# STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS

- **Citation:** [2023] 7 S.C.R. 476
- **Court:** Supreme Court of India
- **Decided:** 2023-03-27
- **Case number:** Civil Appeal No. 7300 of 2022
- **Bench:** Dr. Dhananjaya Y Chandrachud, Hima Kohli
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/state-bank-of-india-ors-v-rajesh-agarwal-ors-37484
- **Pages:** 54

## Headnote

Reserve Bank of India Act, 1934 - Banking Regulation Act,
1949 - Reserve Bank of India (Frauds Classification and Reporting
by Commercial Banks and Select FIs) Directions 2016 - Master
Directions on Frauds - Principle of Natural Justice - Rule of Audi
Alteram Partem - 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 - 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 - Whether
the principles of natural justice should be read into the provisions
of the Master Directions on Frauds - Held : The principles of natural
justice demand that the borrowers must be served a notice, given
an opportunity to explain the conclusions of the forensic audit
report, and be allowed to represent by the banks/ JLF before their
account is classified as fraud under the Master Directions on Frauds
- In addition, the decision classifying the borrower's account as
fraudulent must be made by a reasoned order; and 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.
Reserve Bank of India Act, 1934 - Banking Regulation Act,
1949 - Reserve Bank of India (Frauds Classification and Reporting
by Commercial Banks and Select FIs) Directions 2016 - Principle
of Natural Justice - Civil consequences to borrowers - Whether
the classification of a borrower's account as fraudulent under the
Master Directions on Frauds entails civil consequences to
borrowers - Held: Clause 8.12 of the Master Directions on Frauds
A
B
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D
E
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477
deals with the penal measures for borrowers - Clause 8.12.1
provides that penal provisions as applicable to wilful defaulters
would apply to fraudulent borrowers, including the promoters and
directors of the borrower company - In addition, borrowers are
also liable to suffer the following consequences under the Master
Directions on Frauds : a) No restructuring may be made in the case
of an RFA or fraud accounts (clause 8.12.2); b) No compromise on
settlement involving a fraudulent borrower is allowed unless the
conditions stipulate that the criminal complaint will be continued
(clause 8.12.3) - The classification of a borrower's account as fraud
under the Master Directions on Frauds has difficult civil
consequences for the borrower - 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 - The bar from
raising finances could be fatal for the borrower leading to its 'civil
death' in addition to the infraction of their rights under Article
19(1)(g) of the Constitution - 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.
Reserve Bank of India Act, 1934 - Banking Regulation Act,
1949 - Reserve Bank of India (Frauds Classification and Reporting
by Commercial Banks and Select FIs) Directions 2016 - No implied
exclusion of audi alteram partem - The RBI and the lender banks
have contended that the Master Directions on Frauds impliedly
exclude the right to be heard - Held: 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 intere

## Text

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SUPREME COURT REPORTS
[2023] 7 S.C.R.
[2023] 7 S.C.R. 476
476
STATE BANK OF INDIA & ORS
v.
RAJESH AGARWAL & ORS
(Civil Appeal No. 7300 of 2022)
MARCH 27, 2023
[DR. DHANANJAYA Y CHANDRACHUD, CJI AND
HIMA KOHLI, J.]
Reserve Bank of India Act, 1934 - Banking Regulation Act,
1949 - Reserve Bank of India (Frauds Classification and Reporting
by Commercial Banks and Select FIs) Directions 2016 - Master
Directions on Frauds - Principle of Natural Justice - Rule of Audi
Alteram Partem - 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 - 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 - Whether
the principles of natural justice should be read into the provisions
of the Master Directions on Frauds - Held : The principles of natural
justice demand that the borrowers must be served a notice, given
an opportunity to explain the conclusions of the forensic audit
report, and be allowed to represent by the banks/ JLF before their
account is classified as fraud under the Master Directions on Frauds
- In addition, the decision classifying the borrower's account as
fraudulent must be made by a reasoned order; and 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.
