TaxTMI 
TaxTMI 
2023 (3) TMI 1205
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........................................................................................................ 15 D.2 Audi Alteram Partem ....................................................................................................... 25 D.3 No implied exclusion of audi alteram partem ................................................................... 39 D.4 Challenge to constitutional validity .................................................................................. 48 E. Conclusion .............................................................................................................. 57 A. Background 1. 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. "Master Directions on Frauds" Issued by the Reserve Bank of India "RBI", these directions were challenged before different High Courts primarily on the ground that no opportunity of being heard is envisaged to borrowers before classifying their accounts as fraudulent. The High Court of Telangana has held in the impugned judgment Writ Petition No. 19102 of 2019 that the principles of natural ....
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....ttee "FIC" passed a resolution on 31 July 2019 identifying the company's account as fraud. The company filed a writ petition challenging both the decision of the JLF dated 15 February 2019 and the resolution of the FIC dated 31 July 2019 before the High Court of Telangana. 5. By a judgment dated 10 December 2020, a Division Bench of the High Court allowed the writ petition by holding that the principle of audi alteram partem ought to be read into Clauses 8.9.4 and 8.9.5 of the Master Directions on Frauds. The High Court further directed the lender banks: (i) to give an opportunity of a hearing to the borrowers after furnishing a copy of the forensic audit report; and (ii) to provide an opportunity of a personal hearing to the borrower before classifying their account as fraud. The judgment of the High Court was challenged in SLP (C) No. 3931 of 2021. On 15 April 2021, this Court, while issuing notice, partially stayed the directions issued by the Telangana High Court in the following terms: "Meanwhile, the Minutes/Order dated 15.02.2019 passed by the Joint Lenders Meeting is not to be acted upon. The High Court insofar as it observed that a personal hearing be given is ....
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....tion of the audit report. Bank of Baroda red-flagged the appellant's account on 03 May 2019 based on the observations in the forensic audit report. The appellant's account was classified as fraud on 14 August 2019. A criminal complaint was also lodged with the CBI. The appellant came to know about the classification of their account as fraud in 2021, when they received a copy of the FIR. The appellant filed a writ petition before the High Court of Telangana challenging the validity of the Master Directions on Frauds. The High Court by its judgment dated 31 December 2021 held that no relief could be granted to the appellant on the issue of personal hearing since SLP (C) No. 3931 of 2021 was pending before this Court. The High Court also held that the appellant's account was rightly classified as fraudulent in view of the adverse findings in the forensic audit report. IV. Writ Petition (C) No. 138 of 2022 and SLP (C) No. 3388 of 2022 9. The appellant is one of the directors of a company called M/s Vimal Oil & Foods Limited. The said company availed of loan facilities from various financial institutions over a period of time. In 2015, the auditor of the respondent bank flagged c....
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....2 of the Master Directions on Frauds are also applicable to the promoters, directors, and other whole-time directors. Once a bank account is classified as fraudulent, it carries significant consequences according to the Master Directions on Frauds such as filing of a complaint with the CBI and debarment of the promoters and directors from accessing institutional finance. Further, the action of the banks of classifying an account as 'fraud' is stigmatic, akin to blacklisting the borrower, which affects their right to reputation. Thus, there is a direct impact on the fundamental rights of the individuals concerned, as a consequence of the classification of an account as fraud. c. The Master Directions on Frauds are violative of Articles 14, 19, and 21 of the Constitution of India as they debar a company and its promoters and directors from accessing financial and credit markets for a period of five years without even providing a show cause notice or opportunity of being heard. d. There are other facets to the principle of audi alteram partem apart from a personal hearing. The Master Directions on Frauds does not stand good on other facets of audi alteram partem such....
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....lent on the ground of a violation of the principles of natural justice is devoid of merit for the following reasons: a. The Master Directions on Frauds were necessitated to protect the interests of depositors and banks from the growing instances of frauds. RBI is duly empowered to take pre-emptive measures in public interest to ensure that fraudulent borrowers are brought to justice and loss caused to the banks is mitigated. The clauses of the Master Directions on Frauds, therefore, must be interpreted in light of their purpose and objective, that is, timely detection and dissemination of information and reporting about the fraud. b. The provisions of the Master Directions on Frauds must be construed keeping in mind the following thresholds: (i) justness; (ii) fairness towards the parties aggrieved; (iii) reasonability; and (iv) proportionality between the mischief and the corrective measure. Considering that the Master Directions on Frauds is an economic policy decision, this Court must exercise greater latitude while construing its provisions. c. The procedure for classifying an account as fraud under the Master Directions on Frauds is not arbitrary. Th....
