Introduction
The honorable Apex Court of India has in its recent judgement of State Bank of India v Rajesh Agarwal[1] held that the Master Directions on Fraud by RBI cannot be excluded from the principle of natural justice while classifying the account of borrower as fraud. The judgement holds a crucial importance as there had been many instances of misuse of the master directions by banks in the recent past. The judgement also came as a stop to several ongoing contentions throughout the country in various courts challenging the constitutionality and validity of The Master Directions on the grounds of violation of the principle of natural justice, here particularly, the rule of Audi alteram partem, and violation of fundamental rights under Articles 14,19 and 21 of the constitution.
Since 2016, the RBI has begun giving broad regulatory directives called master directions. The directions released combine guidance on rules and regulations established by The Reserve Bank of India under numerous Acts, including those governing banking matters and foreign exchange transactions. The court held that the present case is not based on the competency of RBI to issue these Master Directions, as it is well within its authority to determine and frame economic measures in the public interest to ensure the proper management of banking companies. Instead, the case delves into whether such measures comport with established principles and due process of law or not.
Master Directions vis-a-vis the Right to be Heard
In July 2016, RBI came out with Master Circulation on Frauds-classification and reporting under section 35A of The Banking Regulation Act, 1949, to curb the growing cases of frauds and protect the interest of depositors. The Master Directions on Frauds does not provide for 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. While the directions specifically mentions that an opportunity of hearing be provided to third party who is involved in the commission of fraudulent activity.[2].
The appellants in the given case contested that while deciding on the status of the account of borrower, Audi alteram partem ought to be read into the Master Directions on Frauds, as the principle can be read into a statue 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. Also, the discrimination between the borrowers and third parties could also be viewed as arbitrary and hence violative of Article 14 of the constitution. Further, the participation of the borrower during the preparation of the forensic audit report does not serve to the principle of natural justice in its substance.
While on the other hand the RBI and other lenders bank contended that the master direction on fraud impliedly exclude the right to be heard, therefore the clauses must be interpreted in light of their purpose and objective, that is, timely detection and dissemination of information and reporting about the fraud. Therefore, the principles of natural justice could be excluded in cases where there is a requirement of promptitude or exigent action. Further they argued that the directions are not arbitrary as ultimate decision on fraud is rendered by a competent court of law thereby giving the parties the opportunity to present their cause.
The court acknowledged that the principles of natural justice have a universal application and constitute an important facet of procedural propriety envisaged under Article 14, the same was also upheld by a Constitution Bench in the case of Tulsiram Patel[3]. Further it relied on its decision in Swadeshi Cotton Mills v Union of India[4] that the court must lean in favor of reading in the principles of natural justice when faced with a regulatory silence. Any exclusion must be confined to the narrowest possible limits. The application of the requirement of a prior hearing could be excluded only in situations where importing it would have the effect of paralyzing the entire process. Here the court held that giving an opportunity of a hearing will not obstruct the taking of prompt action under the Master Directions on Frauds. Though they made it clear that the borrowers and the third party stands on a different footing, hence the Master Directions on Frauds per say does not suffer from arbitrariness on the contended grounds.
Master Directions vis-a-vis the Right to Reputation
The other major point of contention before the bench was whether the classification of a borrower’s account as fraudulent under the Master Directions on Frauds entails civil consequences on borrowers.
The appellants here highlighted Clause 8.12.1 of the master directions, which, barres the borrower, including the promoters and directors of the company from availing credit from financial markets and credit markets including banks for a period of five or more years. On the other hand, RBI argued that the consequences are in public interest therefore are not unjustified. The court ruled that labelling an account as fraudulent has further legal and penal repercussions against the borrowers, which can in many cases result in the borrowers’ civil death by harming their right to reputation in addition to reporting the crime to investigating authorities. It further related the classification to blacklisting the borrowers for not being trustworthy enough to avail credits by the banks. The bench stated that the court in such situation, has consistently held that an opportunity of hearing ought to be provided before a person is blacklisted and hence the similar needs to be followed in the given case as well.
The appellants contended that the principles laid by the court for the purpose of declaring a borrower as a willful defaulter in State Bank of India v Jah Developers[5] , that dealt with requirement of natural justice for the purposes of declaring a borrower as a willful defaulter would squarely be applicable to the given case. While the RBI and other lender banks contended that the process for classification of a borrower as a willful defaulter under the Master Circular on Willful Defaulters significantly differs from the process of classification of an account as fraud under the Master Directions on Frauds therefore the decision of the court in Jah Developers[6] will not be applicable to the facts of the case in hand.
The court concurred on the fact that the procedures are different in the two cases though it simultaneously observed, that the consequences they will face are similar or even harsher for the latter, as by virtue of Clause 8.12.1 of the Master Directions on Frauds, the penal provisions applicable to willful defaulters also apply to fraudulent borrowers. Hence it concluded that the observations in Jah Developers[7] on the effect of declaring a borrower as wilful defaulter will be squarely applicable to the present case.
Conclusion and Observations
The judgement comes as a great relief for borrowers from different segments of the economy, be it big business conglomerates, MSME’s or other flourishing start-ups. It is a good kick for such businesses to conduct their operations, which unavoidably includes availing credits as a crucial part of their finance raising processes, without the fear of exploitation at the hand of lenders. The judgement is a step towards creating a level playing field in the finance system between the creditors and debtors, by checking on the powers of the former and ensuring fairness for the latter. Overall, it is a welcomed judgement by the business class of the country and a positive approach towards promoting the ease of doing business in India. It heads towards normalizing the process of availing loans for the running of business, breaking the stereotype of the creditors being in the influential positions by simply reiterating the same age-old principles of natural justice into the lines of master directions that are issued by the Reserve Bank of India.
[1] State Bank of India v Rajesh Agarwal [2023] SCC OnLine 342 (SC).
[2] Clause 8.12.5 of the Master Directions on Frauds.
[3] Union of India v Tulsiram Patel [1985] 3 SCC 398.
[4] Swadeshi Cotton Mills v Union of India [1981] 1 SCC 664.
[5] State Bank of India v Jah Developers [2019] 6 SCC 787.
[6] Ibid.
[7] Ibid.
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