observing the principles of natural justice.

B. Facts

I. SLP (C) No. 3931 of 2021; SLP (C) No. 4922 of 2021; SLP (C) No. 5056 of 2021

3. B S Limited is a company engaged in the business of power transmission and distribution, passive telecom infrastructure, renewable energy, and mineral resources. It availed loans amounting to Rs. 1406 crores from various banks. The company failed to meet its payment obligations to lender banks, thereby defaulting in repayment of credit facilities. In accordance with the Master Directions on Frauds, all the lender banks formed a Joint Lenders Forum4 with State Bank of India as the lead bank.

4. The JLF declared the company’s assets as Non-Performing Assets5 on 29 August 2016. The lender banks decided to adopt the Sustainable Structuring of Stressed Assets Scheme6 and suggested a forensic audit report and Techno Economic Viability study in its meeting held on 11 July 2016. Based on the conclusions of the forensic audit report, the JLF closed the issue stating that there were no irregularities. However, based on the TEV study it was concluded that the company was not eligible for the S4A scheme and requested it to submit an alternative plan for regularization of its account. In the meanwhile, IDBI Bank - one of the lender banks - red-flagged the account of the company. Additionally, proceedings under the Insolvency and Bankruptcy Code, 2016 were also initiated against the company. On 15 February 2019, the JLF declared the account of the company as fraud by invoking Clause 2.2.1(g) of the Master Directions on Frauds. Subsequently, the Fraud Identification Committee8 passed a resolution on 31 July 2019 identifying the company’s account as fraud. The company filed a writ petition challenging 1 “Master Directions on Frauds” 2 “RBI” 3 Writ Petition No. 19102 of 2019 4 “JLF” 5 “NPA” 6 “S4A Scheme” 7 “TEV” 8 “FIC” 3 both the decision of the JLF dated 15 February 2019 and the resolution of the FIC dated 31 July 2019 before the High Court of Telangana.

5. By a judgment dated 10 December 2020, a Division Bench of the High Court allowed the writ petition by holding that the principle of audi alteram partem ought to be read into Clauses 8.9.4 and 8.9.5 of the Master Directions on Frauds. The High Court further directed the lender banks: (i) to give an opportunity of a hearing to the borrowers after furnishing a copy of the forensic audit report; and (ii) to provide an opportunity of a personal hearing to the borrower before classifying their account as fraud. The judgment of the High Court was challenged in SLP (C) No. 3931 of 2021. On 15 April 2021, this Court, while issuing notice, partially stayed the directions issued by the Telangana High Court in the following terms: “Meanwhile, the Minutes/Order dated 15.02.2019 passed by the Joint Lenders Meeting is not to be acted upon. The High Court insofar as it observed that a personal hearing be given is stayed.” II. SLP (C) No. 762 of 2022; SLP (C) No. 873 of 2022; and SLP (C) No. 1514 of 2022

6. The appellant is a company involved in the manufacture of edible oils, fats, rice and semolina products in the State of Telangana. From 2003 to 2015, the appellant availed of credit facilities to the tune of Rs. 675 crores from a consortium of banks led by the Andhra Bank (now merged with the Union Bank of India). The appellant was declared as an NPA on 14 May 2018 with effect from 31 March 2018. Thereafter, the consortium of lenders in a meeting of the JLF decided to conduct a forensic audit of the appellant for the period till 31 March 2019. The appellant participated in the audit process and submitted all the information required by the auditor from time to time. In September 2019, the appellant learnt that its account has been declared as fraud by the Union Bank of India (erstwhile Andhra Bank). Aggrieved by that classification, the appellant filed a writ petition before the High Court of Telangana. The High Court declined to deal with the issues pertaining to the principles of natural justice and fair play considering the fact that they were pending before this Court in SLP (C) No. 3931 of 2021. By its judgment dated 22 December 2021, the High court dismissed the writ petitions. The court held that the appellant’s account was rightly classified as fraud because the forensic audit report contained adverse findings against the appellant.