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....d giving directions. 13. Section 35A of the BR Act empowers RBI to issue directions to banking companies. Such directions are statutory in nature. Section 35A is extracted below: "35A. Power of the Reserve Bank to give directions - (1) Where the Reserve Bank is satisfied that - (a) in the public interest; or (aa) in the interest of banking policy; or (b) to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company; or (c) to secure the proper management of any banking company generally, it is necessary to issue directions to banking companies generally or to any banking company in particular, it may, from time to time, issue such directions as it deems fit, and the banking companies or the banking company, as the case may be, shall be bound to comply with such directions. (2) The Reserve Bank may, on representation made to it or on its own motion, modify or cancel any direction issued under sub-section (1), and in so modifying or cancelling any direction may impose such conditions as it think....
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....an Penal Code, 1860: "Clause 2.2.1 In order to have uniformity in reporting, frauds have been classified as under, based mainly on the provisions of the Indian Penal Code: a. Misappropriation and criminal breach of trust b. Fraudulent encashment through forged instruments, manipulation of books of account or through fictitious accounts and conversion of property. c. Unauthorised credit facilities extended for reward or for illegal gratification d. Cash shortages. e. Cheating and forgery f. Fraudulent transactions involving foreign exchange g. Any other type of fraud not coming under the specific heads as above." 17. Clause 3 advises banks to make full use of the Central Fraud Registry "CFR" (a database created by RBI to enable banks to share information on fraudulent accounts) for timely identification, control, reporting, and mitigation of risks associated with fraud. Clause 3.3 of the said directions emphasizes the need to provide timely information on frauds and penalizes banks for non-adherence to timelines: "3.3.1 Banks should ensure that the reporting system is suitably streamlines so that del....
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.... the loan life-cycle are expected to compress the total time taken by a bank to identify a fraud and aid more effective action by the law enforcement agencies. The early detection of Fraud and the necessary corrective action are important to reduce the quantum of loss which the continuance of the Fraud may entail." 20. Clause 8.3 deals with Early Warning Signals "EWS" and Red Flagged Accounts. "RFA" Under Clause 8.3.1, a RFA is one where a suspicion of fraudulent activity is thrown up by the presence of one or more EWS. EWS which should alert bank officials about wrongdoings in a loan account are set out in Annexure II. Some of those enumerated are set out below: i. a. Default in undisputed payment to statutory bodies as declared in the annual report; b. Dishonour of high value cheques; ii. Delay in payment of outstanding dues; iii. Funds coming from other banks to liquidate the outstanding loan amount except in the normal course; iv. Exclusive collateral charged to a number of lenders without NOCs of existing charge holders; v. Dispute on title to collateral securities; and vi. Critical issues in the stock audit rep....
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....d as fraud; else based on the majority rule of agreement amongst bank with at least 60% share in the total lending, the account should be red flagged by all the banks and subjected to a forensic audit commissioned or initiated by the consortium leader or the largest lender under MBA. All banks, as part of the consortium of multiple-banking arrangement, shall share the costs and provide the necessary support for such an investigation. 8.9.5 The forensic audit must be completed within a maximum period of three months from the date of the JLF meeting authorizing the audit. Within 15 days of the completion of the forensic audit, the JLF shall reconvene and decide on the status of the account, either by consensus or the majority rule as specified above. In case the decision is to classify the account as a fraud, the RFA status shall be changed to Fraud in all banks and reported to RBI and on the CRILC platform within a week of the said decision. Besides, within 30 days of the RBI reporting, the bank commissioning/ initiating the forensic audit should lodge a complaint with the CBI on behalf of all banks in the consortium/MBA. For this purpose, if the bank initiating the forensi....
