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

Civil Appeal · 2023 INSC 303Decided 27 Mar 2023
Civil Appeal No. 7300 of 2022
Dr. Dhananjaya Y. Chandrachud · Hima Kohli · Pamidighantam Sri Narasimha

Background

Several large corporate borrowers defaulted on bank loans, and their lender banks (acting under the RBI's Master Directions on Frauds, 2016) classified their loan accounts as "fraud" based on forensic audit reports, without giving the borrowers a personal hearing or a chance to respond to the audit findings first. This classification carries serious consequences, including being reported to the CBI and being barred from getting further institutional finance. The Telangana High Court ruled that borrowers must be given a hearing before such classification, and the RBI and banks appealed that ruling to the Supreme Court, while some other borrowers who had lost similar cases in other High Courts also appealed.

Decision Breakdown

The Supreme Court held that classifying an account as fraudulent has severe civil consequences for a borrower, akin to being blacklisted, and therefore the principle of audi alteram partem ("hear the other side," a basic rule of natural justice) must be read into the RBI's Master Directions on Frauds even though the directions do not expressly provide for a hearing. The Court reasoned that nothing in the Directions excludes a hearing, that giving one is practically feasible within the existing timelines, and that many decisions of the Court have required a hearing before actions with comparably serious consequences. It ruled that lender banks must give borrowers a copy of the forensic audit report, a genuine opportunity to respond, and must pass a reasoned order before declaring an account fraudulent (though no hearing is needed merely to register an FIR). Banks that had already classified accounts as fraud without following this process would have to redo it properly. The High Court judgment favoring the borrowers was upheld, and conflicting High Court decisions were set aside.

Lesson Learnt

Even where a regulator's own rules are silent on the point, if a decision by a bank or authority will seriously damage a person's or company's civil rights or reputation (such as being branded as having committed fraud), the law requires giving that person a fair chance to see the evidence and respond before the decision is finalized.

Official source (sci.gov.in)View Judgment (PDF)

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