7. On 24 January 2022, this Court, while issuing notice in SLP (C) No. 762 of 2022, directed that the matter may not be reported to the Central Bureau of Investigation9 for the time being. On 28 March 2022, this Court passed a similar ad-interim order in SLP (C) No. 873 of 2022 and SLP (C) No. 1514 of 2022. III. SLP (C) No. 2980 of 2022 8. The appellant is a promoter and director of Golden Jubilee Hotels Pvt Ltd.10 GJHPL availed financial assistance from the respondent banks for the construction and development of a hotel in Hyderabad. GJHPL’s account was declared as NPA from 31 December 2015 because of its inability to service its debts to the respondent banks. At its meeting on 21 April 2016, the JLF decided to carry out a special audit of the appellant’s company. Thereafter, the appellant participated in a series of meetings between the JLF and was consulted by the forensic auditor during the preparation of the audit report. Bank of Baroda red-flagged the appellant’s account on 03 May 2019 based on the observations in the forensic audit report. The appellant’s account was classified as fraud on 14 August 2019. A criminal complaint was also lodged with the CBI. The appellant came to know 9 “CBI” 10 “GJHPL” 4 about the classification of their account as fraud in 2021, when they received a copy of the FIR. The appellant filed a writ petition before the High Court of Telangana challenging the validity of the Master Directions on Frauds. The High Court by its judgment dated 31 December 2021 held that no relief could be granted to the appellant on the issue of personal hearing since SLP (C) No. 3931 of 2021 was pending before this Court. The High Court also held that the appellant’s account was rightly classified as fraudulent in view of the adverse findings in the forensic audit report. IV. Writ Petition (C) No. 138 of 2022 and SLP (C) No. 3388 of 2022

9. The appellant is one of the directors of a company called M/s Vimal Oil & Foods Limited. The said company availed of loan facilities from various financial institutions over a period of time. In 2015, the auditor of the respondent bank flagged certain irregularities in the accounts of the company. Based on a special audit, the respondent bank declared the account of the company as NPA on 30 September 2015. Thereafter, on 05 July 2016, the company’s account was red-flagged by the respondent bank. In the meantime, the Corporate Insolvency Resolution Process was initiated against the company on 19 December 2017 and the appellant was suspended as Managing Director of the company. Upon suspension, the appellant was not invited to attend the meetings of the JLF. The appellant allegedly learnt that the respondent bank had classified their account as fraud on 21 February 2018 though without any intimation. Further, based on a letter addressed by the respondent bank to the CBI, an FIR came to be registered against the appellant. The appellant alleges that they acquired knowledge about their account being classified as fraud and registration of the FIR only when a search was carried out at their residential premises in pursuance of the FIR. The appellant filed a Special Civil Application challenging the actions of the respondent bank, which was dismissed by the Single Judge of the High Court of Gujarat. The Division Bench partly allowed a Letters Patent Appeal by its judgment dated 23 December 2021 by permitting the appellant to address a representation to the respondent bank but declined to allow a personal hearing. The appellant/ petitioner has also invoked the writ jurisdiction of this Court by challenging the validity of the Master Directions on Frauds. C. Submissions 10. On behalf of the borrowers, we have heard Dr Abhishek Manu Singhvi, Mr Ranjit Kumar, Mr Dhruv Mehta, Mr Arunabh Chowdhury, Mr Navin Pahwa, Senior Advocates and Mr Suraj Prakash, learned counsel. The counsel submit that the procedure for classification of an account as fraud under the Master Directions on Frauds suffers from illegalities because: a. Under Clauses 8.9.4 and 8.9.5 of the Master Directions on Frauds, no notice is given to the borrowing company or its promoters, and directors including whole-time directors. They are not given an opportunity to present a defense and even a copy of the final decision is not provided to them. b. The classification of the borrower’s bank accounts as fraud under the Master Directions on Frauds carries serious civil consequences. The penal provisions under Clause 8.12 of the Master Directions on Frauds are also applicable to the promoters, directors, and other whole-time directors. Once a bank account is classified as fraudulent, it carries significant consequences according to the Master Directions on Frauds such as filing of a complaint with the CBI and debarment of the promoters and directors from accessing institutional finance. Further, the action of the banks of classifying an account “CIRP” 5 as ‘fraud’ is stigmatic, akin to blacklisting the borrower, which affects their right to reputation. Thus, there is a direct impact on the fundamental rights of the individuals concerned, as a consequence of the classification of an account as fraud. c. The Master Directions on Frauds are violative of Articles 14, 19, and 21 of the Constitution of India as they debar a company and its promoters and directors from accessing financial and credit markets for a period of five years without even providing a show cause notice or opportunity of being heard. d. There are other facets to the principle of audi alteram partem apart from a personal hearing. The Master Directions on Frauds does not stand good on other facets of audi alteram partem such as notice of allegations levelled and evidence collected, notice of the penalty proposed, among others. According to the procedure laid down under the Master Directions on Frauds, a company or its promoters and directors are not even informed that they have been classified as fraud and that a penalty has been imposed upon them. e. The Master Directions on Frauds are silent on whether or not the borrower is entitled to an opportunity of being heard after the receipt of forensic audit report and before deciding whether the borrower’s account should be classified as fraud. Since the decision to classify the account as fraud entails significant civil consequences, principles of natural justice ought to be read into the Master Directions on Frauds. f. Clause 8.12.5 of the Master Directions on Frauds expressly stipulates that an opportunity of hearing be provided to third parties. The directions are manifestly arbitrary since on the one hand they provide an opportunity of hearing to third parties, but such an opportunity is denied to borrowers. g. Although the purpose and object of the Master Directions on Frauds is speedy detection and reporting of fraud to law enforcement agencies, such exigencies cannot be a valid ground to exclude the applicability of the principles of natural justice. h. The decision of this Court in State Bank of India v. Jah Developers12 read in the requirement of natural justice for the purposes of declaring a borrower as a willful defaulter. The principles laid down in Jah Developers (supra) would be squarely applicable to the present matters. i. The participation of the borrower during the preparation of the forensic audit report does not in itself fulfil the requirement of the principles of natural justice under the Master Directions on Frauds. Those directions do not expressly provide for the participation or inputs from a borrower during the preparation of the forensic audit report, giving rise to the possibility that in some cases, the borrower is completely excluded from the forensic audit process.