Reserve Bank of India Act, 1934 - Banking Regulation Act,
1949 - Reserve Bank of India (Frauds Classification and Reporting
by Commercial Banks and Select FIs) Directions 2016 - Principle
of Natural Justice - Civil consequences to borrowers - Whether
the classification of a borrower's account as fraudulent under the
Master Directions on Frauds entails civil consequences to
borrowers - Held: Clause 8.12 of the Master Directions on Frauds
A
B
C
D
E
F
G
H
477
deals with the penal measures for borrowers - Clause 8.12.1
provides that penal provisions as applicable to wilful defaulters
would apply to fraudulent borrowers, including the promoters and
directors of the borrower company - In addition, borrowers are
also liable to suffer the following consequences under the Master
Directions on Frauds : a) No restructuring may be made in the case
of an RFA or fraud accounts (clause 8.12.2); b) No compromise on
settlement involving a fraudulent borrower is allowed unless the
conditions stipulate that the criminal complaint will be continued
(clause 8.12.3) - The classification of a borrower's account as fraud
under the Master Directions on Frauds has difficult civil
consequences for the borrower - 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 - The bar from
raising finances could be fatal for the borrower leading to its 'civil
death' in addition to the infraction of their rights under Article
19(1)(g) of the Constitution - 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.
Reserve Bank of India Act, 1934 - Banking Regulation Act,
1949 - Reserve Bank of India (Frauds Classification and Reporting
by Commercial Banks and Select FIs) Directions 2016 - No implied
exclusion of audi alteram partem - The RBI and the lender banks
have contended that the Master Directions on Frauds impliedly
exclude the right to be heard - Held: 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.
Principles/Doctrines - Principles of natural justice - 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,
STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS
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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 statutory authorities do not intend to
contravene fundamental rights.
Disposing of the appeals, the Court
HELD: Audi Alteram Partem
1. 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 statutory authorities do not intend to
contravene fundamental rights. Application of the said principles
depends on the facts and circumstances of the case, express
language and basic scheme of the statute under which the
administrative power is exercised, the nature and purpose for
which the power is conferred, and the final effect of the exercise
of that power. [Para 29][502-E-G]
2. Chapter VIII of the Master Directions on Fraud provides
detailed procedures to be followed by the banks before forming
an opinion to proceed with a criminal complaint against the
borrowers. Under the said chapter, the lender banks have to
report a borrower to the CBI after classifying the borrower's
account as fraudulent. However, the classification of the
borrower's account does not simpliciter lead to reporting of
criminal complaint with the enforcement authorities; it also entails
penal consequences for the borrowers as laid down under Clause
8.12. The process of forming an informed opinion under the
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Master Directions on Frauds is administrative in nature. This
has also been acceded to by RBI and lender banks in their written
submissions. It is now a settled principle of law that the rule of
audi alteram partem applies to administrative actions, apart from
judicial and quasi-judicial functions. 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. [Paras 31, 32][503-DG]
3. The RBI and lender banks have argued that the civil
consequences contemplated in Clause 8.12.1 of the Master
Directions on Frauds are reasonable. Under the said clause, the
borrower, including the promoters and directors of the company,
are barred from availing credit from financial markets and credit
markets for a period of five years, and possibly even beyond.
According to RBI and lender banks, such a restriction has to be
perceived from the perspective of public interest. While
acknowledging that the procedure which has been laid down in
the Master Directions on Frauds is conceived in public interest,
to protect the banking system, it cannot be ignore the serious
civil consequences which emanate to the borrowers. [Para
38][505-G; 506-A-B]
4. 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. The bar from raising
finances could be fatal for the borrower leading to its 'civil death'
in addition to the infraction of their rights under Article 19(1)(g)
of the Constitution. 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. Indeed, debarment
is akin to blacklisting a borrower from availing credit. [Para
42][509-A-C]
No implied exclusion of audi alteram partem
5. The Master Directions on Frauds do not expressly
exclude a right of hearing to the borrowers before action to class
STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS
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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.
