Audi alteram partem application cannot be impliedly excluded under the Master Directions on Frauds: Supreme Court

On March 27, 2023, while hearing the State Bank of India vs Rajesh Agarwal case, the Supreme Court of India upheld the Telangana High Court’s decision that the principles of natural justice must be read into the provisions of the Master Directions on Frauds. The borrowers should be given an opportunity of being heard before classifying their accounts as fraudulent. The matter was presented before the Chief Justice of India DY Chandrachud and Justice Hima Kohli. The bench stated that “The impugned decision to classify the borrower account as fraud is vitiated by the failure to observe the rule of Audi alteram partem.” The Supreme Court also added that the process of forming an informed opinion under the Master Directions on Frauds was administrative in nature. Moreover, in administrative law, it was mandatory to provide for an opportunity of being heard when an administrative action results in civil consequences to a person or entity. 

In addition, the top Court also highlighted that the classification of an account as a fraud not only results in reporting the fact to investigating agencies but also has other penal and civil consequences. The bench added, “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. 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.” The Supreme Court bench also stated that the Master Directions on Frauds do not expressly exclude a right of hearing to the borrowers before action to class their account as fraud is initiated. The principles of natural justice could be read into a statute or a notification where it was silent on granting an opportunity of a hearing to a party whose rights and interests were likely to be affected by the orders that might be passed. Moreover, the mere participation of the borrower during the course of the preparation of a forensic audit report would not fulfill the requirements of natural justice.

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In this case, 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 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 was envisaged by borrowers before classifying their accounts as fraudulent. The High Court of Telangana, held in the impugned judgment that the principles of natural justice must be read into the provisions of the Master Directions on Frauds. The case was then listed for hearing in the top Court that highlighted that “Principles of natural justice demand that the borrowers must be served 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.” The Apex Court observed that “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.”

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