11. On behalf of the RBI and lender banks, we have heard Mr Tushar Mehta, Solicitor General of India, Mr Gopal Jain, Senior Counsel and Mr Ramesh Babu M R and Mr G N Reddy, learned counsel. Counsel submitted that the challenge to the classification of a loan account as fraudulent on the ground of a violation of the principles of natural justice is devoid of merit for the following reasons: a. The Master Directions on Frauds were necessitated to protect the interests of depositors and banks from the growing instances of frauds. RBI is duly empowered to take pre-emptive measures in public interest to ensure that fraudulent borrowers are brought to justice and loss caused to the banks is mitigated. The clauses of the Master 12 (2019) 6 SCC 787 6 Directions on Frauds, therefore, must be interpreted in light of their purpose and objective, that is, timely detection and dissemination of information and reporting about the fraud. b. The provisions of the Master Directions on Frauds must be construed keeping in mind the following thresholds: (i) justness; (ii) fairness towards the parties aggrieved; (iii) reasonability; and (iv) proportionality between the mischief and the corrective measure. Considering that the Master Directions on Frauds is an economic policy decision, this Court must exercise greater latitude while construing its provisions. c. The procedure for classifying an account as fraud under the Master Directions on Frauds is not arbitrary. The classification is done only for reporting the matter to law enforcement agencies. The banks already have in place a structured organizational setup to identify and investigate fraudulent activities in bank accounts. Banks file complaints before law enforcement agencies, who conduct an investigation. The ultimate decision on fraud is rendered by a competent court of law. d. Principles of natural justice are not applicable at the stage of setting the process of criminal law in motion. Since the lender bank is an injured party in case of fraudulent accounts, it has the right to report the crime to the law enforcement agencies without giving an opportunity of being heard to the fraudulent borrower. Issuing of a show cause notice to fraudulent borrowers may forewarn them and hamper the investigation by law enforcement agencies. e. Debarring fraudulent borrowers from availing bank finances is a preventive measure without which the Master Directions on Frauds will be rendered toothless. Such a measure is necessary to prevent a fraudulent borrower from committing frauds in other banks. f. The requirement of notice or prior hearing could be excluded if it impedes the taking of prompt action. Further, it is not an inviolable rule that personal hearing ought to be given in all cases. g. The process for classification of a borrower as a willful defaulter under the Master Circular on Willful Defaulters13 significantly differs from the process of classification of an account as fraud under the Master Directions on Frauds. Therefore, the decision of this Court in Jah Developers (supra) will not be applicable to the facts of the present appeal. D. Analysis D.1 Regulatory Framework