[Para 53][513-E]
6. Audi alteram partem, therefore, entails that an entity
against whom evidence is collected must: (i) be provided an
opportunity to explain the evidence against it; (ii) be informed of
the proposed action, and (iii) be allowed to represent why the
proposed action should not be taken. Hence, the mere
participation of the borrower during the course of the preparation
of a forensic audit report would not fulfil the requirements of
natural justice. The decision to classify an account as fraud
involves due application of mind to the facts and law by the lender
banks. The lender banks, either individually or through a JLF,
have to decide whether a borrower has breached the terms and
conditions of a loan agreement, and based upon such determination
the lender banks can seek appropriate remedies. Therefore,
principles of natural justice demand that the borrowers must be
served a 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. [Para
65][520-F-H]
7. The conclusions are summarized as follows: i. No
opportunity of being heard is required before an FIR is lodged
and registered; ii. Classification of an account as fraud not only
results in reporting the crime to investigating agencies, but also
has other penal and civil consequences against the borrowers;
iii. Debarring the borrowers from accessing institutional finance
under Clause 8.12.1 of the Master Directions on Frauds results
in serious civil consequences for the borrower; iv. Such a
debarment under Clause 8.12.1 of the Master Directions on
Frauds is akin to blacklisting the borrowers for being
untrustworthy and unworthy of credit by banks. This Court has
consistently held that an opportunity of hearing ought to be
provided before a person is blacklisted; v. The application of audi
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alteram partem cannot be impliedly excluded under the Master
Directions on Frauds. In view of the time frame contemplated
under the Master Directions on Frauds as well as the nature of
the procedure adopted, it is reasonably practicable for the lender
banks to provide an opportunity of a hearing to the borrowers
before classifying their account as fraud; vi. The principles of
natural justice demand that the borrowers must be served a
notice, given an opportunity to explain the conclusions of the
forensic audit report, and be allowed to represent by the banks/
JLF before their account is classified as fraud under the Master
Directions on Frauds. In addition, the decision classifying the
borrower's account as fraudulent must be made by a reasoned
order; and vii. 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. [Para 81][528-A-H]
Maneka Gandhi v. Union of India (1978) 1 SCC 248 :
[1978] 2 SCR 621; Union of India v. Tulsiram Patel
(1985) 3 SCC 398 : [1985] 2 Suppl. SCR 131; Olga
Tellis v. Bombay Municipal Corporation (1985) 3 SCC
545 : [1985] 2 Suppl. SCR 51; C B Gautam v. Union of
India (1993) 1 SCC 78 : [1992] 3 Suppl. SCR 12 -
followed.
State of Orissa v. Dr (Miss) Binapani Dei AIR 1967 SC
1269 : [1967] SCR 625; Canara Bank v. V K Awasthy
(2005) 6 SCC 321 : [2005] 3 SCR 81; Erusian
Equipment & Chemicals Ltd v. State of West Bengal
(1975) 1 SCC 70 : [1975] 2 SCR 674; Joseph
Vilangandan v. Executive Engineer (1978) 3 SCC 36 :
[1978] 3 SCR 514; Raghunath Thakur v. State of Bihar
(1989) 1 SCC 229 : [1988] 3 Suppl. SCR 867; Gorkha
Security Services v. Govt (NCT of Delhi) (2014) 9 SCC
105: [2014] 13 SCR 617; State of Maharashtra v. Public
Concern for Governance Trust (2007) 3 SCC 587 :
[2007] 1 SCR 87; Swadeshi Cotton Mills v. Union of
STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS
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B
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SUPREME COURT REPORTS
[2023] 7 S.C.R.