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....esult in loss of documents, unavailability of witnesses, absconding borrowers, loss of money trail and asset tripping by fraudulent borrowers. 27. The penal measures for fraudulent borrowers are set out in Clause 8.12 which reads as follows: 8.12 Penal measures for fraudulent borrowers 8.12.1 In general, the penal provisions as applicable to wilful defaulters would apply to the fraudulent borrowers including the promoter director(s) and other whole time directors of the company insofar as raising of funds from the banking system or from capital markets by companies with which they are associated is concerned, etc. In particular, borrowers who have defaulted and have also committed a fraud in the account would be debarred from availing bank finance from Scheduled Commercial Banks, Development Financial Institutions, Government owned NBFCs, Investment Institutions, etc., for a period of five years from the date of full payment of the defrauded amount. After this period, it is for individual institutions to take a call on whether to lend to such a borrower. The penal provisions would apply to non-whole time directors (like nominee directors and independent directo....
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....ions to decide whether to lend to fraudulent borrowers, including directors and promoters of the borrowing company. Additionally, under Clause 8.12.2, fraudulent borrowers are denied restructuring or grant of additional facilities by banks and other such financial institutions. D.2 Audi Alteram Partem 29. We need to bear in mind that the principles of natural justice are not mere legal formalities. They constitute substantive obligations that need to be followed by decision-making and adjudicating authorities. The principles of natural justice act as a guarantee against arbitrary action, both in terms of procedure and substance, by judicial, quasi-judicial, and administrative authorities. Two fundamental principles of natural justice are entrenched in Indian jurisprudence: (i) nemo judex in causa sua, which means that no person should be a judge in their own cause; and (ii) audi alteram partem, which means that a person affected by administrative, judicial or quasi-judicial action must be heard before a decision is taken. The courts generally favor interpretation of a statutory provision consistent with the principles of natural justice because it is presumed that the statuto....
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....ed principle of law that the rule of audi alteram partem applies to administrative actions, apart from judicial and quasi-judicial functions. A K Kraipak v. Union of India, (1969) 2 SCC 262; Governing Body, St Anthony's College, Shillong and Ors v. Rev. Fr. Paul Petta of Shillong, (1988) Supp SCC 676; Uma Nath Pandey and Ors v. State of Uttar Pradesh, (2009) 12 SCC 40 It is also a settled position in administrative law that it is mandatory to provide for an opportunity of being heard when an administrative action results in civil consequences to a person or entity. 33. In State of Orissa v. Dr (Miss) Binapani Dei AIR 1967 SC 1269, a two-judge bench of this Court held that every authority which has the power to take punitive or damaging action has a duty to give a reasonable opportunity to be heard. This Court further held that an administrative action which involves civil consequences must be made consistent with the rules of natural justice: "9. [...] The rule that a party to whose prejudice an order is intended to be passed is entitled to a hearing applies alike to judicial tribunals and bodies of persons invested with authority to adjudicate upon matters involving ci....
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....ust depend to a great extent on the fact and circumstances of that case, the framework of the statute under which the enquiry is held. The old distinction between a judicial act and an administrative act has withered away. Even an administrative order which involves civil consequences must be consistent with the rules of natural justice. The expression "civil consequences" encompasses infraction of not merely property or personal rights but of civil liberties, material deprivations and non-pecuniary damages. In its wide umbrella comes everything that affects a citizen in his civil life. (emphasis supplied) There is a consistent pattern of judicial thought that civil consequences entail infractions not merely of property or personal rights, but also of civil liberties, material deprivations, and non-pecuniary damages. Every order or proceeding which involves civil consequences or adversely affects a citizen should be in accordance with the principles of natural justice. 37. The next question that requires our consideration is whether the classification of a borrower's account as fraudulent under the Master Directions on Frauds entails civil consequences to borrowers. ....
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....tinued (clause 8.12.3) The above consequences show that the classification of a borrower's account as fraud under the Master Directions on Frauds has difficult civil consequences for the borrower. The classification of an account as fraud not only results in reporting the fact to investigating agencies, but has other penal and civil consequences as specified in Clauses 8.12.1 and 8.12.3. The borrowers have placed reliance on Jah Developers (supra) to submit that debarring them from accessing institutional finance under Clause 8.12.1 of the Master Directions affects the fundamental right of the borrower to carry on business. On the other hand, the RBI and lender banks have argued that reliance on the observations in Jah Developers (supra) is misplaced because the decision dealt with the classification of a borrower as wilful defaulter, whereas the present batch of appeals deal with the classification of a borrower's account as fraud. 41. The question in Jah Developers (supra) was whether a person who is declared to be a wilful defaulter according to the procedure laid down in the Master Circular on Wilful Defaulters is entitled to be represented by a lawyer of their choice bef....
