Bank Cannot Classify Borrower Account as Fraud Without Show Cause Notice or Hearing

Delhi HC quashed a bank's fraud classification of a borrower's account, finding the action arbitrary and unreasonable. The court held that no show cause notice was issued to the petitioner, no hearing was provided, and he was not informed of his classification or uploading to RBI's Central Fraud Registry. Citing SC precedent in State Bank of India v. Rajesh Agarwal, the court ruled that principles of natural justice must be followed when implementing RBI's Master Directions on Fraud, as such classifications severely impact borrowers' future business prospects and access to institutional finance.

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Issues Involved:

1. Invocation of writ jurisdiction under Articles 226 and 227 regarding the respondent bank's classification of the petitioner's account as 'fraud'.
2. Alleged violation of principles of natural justice in the classification process.
3. Examination of forensic audit findings and their implications.
4. Application of principles from the Supreme Court judgment in State Bank of India v. Rajesh Aggarwal concerning classification as 'fraud'.

Detailed Analysis:

1. Invocation of Writ Jurisdiction:

The petitioner sought relief under Articles 226 and 227 of the Constitution of India, challenging the respondent bank's decision to classify his account as 'fraud'. The petitioner argued that this action was arbitrary, unfair, and unreasonable, and sought a writ of mandamus or certiorari to quash the impugned action.

2. Alleged Violation of Principles of Natural Justice:

The petitioner contended that the respondent bank's actions violated principles of natural justice. He claimed that he was not issued a Show Cause Notice (SCN) regarding his classification as 'fraud', nor was he informed about the uploading of his name on the Central Fraud Registry. The petitioner emphasized that no relevant documents, such as the forensic audit report, were provided, and he was not afforded a hearing or informed of the bank's decision dated 20.06.2019.

3. Examination of Forensic Audit Findings:

The respondent bank's counter-affidavit highlighted findings from a forensic audit conducted by M/s. Haribhakti & Company. The audit revealed that MBSL, the company in question, allegedly diverted funds, made irrational investments, and engaged in transactions without proper documentation. These findings led to the classification of both MBIL and MBSL as 'fraud' and were reported to the RBI. The petitioner, however, disputed these findings and argued that the forensic audit's conclusions were reached without his involvement or opportunity to respond.

4. Application of Supreme Court Judgment in State Bank of India v. Rajesh Aggarwal:

The judgment extensively referenced the Supreme Court's decision in State Bank of India v. Rajesh Aggarwal, which emphasized the necessity of adhering to principles of natural justice when classifying accounts as 'fraud'. The Supreme Court held that such classification has severe civil consequences, akin to blacklisting, and necessitates providing the borrower an opportunity to be heard. The judgment underscored that the principles of audi alteram partem (the right to be heard) must be read into the RBI's Master Directions on Frauds to prevent arbitrariness.

Conclusion:

The High Court concluded that the respondent bank failed to adhere to the principles of natural justice before classifying the petitioner's account as 'fraud'. The court found that no SCN was issued, no hearing was provided, and the petitioner was not informed of the decision or given access to relevant documents. Consequently, the writ petition was allowed, and the impugned order dated 20.06.2019, classifying the petitioner as 'fraud', was quashed. The court directed the respondent bank to remove the petitioner's name from the Central Fraud Registry within 15 days, and the petition was disposed of with each party bearing their own costs.

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