India (1981) 1 SCC 664 : [1981] 2 SCR 533; Mangilal
v. State of Madhya Pradesh (2004) 2 SCC 447 : [2004]
1 SCR 1; K I Shephard v. Union of India (1987) 4 SCC
431 : [1988] 1 SCR 188; Union of India v. Col. J N
Sinha (1970) 2 SCC 458 : [1971] 1 SCR 791; Kesar
Enterprises Ltd v. State of Uttar Pradesh (2011) 13 SCC
733 : [2011] 9 SCR 19 - relied on.
State Bank of India v. Jah Developers (2019) 6 SCC
787: [2019] 7 SCR 701; Union of India v. Col. J N
Sinha (1970) 2 SCC 458 : [1971] 1 SCR 791; Anju
Chaudhary v. State of UP (2013) 6 SCC 384 : [2012]
13 SCR 901; A K Kraipak v. Union of India (1969) 2
SCC 262 : [1970] 1 SCR 457; Governing Body, St
Anthony's College, Shillong and Ors v. Rev. Fr. Paul
Petta of Shillong (1988) Supp SCC 676 : [1988] Suppl.
SCR 507; Uma Nath Pandey and Ors v. State of Uttar
Pradesh (2009) 12 SCC 40 : [2009] 4 SCR 374;
Mohinder Singh Gill v. Chief Election Commissioner,
New Delhi (1978) 1 SCC 405 : [1978] 2 SCR 272; D K
Yadav v. J M A Industries (1993) 3 SCC 259 : [1993] 3
SCR 930; Peerless General Finance and Investment
Co. Ltd v. Reserve Bank of India (1992) 2 SCC 343 :
[1992] 1 SCR 406; Joseph Kuruvilla Vellukunnel v.
Reserve Bank of India AIR 1962 SC 1371 : [1962]
Suppl. SCR 632; Internet and Mobile Association of
India v. Reserve Bank of India (2020) 10 SCC 274 :
[2020] 2 SCR 297; Ajit Kumar Nag v. General Manager
(PJ), Indian Oil Corp. Ltd. (2005) 7 SCC 764 : [2005]
3 Suppl. SCR 314; Keshav Mills Co. Ltd. v. Union of
India (1973) 1 SCC 380 : [1973] 3 SCR 22; Delhi Cloth
Mills & General Mills v. Union of India (1983) 4 SCC
166 : [1983] 3 SCR 438; E P Royappa v. State of Tamil
Nadu (1974) 4 SCC 3 : [1974] 2 SCR 348; State of AP
v. McDowell (1996) 3 SCC 709 : [1996] 3 SCR 721;
Om Kumar v. Union of India (2001) 2 SCC 386 : [2000]
4 Suppl. SCR 693; Chairman and Managing Director,
United Commercial Bank v. P C Kakkar (2003) 4 SCC
364 : [2003] 1 SCR 1034; Cantonment Board v.
Taramani Devi 1992 Supp (2) SCC 501; Delhi Transport
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Corporation v. DTC Mazdoor Congress 1991 Supp (1)
SCC 600 : [1990] 1 Suppl. SCR 142; Sahara India
(Firm), Lucknow v. Commissioner of Income Tax,
Central-I (2008) 14 SCC 151 : [2008] 6 SCR 427;
Kranti Associates (P) Ltd. v. Masood Ahmed Khan
(2010) 9 SCC 496 : [2010] 10 SCR 1070 - referred
to.
Black's Law Dictionary, 5th edn (1979); P Ramanatha
Aiyar, 'The Law Lexicon : The Encyclopedic Law
Dictionary' (1997 edn) - referred to.
