Banks must provide forensic audit reports and hearing opportunity before declaring borrower accounts fraudulent

Gujarat HC quashed banks' decision declaring company account as fraud for violating natural justice principles. Banks failed to provide forensic audit reports to borrower or opportunity for representation before classification. Court relied on SC precedent in State Bank of India v. Rajesh Agarwal requiring lenders to furnish audit reports and allow reasonable opportunity for borrower response before fraud classification. Matter remitted to banks to complete proceedings after providing reports and hearing borrower's representation. Petition partly allowed.

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Issues Involved:
1. Declaration of the company's account as fraud by respondent banks.
2. Adherence to principles of natural justice, particularly the rule of audi alteram partem.

Summary:

Issue 1: Declaration of the Company's Account as Fraud
The petitioners, promoters, suspended directors, and shareholders of the company, challenged the decision of respondent banks taken in the Joint Lenders Meeting on 29.09.2020, declaring the account of M/s Syntex Industries Limited as fraud. The company was under the Corporate Insolvency Resolution Process (CIRP) as per the Insolvency and Bankruptcy Code, 2016. The decision was based on forensic audit reports dated 11.08.2020 and 18.09.2020, indicating breaches such as misfeasance, embezzlement, and siphoning off funds. The petitioners contended that the forensic audit reports were not provided to them, violating the principles of natural justice.

Issue 2: Adherence to Principles of Natural Justice
The petitioners argued that they were not given an opportunity to respond to the forensic audit reports, which is a mandate under the principles of natural justice as reinforced by the Supreme Court in State Bank of India and Others v. Rajesh Agarwal and Others (2023) 6 SCC 1. The Supreme Court held that the rule of audi alteram partem must be read into the Master Directions on Frauds to prevent arbitrariness. The lender banks must provide borrowers with audit reports and a reasonable opportunity to submit a representation before classifying accounts as fraud.

Judgment:
The High Court found that the respondent banks did not observe the principles of natural justice, particularly the rule of audi alteram partem, as the forensic audit reports were not provided to the petitioners. Consequently, the decision to declare the company's account as fraud was quashed and set aside. The matter was remitted to the respondent banks to furnish the forensic audit reports to the petitioners and allow them a reasonable opportunity to submit a representation. The banks were directed to complete this process and pass a reasoned order within six months, in conformity with the principles laid down by the Supreme Court. The court did not express any opinion on related criminal proceedings. The petition was partly allowed with no order as to costs.

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