Summary: The RBI’s fraud classification framework has undergone an important procedural shift following judicial scrutiny of the consequences attached to declaring borrower accounts fraudulent. The Supreme Court’s decision in State Bank of India v. Rajesh Agarwal emphasised the application of audi alteram partem where fraud classification produces serious civil consequences. RBI’s July 2024 Master Directions subsequently incorporated natural justice safeguards, including a detailed show-cause notice, at least 21 days to respond, consideration of the response and a reasoned order. Against this background, the article examines whether classification of a company’s account as fraud can automatically expose its directors to the same classification. It argues that a company and its directors possess distinct legal identities and that individual culpability cannot simply be inferred from corporate fraud classification. The discussion considers the Supreme Court’s distinction between different business structures, Section 447 of the Companies Act, 2013 and recent judicial intervention concerning fraud classifications. It also examines the tension between rapid precautionary action by lenders and procedural safeguards for directors who may have had no involvement in fraudulent conduct. The central proposition is that banking efficiency and fraud prevention remain important, but serious consequences against individual directors should follow an individualised process rather than automatic attribution based solely on their association with the company.
Introduction
A director of a company wakes up and finds the company tagged as a fraud by the lenders. Does that make the directors automatically fraudsters? Under the regulatory framework of the Reserve Bank of India’s Master Circular, banks frequently extend corporate fraud classification directly to individual board members. However, contemporary Indian jurisprudence has pushed back against the “guilt by association” inherent in older banking regulation. Supreme Court’s mandate of audi alteram partem forced RBI to issue an overhauled master direction on fraud risk management in July 2024, mandating a separate procedural inquiry for individual liability.
The circular requires banks to classify an individual’s account as fraud not based on suspicion but rather on evidence, which includes misrepresentation in financial statements, unethical or fraudulent use of credit facilities. Once the classification is complete, the banks must report to the RBI and investigating agencies like the CBI, and in the subsequent step, banks put the account on the caution list, making it ineligible for any kind of fresh credit. It is the latter step that eventually extends to directors without any independent investigation, which has become the subject of recent litigation.
The court is guiding a fundamental divergence from the automatic penal reach of RBI’s Fraud Master Circular. A case in point is a mid-sized company that defaults on its credit facilities and eventually ends up in a corporate insolvency procedure. During this, it was found that the company is being categorized as fraudulent under the RBI master circular. Now, the real question is whether the directors can also be considered automatically fraudulent or not.
Directors Are Not the Company
The RBI’s fraud master circular to safeguard the banking system provides a robust mechanism to tackle fraud, but sometimes banks consider corporate identity as an obstacle that needs to be bypassed without following any formal procedure. The bank usually associates the company and director as the same entity. In Dhanasingh Prabhu v. Chandrasekhar, the Supreme Court ruled that we must be careful to distinguish between business structures; partners may be linked to each other in a permanent and inextricable manner, but the directors and the company shall not be considered the same and cannot be considered as a single unit.
A company enjoys separate legal personality, and that is why the corporate veil cannot be lifted unless a statute explicitly permits it, or unless there is a formal judicial proceeding. The penal liability for corporate fraud is governed by Section 447 of the Companies Act 2013, which requires a high evidentiary threshold and formal legal procedure to establish criminal intent and individual liability. Banks and lenders do not possess the power to unilaterally bypass the statutory provisions of the Companies Act 2013.
The Banking Playbook: The Price of Expediency over Accuracy
Banks usually treat the director and the company as a single unit, which penalizes the entire leadership hierarchy, even if it violates the fundamental principle of audi alteram partem. The reason why banks and lenders adopt expediency over accuracy is that they are under immense pressure to identify all possible financial risks in high-stakes matters. It becomes more convenient for the banks to apply the tag to the entire corporate entity, and the extension of the process results in the automatic tagging of directors with fraud liability, and that’s why directors have to approach the court because of the fear created by the banks.
The judicial intervention is not an isolated incident; it is an established trend. In Narendra Rajani and ors v. Axis Bank Ltd. and ors (Bombay High Court),WRIT PETITION NO. 1580 OF 2026, the Bombay High Court held that directors would not face penal consequences if the company had been categorised as a fraud. The directors themselves must be declared fraudsters after following the proper procedure as prescribed in the circular. Similarly, in Naresh Jagdishrai Goyal v. Bank of India (WRIT PETITION (L) NO.26973 OF 2025), the Bombay High Court set aside the bank’s order in which the Jet Airways founder’s account was declared as fraudulent. Subsequently, in SBI v. Rajesh Agarwal, the Supreme Court held that the identification of the borrower’s account as fraudulent at the time of fraud declaration by the companies violates the basic principle of audi alteram partem. And collectively, these rulings direct an important shift: the judiciary is recalibrating the balance between banking efficiency and procedural fairness by establishing that expediency cannot be considered a justification to violate the principle of natural justice, reaffirming that fraud classification does not make the directors automatically fraudulent. For a director to be established as fraudulent, the culpability of each director must be individually established in a separate proceeding before the courts. The rulings not only managed to protect the individual directors’ interests; they completely removed the automatic tagging mechanism entirely by making it compulsory for the banks to issue 21 days show cause notice period in their 2024 master directions.
Dilemma of Precautionary Measures vs Due Process
Due process is an essential element of natural justice. However, skeptics criticize this due process and argue that courts are trying to develop a separate mechanism by creating a shield for fraudsters, which gives them the required time to relocate funds, alter corporate records, and dissipate assets conveniently. For instance, consider a situation where a company has been declared fraudulent by the appropriate authority, and there is a presumption that someone from the leadership group either participated in or had knowledge of any illegal fraudulent activities. Here also, banks and lending institutions have no authority to unilaterally label individuals as fraudsters; not only that, a separate hearing and investigation are mandatory before tagging any director as fraudulent, which results in no precautionary measure left for them but to wait for the procedural result. The wait time created here acts like a temporal cushion, providing individuals with desired leeway from immediate banking penalties.
At first glance, the criticism might appear compelling from a risk management perspective, but it defies the basic principle of natural justice. The principle of natural justice is unwritten in India but holds a strong position. It is a result of necessary judicial thinking and advocates for the most appropriate standard of fair play, especially in corporate law. It ensures delivery of justice to the parties even though it is procedural in nature. The requirement of due process does not create a shield for fraudulent conduct; rather, it is a protection against arbitrary conviction without giving any opportunity of being heard.
Consider a situation where a director serves a manufacturing firm as an operational director, and the company’s promoter submits forged financial statements, fake revenue reports, and profit invoices to the lender for the desired valuation of the company, and later, banks classify the entire company as fraudulent because the company benefited from forged documentation. An operational director in charge of manufacturing did not participate in any way in the whole act and had no knowledge of the fraud led by the promoters. Here, if the banks or lenders make the operational director automatically liable without any formal procedure, it would result in complete arbitrariness and injustice. This will impact the economy, finances, and reputation of an individual. The judiciary’s stance is not an obstacle for the banks and lenders but a safeguard for corporate integrity. By making the 21-day notice period a mandate, courts and drafters are trying to provide constitutional fairness. Courts are ultimately striking this balance to protect the interests of innocent directors from arbitrary actions so that perpetrators are held accountable by following essential procedures of due process.
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Rajnish Kumar is a 4th-year law student at Lloyd Law College, Greater Noida.