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....te. This is for the reason that no additional facilities can be granted by any bank/financial institutions, and entrepreneurs/promoters would be barred from institutional finance for five years. Banks/financial institutions can even change the management of the wilful defaulter, and a promoter/director of a wilful defaulter cannot be made promoter or director of any other borrower company. Equally, under Section 29-A of the Insolvency and Bankruptcy Code, 2016, a wilful defaulter cannot even apply to be a resolution applicant. Given these drastic consequences, it is clear that the Revised Circular, being in public interest, must be construed reasonably. (emphasis supplied) In Jah Developers (supra), this Court construed the Master Circular on Wilful Defaulters by harmonizing it with the principles of natural justice. Particularly, it was directed that: (i) the First Committee must give its order to the borrower as soon as possible; (ii) the Borrower, thereafter, can file a written representation against the order of First Committee to the Review Committee; and (iii) the Review Committee must pass a reasoned order which must be provided to the borrower. 42. Classifica....
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.... banks from dealing with unscrupulous borrowers in public interest. Debarring a borrower under Clause 8.12.1 of the Master Directions on Frauds is akin to blacklisting the borrower for being untrustworthy and unworthy of credit by the banks. This Court has consistently held that an opportunity of a hearing ought to be provided before a person is put on a blacklist. 44. In Erusian Equipment & Chemicals Ltd v. State of West Bengal (1975) 1 SCC 70, the issue before this Court was whether a person is entitled to a notice to be heard before being blacklisted by the government. This Court held that since blacklisting affects the privileges of the blacklisted person, fundamentals of fair play require that such a person be provided an opportunity of being heard: "20. Blacklisting has the effect of preventing a person from the privilege and advantage of entering into lawful relationship with the Government for purposes of gains. The fact that a disability is created by the order of blacklisting indicates that the relevant authority is to have an objective satisfaction. Fundamentals of fair play require that the person concerned should be given an opportunity to represent his cas....
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....gainst whom action of blacklisting is sought to be taken has a valid and solid rationale behind it. With blacklisting, many civil and/or evil consequences follow. It is described as "civil death" of a person who is foisted with the order of blacklisting. Such an order is stigmatic in nature and debars such a person from participating in government tenders which means precluding him from the award of government contracts. (emphasis supplied) 48. Classification of a borrower's account as fraud has the effect of preventing the borrower from accessing institutional finance for the purpose of business. It also entails significant civil consequences as it jeopardizes the future of the business of the borrower. Therefore, the principles of natural justice necessitate giving an opportunity of a hearing before debarring the borrower from accessing institutional finance under Clause 8.12.1 of the Master Directions on Frauds. The action of classifying an account as fraud not only affects the business and goodwill of the borrower, but also the right to reputation. 49. In State of Maharashtra v. Public Concern for Governance Trust (2007) 3 SCC 587, a two-judge bench of this Court....
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....the right to be heard. The objective of the Master Directions on Frauds is to ensure timely detection and reporting of cases of fraud to alert other banks and initiate criminal proceedings. The Directions contemplate an opportunity of hearing to a third party who is involved in the commission of fraudulent activity, but do not explicitly provide for hearing to a borrower. Thus, it is urged that hearing to the borrowers is excluded by necessary implication. 53. The Master Directions on Frauds do not expressly exclude a right of hearing to the borrowers before action to class their account as frauds is initiated. The principles of natural justice can be read into a statute 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. 54. In a decision of a three-judge bench of this Court in Swadeshi Cotton Mills v. Union of India (1981) 1 SCC 664, the issue was whether the Central government was required to comply with the requirements of audi alteram partem before it took over the management of an industrial undertaking under Section 18-AA(1)(a) of the Industries (D....