Case Law Reference
[2019] 7 SCR 701
referred to
Para 10
[1971] 1 SCR 791
relied on
Para 29
[2012] 13 SCR 901
referred to
Para 30
[1970] 1 SCR 457
referred to
Para 32
[1988] Suppl. SCR 507
referred to
Para 32
[2009] 4 SCR 374
referred to
Para 32
[1967] SCR 625
relied on
Para 33
[1978] 2 SCR 621
followed
Para 34
[1978] 2 SCR 272
referred to
Para 35
[1993] 3 SCR 930
referred to
Para 35
[2005] 3 SCR 81
relied on
Para 36
[1975] 2 SCR 674
relied on
Para 44
[1978] 3 SCR 514
relied on
Para 45
[1988] 3 Suppl. SCR 867
relied on
Para 46
[2014] 13 SCR 617
relied on
Para 47
[2007] 1 SCR 87
relied on
Para 49
[1992] 1 SCR 406
referred to
Para 50
[1962] Suppl. SCR 632
referred to
Para 50
[2020] 2 SCR 297
referred to
Para 50
STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS
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[2023] 7 S.C.R.
[1981] 2 SCR 533
relied on
Para 54
[2004] 1 SCR 1
relied on
Para 56
[2005] 3 Suppl. SCR 314
referred to
Para 57
[1985] 2 Suppl. SCR 131
followed
Para 57
[1988] 1 SCR 188
relied on
Para 59
[1973] 3 SCR 22
referred to
Para 62
[1983] 3 SCR 438
referred to
Para 66
[1974] 2 SCR 348
referred to
Para 68
[1996] 3 SCR 721
referred to
Para 68
[2000] 4 Suppl. SCR 693
referred to
Para 68
[2003] 1 SCR 1034
referred to
Para 68
1992 Supp (2) SCC 501
referred to
Para 70
[1990] 1 Suppl. SCR 142
referred to
Para 70
[1985] 2 Suppl. SCR 51
followed
Para 72
[1971] 1 SCR 791
referred to
Para 73
[1992] 3 Suppl. SCR 12
followed
Para 74
[2008] 6 SCR 427
referred to
Para 75
[2011] 9 SCR 19
relied on
Para 76
[2010] 10 SCR 1070
referred to
Para 78
CIVIL APPELLATE/ORIGINAL JURISDICTION: Civil Appeal
No. 7300 of 2022.
From the Judgment and Order dated 10.12.2020 of the High Court
for the State of Telangana at Hyderabad in WP No. 19102 of 2019.
With
Civil Appeal Nos. 7301, 7302, 7303, 7304, 7305, 7306, 7307 of
2022 and Writ Petition no. 138 of 2022.
Tushar Mehta, SG, Gopal Jain, Ranjit Kumar, Dhruv Mehta, Dr.
Abhishek Manu Singhvi, Navin Pahwa, Arunabh Chowdhury, Gopal Jain,
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Sr. Advs., Sanjay Kapur, Ms. Megha Karnwal, Arjun Bhatia, Ms. Akshata
Joshi, Ms. Shubhra Kapur, Ms. Pragya Baghel, Ramesh Babu M.R.,
Ms. Manisha Singh, Ms. Nisha Sharma, Ms. Jagrati Bharti, Mahesh
Agarwal, Sumesh Dhawan, Rishi Agrawala, Vastala Kak, Himanshu
Satija, Pranjit Bhattacharya, Kailashnath, V. Murali Manohar, Nishant
Rao, E.C. Agrawala, Suraj Prakash, Mrinal Litoriya, Ms. Priyanka
Solanki, Ms. Nidhi Mohan Parashar, Ravi Pahwa, Ms. Monisha Handa,
Rajul Shrivastav, Mohit D. Ram, Anubhav Sharma, Kanu Agrawal, Ms.