12. RBI is a statutory body constituted under Section 3 of the Reserve Bank of India Act, 1934. The RBI has been constituted for the purpose of taking over the management of currency from the Central Government, regulating the issue of bank notes, keeping of reserves with a view to securing monetary stability, and operating the currency and credit system of India. RBI is entrusted with the statutory obligation of administering the provisions of the Banking Regulation Act, 194914 . The BR Act vests RBI with various powers with respect to banking companies such as granting licenses, conducting inspections and giving directions.

13. Section 35A of the BR Act empowers RBI to issue directions to banking companies. Such directions are statutory in nature. Section 35A is extracted below: “35A. Power of the Reserve Bank to give directions – (1) Where the Reserve Bank is satisfied that – 13 Master Circular on Wilful Defaulters, 2015 14 “BR Act” 7 (a) in the public interest; or (aa) in the interest of banking policy; or (b) to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company; or (c) to secure the proper management of any banking company generally, it is necessary to issue directions to banking companies generally or to any banking company in particular, it may, from time to time, issue such directions as it deems fit, and the banking companies or the banking company, as the case may be, shall be bound to comply with such directions. (2) The Reserve Bank may, on representation made to it or on its own motion, modify or cancel any direction issued under subsection (1), and in so modifying or cancelling any direction may impose such conditions as it thinks fit, subject to which modifications or cancellation shall have effect.”

14. RBI has been issuing ‘master directions’ on diverse issues since 2016. These directions encompass the instructions on that particular subject. The master directions are updated whenever there is a change in policy, and such changes get reflected on RBI’s website. In exercise of the power conferred by Section 35A, RBI issued the Master Directions on Frauds on 01 July 2016 to consolidate and update seven earlier circulars on classification of fraud, reporting and monitoring issued between June 2009 and January 2016. The Master Directions on Frauds were updated on 03 July 2017. The purpose of the Master Directions is extracted below: “1.3 Purpose These directions are issued with a view to providing a framework to banks to enable them to detect and report frauds early and taking timely consequent actions like reporting to the Investigative agencies so that fraudsters are brought to book early, examining staff accountability and do effective fraud risk management. These directions also aim to enable faster dissemination of information by the Reserve Bank of India (RBI) to banks on the details of frauds, unscrupulous borrowers and related parties, based on the banks’ reporting so that necessary safeguards / preventive measures by way of appropriate procedures and internal checks may be introduced and caution exercised while dealing with such parties by banks.”

15. The above directions were issued to achieve specific purposes: (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. These purposes are reflected in Clause 2.1.1 of the Master Directions on Frauds: “Clause 2.1.1 The Chairmen and Managing Directors/Chief Executive Officers (CMD/CEOs) of banks must provide focus on the “Fraud Prevention and Management Function” to enable, among others, effective investigation of fraud cases and prompt as well as accurate reporting to appropriate regulatory and law enforcement authorities including Reserve Bank of India.” (emphasis supplied)

16. Clause 2.2.1 classifies frauds based on the provisions of the Indian Penal Code, 1860: “Clause 2.2.1 In order to have uniformity in reporting, frauds have been classified as under, based mainly on the provisions of the Indian Penal Code: 8 a. Misappropriation and criminal breach of trust b. Fraudulent encashment through forged instruments, manipulation of books of account or through fictitious accounts and conversion of property. c. Unauthorised credit facilities extended for reward or for illegal gratification d. Cash shortages. e. Cheating and forgery f. Fraudulent transactions involving foreign exchange g. Any other type of fraud not coming under the specific heads as above.”