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....son - which is more or less a facet of the first - for holding that the mere use of the word "immediate" in the phrase "immediate action is necessary", does not necessarily and absolutely exclude the prior application of the audi alteram partem rule, is that immediacy or urgency requiring swift action is a situational fact having a direct nexus with the likelihood of adverse effect on fall in production. And, such likelihood and the urgency of action to prevent it, may vary greatly in degree. The words "likely to affect. . .production" used in Section 18-AA(1)(a) are flexible enough to comprehend a wide spectrum of situations ranging from the one where the likelihood of the happening of the apprehended event is imminent to that where it may be reasonably anticipated to happen sometime in the near future. Cases of extreme urgency where action under Section 18-AA(1)(a) to prevent fall in production and consequent injury to public interest, brooks absolutely no delay, would be rare. In most cases, where the urgency is not so extreme, it is practicable to adjust and strike a balance between the competing claims of hurry and hearing." (emphasis supplied) Sarkaria, J observed....
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..... [...] (emphasis supplied) 57. As a counter to the above legal position, the RBI and lender banks have contended that the principles of natural justice could be excluded in cases where there is a requirement of promptitude or exigent action. In support of the submission, the RBI and banks have relied upon Ajit Kumar Nag v. General Manager (PJ), Indian Oil Corp. Ltd (2005) 7 SCC 764, which in turn relied on the Constitution Bench decision of this Court in Union of India v. Tulsiram Patel. (1985) 3 SCC 398 In Tulsiram Patel (supra), this Court observed that a right to a prior notice and an opportunity to be heard could be excluded if allowing for such a right would obstruct the taking of prompt action: 101. [...] So far as the audi alteram partem rule is concerned, both in England and in India, it is well established that where a right to a prior notice and an opportunity to be heard before an order is passed would obstruct the taking of prompt action, such a right can be excluded. This right can also be excluded where the nature of the action to be taken, its object and purpose and the scheme of the relevant statutory provisions warrant its exclusion; nor can t....
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....e, Clause 8.9.6 of the Master Directions on Frauds contemplates that the procedure for the classification of an account as fraud has to be completed within six months. The procedure adopted under the Master Directions on Frauds provides enough time to the banks to deliberate before classifying an account as fraud. During this interval, the banks can serve a notice to the borrowers, and give them an opportunity to submit their reply and representation regarding the findings of the forensic audit report. Given the wide time frames contemplated under the Master Directions on Frauds as well as the nature of the procedure adopted, it is reasonably practicable for banks to provide an adequate opportunity of a hearing to the borrowers before classifying their account as fraud. The exclusion contemplated in the decision of this Court in Tulsiram Patel (supra) would not be applicable because giving an opportunity of a hearing to the borrowers will not obstruct the taking of prompt action under the Master Directions on Frauds. 61. The RBI and lender banks have further submitted that the requirement of natural justice is already fulfilled under the Master Directions on Frauds as the borrow....
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.... 85. The contention does not appear to be well founded. Firstly, this documentary evidence, at best, shows that the Company was in debt and the assets of some of its "units" had been hypothecated or mortgaged as security for those debts. Given an opportunity the Company might have explained that as a result of this indebtedness there was no likelihood of fall in production, which is one of the essential conditions in regard to which the Government must be satisfied before taking action under Section 18A-A(1)(a). Secondly, what the rule of natural justice required in the circumstances of this case, was not only that the Company should have been given an opportunity to explain the evidence against it, but also an opportunity to be informed of the proposed action of take over and to represent why it be not taken. (emphasis supplied) 64. Audi alteram partem has several facets, including the service of a notice to any person against whom a prejudicial order may be passed and providing an opportunity to explain the evidence collected. In Tulsiram Patel (supra), this Court explained the wide amplitude of audi alteram partem: 96. The rule of natural justice with whic....
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....d and unbridled powers on banks. To counter the submission, the RBI and lender banks have relied upon the decision in Delhi Cloth Mills & General Mills v. Union of India (1983) 4 SCC 166 to submit that the provisions of the Master Directions on Frauds are not arbitrary as they have a reasonable nexus to the object sought to be achieved. It was further argued that the Courts should not interfere with and supplant their wisdom in an economic policy decision unless there is blatant perversity, arbitrariness, or mala fides. 67. The RBI has the right to take all such measures as are necessary to protect the health of the banking system. Hence, the Master Directions on Frauds lay down the procedure for banks, who in case of a breach of loan agreements by borrowers, can seek appropriate remedies by approaching law enforcement agencies and debarring borrowers from accessing further institutional finance. However, any policy decision which contemplates serious civil consequences for any person will be open to challenge for being arbitrary if the principles of natural justice are not applied during the process. 68. In E P Royappa v. State of Tamil Nadu (1974) 4 SCC 3, this Court held t....