Neela Kedar Gokhale, Ms. Akanksha Kaul, Ms. Praveena Gautam,
Arvind Kumar Sharma, M.K. Maroria, Mayank Pandey, Annam
Venkatesh, Ms. Sairica Raju, Ms. Swati Ghildiyal, Jasmeet Singh,
Mahinder Singh Hura, Saif Ali, Divjot Singh Bhatia, Pushpendra Singh
Bhadoriya, Ms. Rusheet Saluja, Ms. Mandeep Kaur, Siddharth Handa,
Karma Dorjee, Dechen W. Lachungpa, Anirudh M. Sethi, Siddharth
Seem, Sourabh Tandon, Ms. Richa Kapoor, Kunal Anand, Ms. Shivani
Sharma, Ms. Jyoti Zongluju, M/s. Coac, Ms. Suvarna Kashyup, Pankaj
Vivek, Krishan Kumar, Nitin Pal, Swikirtimala Dubey, Anand Shankar
Jha, Arpit Gupta, Ms. Meenakshi S. Devgan, Girish Bhardwaj, Abhilekh
Tiwari, Alok Kumar, G.N. Reddy, Manan Gambhir, Ms. Garima Soni,
Ms. Neetu Rahi, Rohil Pandit, A. Radhakrishnan, Ms. Astha Deep, Ms.
Ruma Sarasani, PBA Srinivasan, Parth Tandon, Ms. Prerana Sabharwal,
Ms. Srishti Bansal, Parth Kumar, V. Aravind, Amit K. Nain, Brijesh
Kumar Tamber, Yashu Rustagi, Advs. for the appearing parties.
The Judgment of the Court was delivered by
DR. DHANANJAYA Y CHANDRACHUD, CJI
A.
Background .................................................................4*
B.
Facts .............................................................................5*
C.
Submissions ................................................................10*
D.
Analysis ......................................................................15*
D.1
Regulatory Framework ...........................................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*
STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS
*Ed. Note: Pagination is as per the original judgment.
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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 2016.1 Issued by the Reserve Bank of India2,
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 heldin the impugned judgment3 that the principles of natural
justice must be read into the provisions of the Master Directions on
Frauds. The decision has been assailed by the RBI and lender banks
through these civil appeals.
2. In this background the court has to consider whether the
principles of natural justice should be read into the provisions of the
Master Directions on Frauds. For the reasons to follow, we hold that the
principles of natural justice, particularly the rule of audi alteram partem,
has to be necessarily read into the Master Directions on Frauds to save
it from the vice of arbitrariness. Since the classification of an account as
fraud entails serious civil consequences for the borrower, the directions
must be construed reasonably by reading into them the requirement of
observing the principles of natural justice.
B. Facts
I. SLP (C) No. 3931 of 2021; SLP (C) No. 4922 of 2021;
SLP (C) No. 5056 of 2021
3. B S Limited is a company engaged in the business of power
transmission and distribution, passive telecom infrastructure, renewable
energy, and mineral resources. It availed loans amounting to Rs. 1406
crores from various banks. The company failed to meet its payment
obligations to lender banks, thereby defaulting in repayment of credit
facilities. In accordance with the Master Directions on Frauds, all the
lender banks formed a Joint Lenders Forum4 with State Bank of India
as the lead bank.
4. The JLF declared the company's assets as Non-Performing
Assets5 on 29 August 2016. The lender banks decided to adopt the
1 "Master Directions on Frauds"
2 "RBI"
3 Writ Petition No. 19102 of 2019
4 "JLF"
5 "NPA"
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Sustainable Structuring of Stressed Assets Scheme6 and suggested a
forensic audit report and Techno Economic Viability7 study in its meeting
held on 11 July 2016. Based on the conclusions of the forensic audit
report, the JLF closed the issue stating that there were no irregularities.
However, based on the TEV study it was concluded that the company
was not eligible for the S4A scheme and requested it to submit an
alternative plan for regularization of its account. In the meanwhile, IDBI
Bank - one of the lender banks - red-flagged the account of the company.
Additionally, proceedings under the Insolvency and Bankruptcy Code,
2016 were also initiated against the company. On 15 February 2019, the
JLF declared the account of the company as fraud by invoking Clause
2.2.1(g) of the Master Directions on Frauds. Subsequently, the Fraud
Identification Committee8 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 auditreport; 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 stayed."
II. SLP (C) No. 762 of 2022; SLP (C) No. 873 of 2022; and
SLP (C) No. 1514 of 2022
6. The appellant is a company involved in the manufacture of
edible oils, fats, rice and semolina products in the State of Telangana.