17. Clause 3 advises banks to make full use of the Central Fraud Registry15 (a database created by RBI to enable banks to share information on fraudulent accounts) for timely identification, control, reporting, and mitigation of risks associated with fraud. Clause 3.3 of the said directions emphasizes the need to provide timely information on frauds and penalizes banks for non-adherence to timelines: “3.3.1 Banks should ensure that the reporting system is suitably streamlines so that delays in reporting of frauds, submission of delayed and incomplete fraud reports are avoided. Banks must fix staff accountability in respect of delays in reporting fraud cases to RBI. 3.3.2. Delay in reporting of frauds and the consequent delay in alerting other banks about the modus operandi and dissemination of information through Caution Advice/ CFR against unscrupulous borrowers could result in similar frauds being perpetrated elsewhere. Banks should therefore, strictly adhere to the timeframe fixed in this circular for reporting of fraud cases to RBI failing which they would be liable for penal action prescribed under Section 47(A) of the Banking Regulation Act, 1949.” (emphasis supplied)

18. The Master Directions on Frauds provides a regulatory framework for four types of frauds: (i) Chapter IV deals with attempted fraud; (ii) Chapter VII deals with cheque related frauds; (iii) Chapter VIII deals with loan frauds; and (iv) Chapter X deals with cases relating to theft, burglary, dacoity, and bank robberies. The dispute in the present batch of cases is concerned with Chapter VIII dealing with loan frauds.

19. Chapter VI states that as a general rule, cases involving fraud/ embezzlement should invariably be referred to the state police or CBI. Chapter VIII provides for more robust safeguards which ensure that banks report frauds to investigating agencies after forming an informed opinion. The framework for dealing with loan frauds was put in place by a circular dated 07 May 2015. The objective of the framework has been enumerated in Clause 8.2: “8.2 Objective of the framework The objective of the framework is to direct the focus of banks on the aspects relating to prevention, early detection, prompt reporting to the RBI (for system level aggregation, monitoring & dissemination) and the investigative agencies (for instituting criminal proceedings against fraudulent borrowers) and timely initiation of the staff accountability proceedings (for determining negligence or connivance, if any) while ensuring that the normal conduct of business of the banks and their risk taking ability is not adversely impacted and no new and onerous responsibilities are placed on the banks. In order to achieve this objective, the framework has stipulated time lines with the action incumbent on a bank. The time lines / stage wise actions in the loan life-cycle are expected to compress the total time taken by a bank to identify a fraud and aid more effective action by the law enforcement agencies. The early detection of Fraud and the necessary 15 “CFR” 9 corrective action are important to reduce the quantum of loss which the continuance of the Fraud may entail.”

20. Clause 8.3 deals with Early Warning Signals16 and Red Flagged Accounts.17 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. EWS which should alert bank officials about wrongdoings in a loan account are set out in Annexure II. Some of those enumerated are set out below: i. a. Default in undisputed payment to statutory bodies as declared in the annual report; b. Dishonour of high value cheques; ii. Delay in payment of outstanding dues; iii. Funds coming from other banks to liquidate the outstanding loan amount except in the normal course; iv. Exclusive collateral charged to a number of lenders without NOCs of existing charge holders; v. Dispute on title to collateral securities; and vi. Critical issues in the stock audit report.

21. EWS provide indications of wrongdoing which may later turn out to be frauds. A bank is put on alert by the presence of EWS and must use them to trigger a detailed investigation into the concerned bank account. According to Clause 8.3.5, the officer responsible for operations in the account should promptly report any manifestation of EWS to the Fraud Monitoring Group18 constituted by the bank. The clause directs banks to take cognizance of EWS and launch a detailed investigation into an RFA.