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.... Article 12, is charged with the duty of deciding a matter. In such a case, the principles of natural justice require that it must decide such matter fairly and impartially." (emphasis supplied) 70. In Cantonment Board v. Taramani Devi 1992 Supp (2) SCC 501, a two-judge bench of this Court held that the rule of audi alteram partem is a part of Article 14. Similarly, in Delhi Transport Corporation v. DTC Mazdoor Congress 1991 Supp (1) SCC 600, this Court observed that the rule of audi alteram partem enforces the equality clause in Article 14. Therefore, any administrative action which violates the rule of audi alteram partem is arbitrary and violative of Article 14. 71. Administrative proceedings which entail significant civil consequences must be read consistent with the principles of natural justice to meet the requirement of Article 14. Where possible, the rule of audi alteram partem ought to be read into a statutory rule to render it compliant with the principles of equality and non-arbitrariness envisaged under Article 14. The Master Directions on Frauds do not expressly provide the borrowers an opportunity of being heard before classifying the borrower's account....
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....e in accordance with any of the principles of natural justice or not depends upon the express words of the provision conferring the power, the nature of the power conferred, the purpose for which it is conferred and the effect of the exercise of that power. (emphasis supplied) 74. In C B Gautam v. Union of India (1993) 1 SCC 78, the question before a Constitution Bench of this Court was whether a show cause notice must be issued to an intending purchaser and seller of property before making a compulsory purchase under Section 269-UD(1) of Chapter XX-C of the Income Tax Act, 1961. Chief Justice M H Kania speaking for the Constitution Bench held that where the validity of a provision would be open to serious challenge for want of an opportunity of being heard, Courts have read such a requirement into the provision. In C B Gautam (supra), this Court read the principles of natural justice into the provisions of Chapter XX-C to save them from the vice of arbitrariness. The Constitution Bench held: 30. [...] Again, there is no express provision in Chapter XX-C barring the giving of a show-cause notice or reasonable opportunity to show cause nor is there anything in t....
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.... 30. Having considered the issue, framed in para 16, on the touchstone of the aforenoted legal principles in regard to the applicability of the principles of natural justice, we are of the opinion that keeping in view the nature, scope and consequences of direction under sub-rule (7) of Rule 633 of the Excise Manual, the principles of natural justice demand that a show-cause notice should be issued and an opportunity of hearing should be afforded to the person concerned before an order under the said Rule is made, notwithstanding the fact that the said Rule does not contain any express provision for the affected party being given an opportunity of being heard. [...] 32. In our view, therefore, if the requirement of an opportunity to show cause is not read into the said Rule, an action thereunder would be open to challenge as violative of Article 14 of the Constitution of India on the ground that the power conferred on the competent authority under the provision is arbitrary. (emphasis supplied) 77. It has been elucidated in the preceding paragraphs that the classification of a borrower's account as fraud in accordance with the procedure laid down in th....
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.... our aforesaid reasoning, we hold that the decision by the lender banks to classify the borrower accounts as fraud, is violative of the principles of natural justice. The banks would be at liberty to take fresh steps in accordance with this decision. 80. Lastly, the borrowers have argued that the Master Directions on Frauds suffer from manifest arbitrariness because they stipulate an opportunity of a hearing to third parties, while denying the same to borrowers, who face significant civil consequences. Clause 8.12.5 of the Master Directions on Frauds provides that banks have to satisfy themselves of the involvement of third parties and provide them with an opportunity of being heard before reporting them to Indian Banks' Association. We are unable to accept this argument of the borrowers in light of the fact that the borrowers and the third parties stand on a different footing because: (i) the borrowers are the main perpetrators of fraud, while the third parties are merely facilitators; and (ii) it is the borrowers who face the significant civil consequences stipulated under clauses 8.12.1 and 8.12.2, while the third party service providers are merely referred to the Indian Bank....