6 "S4A Scheme"
7 "TEV"
8 "FIC"
STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS
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From 2003 to 2015, the appellant availed of credit facilities to the tune of
Rs. 675 crores from a consortium of banks led by the Andhra Bank
(now merged with the Union Bank of India). The appellant was declared
as an NPA on 14 May 2018 with effect from 31 March 2018. Thereafter,
the consortium of lenders in a meeting of the JLF decided to conduct a
forensic audit of the appellant for the period till 31 March 2019. The
appellant participated in the audit process and submitted all the information
required by the auditor from time to time. In September 2019, the appellant
learnt that its account has been declared as fraud by the Union Bank of
India (erstwhile Andhra Bank). Aggrieved by that classification, the
appellant filed a writ petition before the High Court of Telangana. The
High Court declined to deal with the issues pertaining to the principles of
natural justice and fair play considering the fact that they were pending
before this Court in SLP (C) No. 3931 of 2021. By its judgment dated 22
December 2021, the High court dismissed the writ petitions. The court
held that the appellant's account was rightly classified as fraud because
the forensic audit report contained adverse findings against the appellant.
7. On 24 January 2022, this Court, while issuing notice in SLP(C)
No. 762 of 2022, directed that the matter may not be reported to the
Central Bureau of Investigation9 for the time being. On 28 March 2022,
this Court passed a similar ad-interim order in SLP(C) No. 873 of 2022
and SLP(C) No. 1514 of 2022.
III. SLP (C) No. 2980 of 2022
8. The appellant is a promoter and director of Golden Jubilee Hotels
Pvt Ltd.10 GJHPL availed financial assistance from the respondent banks
for the construction and development of a hotel in Hyderabad. GJHPL's
account was declared as NPA from 31 December 2015 because of its
inability to service its debts to the respondent banks. At its meeting on 21
April 2016, the JLF decided to carry out a special audit of the appellant's
company. Thereafter, the appellant participated in a series of meetings
between the JLF and was consulted by the forensic auditor during the
preparation 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,
9 "CBI"
10 "GJHPL"
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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 certain irregularities in the accounts
of the company. Based on a special audit, the respondent bank declared
the account of the company as NPA on 30 September 2015. Thereafter,
on 05 July 2016, the company's account was red-flagged by the
respondent bank. In the meantime, the Corporate Insolvency Resolution
Process11 was initiated against the company on 19 December 2017 and
the appellant was suspended as Managing Director of the company.
Upon suspension, the appellant was not invited to attend the meetings of
the JLF. The appellant allegedly learnt that the respondent bank had
classified their account as fraud on 21 February 2018 though without
any intimation. Further, based on a letter addressed by the respondent
bank to the CBI, an FIR came to be registered against the appellant.
The appellant alleges that they acquired knowledge about their account
being classified as fraud and registration of the FIR only when a search
was carried out at their residential premises in pursuance of the FIR.
The appellant filed a Special Civil Application challenging the actions of
the respondent bank, which was dismissed by the Single Judge of the
High Court of Gujarat. The Division Bench partly allowed a Letters
Patent Appeal by its judgment dated 23 December 2021 by permitting
the appellant to address a representation tothe respondent bank but
declined to allowa personal hearing. The appellant/ petitioner has also
invoked the writ jurisdiction of this Court by challenging the validity of
the Master Directions on Frauds.
11 "CIRP"
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C. Submissions
10. On behalf of the borrowers, we have heard Dr Abhishek Manu
Singhvi, Mr Ranjit Kumar, Mr Dhruv Mehta, Mr Arunabh Chowdhury,
Mr Navin Pahwa, Senior Advocates and Mr Suraj Prakash, learned
counsel. The counsel submit that the procedure for classification of an
account as fraud under the Master Directions on Frauds suffers from
illegalities because:
a.