22. Clause 8.8 deals with situations where a bank is the sole lender. In such situations, the FMG is entrusted with the responsibility to take a call on whether a bank account in which EWS are observed should be classified as RFA. The bank is permitted to use external auditors before taking a final call on RFA status. However, within six months the bank is required to either lift the RFA status or classify the account as fraud in accordance with the investigation or forensic audits.

23. Clause 8.9 deals with lending under consortium or multiple banking arrangements19 . Clause 8.9.2 provides that all banks which have financed a borrower under an MBA should take coordinated action based on a commonly agreed strategy for subsequent legal actions, follow-ups, exchange of details and information on a consistent basis. Clauses 8.9.4 and 8.9.5 provide the procedure for classification of a borrower’s account as fraud: “8.9.4 The initial decision to classify any standard account or NPA account as RFA or Fraud will be at the individual level and it would be the responsibility of this bank to report the RFA or Fraud status of the account on the CRILC platform so that other banks are alerted. In case it is decided at the individual bank level to classify the account as fraud straightaway at this stage itself, the bank shall then report the fraud to RBI within 21 days of detection and also report the case to CBI/Police, as it is being done hitherto. Further, within 15 days of RFA/Fraud classification, the bank which has red flagged the account or detected the fraud would ask the consortium leader or the largest lender under MBA to convene a meeting of the JLF to discuss the issue. The meeting of the JLF so requisitioned must be convened within 15 days of such a request being received. In case there is a broad agreement, the account should be classified as fraud; 16 “EWS” 17 “RFA” 18 “FMG” 19 “MBA” 10 else based on the majority rule of agreement amongst bank with at least 60% share in the total lending, the account should be red flagged by all the banks and subjected to a forensic audit commissioned or initiated by the consortium leader or the largest lender under MBA. All banks, as part of the consortium of multiple-banking arrangement, shall share the costs and provide the necessary support for such an investigation. 8.9.5 The forensic audit must be completed within a maximum period of three months from the date of the JLF meeting authorizing the audit. Within 15 days of the completion of the forensic audit, the JLF shall reconvene and decide on the status of the account, either by consensus or the majority rule as specified above. In case the decision is to classify the account as a fraud, the RFA status shall be changed to Fraud in all banks and reported to RBI and on the CRILC platform within a week of the said decision. Besides, within 30 days of the RBI reporting, the bank commissioning/ initiating the forensic audit should lodge a complaint with the CBI on behalf of all banks in the consortium/MBA. For this purpose, if the bank initiating the forensic audit is a private sector bank, the complaint shall be lodged with the CBI by the PSU bank with the largest exposure to the account in the consortium/MBA. If there is no PSU bank in the consortium/MBA or it is a solo bank lending by a private sector bank/ foreign bank, the private bank/foreign bank shall report to the Police as per extant instructions. This would be in addition to the complaint already lodged by the first bank which had detected the fraud and informed the consortium/MBA.” (emphasis supplied)

24. Clause 8.9.4 stipulates that the initial decision to classify an account as RFA or fraud vests with the individual bank. Once the bank classifies the account as fraud, it is the responsibility of that bank to report the RFA or fraud status on the account on the Central Repository of Information on Large Credits20 platform to alert other banks. In case the individual bank decides to straightaway classify the account as fraud, it is obligated to report the fraud to RBI within 21 days of detection and also report the case to CBI/Police. Further, within 15 days the individual bank could ask the consortium leader or the largest lender under the MBA to convene a meeting of the JLF to discuss the issue. The meeting of the JLF has to be convened within 15 days of the request being received. The JLF can classify an account as fraud in case there is a broad consensus. Otherwise, the clause indicates that based on an agreement amongst banks with at least a 60 percent share in total lending, the account should be red-flagged by all banks and subjected to forensic audit commissioned or initiated by the consortium leader or the largest lender under MBA.

25. Clause 8.9.5 states that the forensic audit has to be completed within 3 months from the date of the JLF meeting authorizing the audit. Within 15 days of the completion of the audit, the JLF has to decide to classify the account as fraud and report it to the RBI. The clause also requires the bank commissioning the audit to lodge a complaint with CBI on behalf of all banks in the consortium within 30 days of reporting to RBI.

26. Clause 8.11 deals with the filing of complaints to law enforcement agencies. Clause 8.11.1 requires banks to lodge complaints with law enforcement agencies immediately on detecting fraud. The clause enjoins banks to avoid delay in filing a complaint as it may result in loss of documents, unavailability of witnesses, absconding borrowers, loss of money trail and asset tripping by fraudulent borrowers. 27. The penal measures for fraudulent borrowers are set out in Clause 8.12 which reads as follows: 8.12 Penal measures for fraudulent borrowers 20 “CRILC” 11 8.12.1 In general, the penal provisions as applicable to wilful defaulters would apply to the fraudulent borrowers including the promoter director(s) and other whole time directors of the company insofar as raising of funds from the banking system or from capital markets by companies with which they are associated is concerned, etc. In particular, borrowers who have defaulted and have also committed a fraud in the account would be debarred from availing bank finance from Scheduled Commercial Banks, Development Financial Institutions, Government owned NBFCs, Investment Institutions, etc., for a period of five years from the date of full payment of the defrauded amount. After this period, it is for individual institutions to take a call on whether to lend to such a borrower. The penal provisions would apply to non-whole time directors (like nominee directors and independent directors) only in rarest of cases based on conclusive proof of their complicity. 8.12.2 No restructuring or grant of additional facilities may be made in the case of RFA or fraud accounts. However, in cases of fraud/malfeasance where the existing promoters are replaced by new promoters and the borrower company is totally delinked from such erstwhile promoters/management, banks and JLF may take a view on restructuring of such accounts based on their viability, without prejudice to the continuance of the criminal actions against the erstwhile promoters/management. 8.12.3 No compromise settlement involving a fraudulent borrower is allowed unless the conditions stipulate that the criminal complaint will be continued. 8.12.4 In addition to above borrower – fraudsters, third parties such as builders, warehouse/ cold storage owners, motor vehicle/ tractor dealers, travel agents, etc. and professionals such as architects, valuers, chartered accountants, advocates, etc. are also held accountable if they play a vital role in credit sanction/ disbursement or facilitated the perpetration of frauds. Banks are advisable to report to Indian Banks Association (IBA) the details of such parties involved in frauds. 8.12.5 Before reporting to IBA, banks have to satisfy themselves of the involvement of third parties concerned and also provide them with an opportunity of being heard. In this regard the banks should follow normal procedures and the processes followed should be suitably recorded. On the basis of such information, IBA would, in turn, prepare caution lists of such third parties for circulation among the banks.” (emphasis supplied) 28. Clause 8.12.1 provides that the penal provisions as applicable to willful defaulters would apply to fraudulent borrowers as regards the raising of funds from the banking system and financial institutions. Importantly, under the clause, fraudulent borrowers include promoters, directors, and other whole-time directors of the borrowing company. It debars fraudulent borrowers from availing banking finance from scheduled commercial banks, development financial institutions, government owned NBFCs, investment institutions, etc. for a period of five years from the date of full payment of the defrauded amount. Even after the completion of the five-year period, it is for the individual financial institutions to decide whether to lend to fraudulent borrowers, including directors and promoters of the borrowing company. Additionally, under Clause 8.12.2, fraudulent borrowers are denied restructuring or grant of additional facilities by banks and other such financial institutions. D.2 Audi alteram partem

29. We need to bear in mind that the principles of natural justice are not mere legal formalities. They constitute substantive obligations that need to be followed by decisionmaking and adjudicating authorities. The principles of natural justice act as a guarantee against arbitrary action, both in terms of procedure and substance, by judicial, quasijudicial, and administrative authorities. Two fundamental principles of natural justice are entrenched in Indian jurisprudence: (i) nemo judex in causa sua, which means that no 12 person should be a judge in their own cause; and (ii) audi alteram partem, which means that a person affected by administrative, judicial or quasijudicial 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.21