Under Clauses 8.9.4 and 8.9.5 of the Master Directions on
Frauds, no notice is given to the borrowing company or its
promoters, and directors including whole-time directors.
They are not given an opportunity to present a defense and
even a copy of the final decision is not provided to them.
b.
The classification of the borrower's bank accounts as fraud
under the Master Directions on Frauds carries serious civil
consequences. The penal provisions under Clause 8.12 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 as notice of allegations levelled
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and evidence collected,notice of the penalty proposed,
among others. According to the procedure laid down under
the Master Directions on Frauds, a company or its promoters
and directors are not even informed that they have been
classified as fraud and that a penalty has been imposed
upon them.
e.
The Master Directions on Frauds are silent on whether or
not the borrower is entitled to an opportunity of being heard
after the receipt of forensic audit report and before deciding
whether the borrower's account should be classified as
fraud. Since the decision to classify the account as fraud
entails significant civil consequences, principles of natural
justice ought to be read into the Master Directions on Frauds.
f.
Clause 8.12.5 of the Master Directions on Frauds expressly
stipulates that an opportunity of hearing be provided to third
parties. The directionsare manifestly arbitrary since on the
one hand they provide an opportunity of hearing to third
parties, but such an opportunity is denied to borrowers.
g.
Although the purpose and object of the Master Directions
on Frauds is speedy detection and reporting of fraud to law
enforcement agencies, such exigencies cannot be a valid
ground to exclude the applicability of the principles of natural
justice.
h.
The decision of this Court in State Bank of India v. Jah
Developers12 read in the requirement of natural justice
for the purposes of declaring a borrower as a willful
defaulter. The principles laid down in Jah Developers
(supra) would be squarely applicable to the present matters.
i.
The participation of the borrower during the preparation of
the forensic audit report does not in itself fulfil the
requirement of the principles of natural justice under the
Master Directions on Frauds. Those directions do not
expressly provide for the participation or inputs from a
borrower during the preparation of the forensic audit report,
giving rise to the possibility that in some cases, the borrower
is completely excluded from the forensic audit process.
12 (2019) 6 SCC 787
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[DR. DHANANJAYA Y CHANDRACHUD, CJI]
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11. On behalf of the RBI and lender banks, we have heard Mr
Tushar Mehta, Solicitor General of India, Mr Gopal Jain, Senior Counsel
and Mr Ramesh Babu M R and Mr G N Reddy, learned counsel. Counsel
submitted that the challenge to the classification of a loan account as
fraudulent 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 economicpolicy 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. The
classification is done only for reporting the matter to law
enforcement agencies. The banks already have in place a
structured organizational setup to identify and investigate
fraudulent activities in bank accounts. Banks file complaints
before law enforcement agencies, who conduct an
investigation. The ultimate decision on fraud is rendered by
a competent court of law.
d.
Principles of natural justice are not applicable at the stage
of setting the process of criminal law in motion. Since the
lender bank is an injured party in case of fraudulent accounts,
it has the right to report the crime to the law enforcement
agencies without giving an opportunity of being heard to
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the fraudulent borrower. Issuing of a show cause notice to
fraudulent borrowers may forewarn them and hamper the
investigation by law enforcement agencies.
e.
Debarring fraudulent borrowers from availing bank finances
is a preventive measure without which the Master Directions
on Frauds will be rendered toothless. Such a measure is
necessary to prevent a fraudulent borrower from
committing frauds in other banks.
f.
The requirement of notice or prior hearing could be excluded
if it impedes the taking of prompt action. Further, it is not an
inviolable rule that personal hearing ought to be given in all
cases.
g.
The process for classification of a borrower as a willful
defaulter under the Master Circular on Willful Defaulters13
significantly differs from the process of classification of an
account as fraud under the Master Directions on Frauds.
Therefore, the decision of this Court in Jah Developers
(supra) will not be applicable to the facts of the present
appeal.
D. Analysis
D.1 Regulatory Framework
12. RBI is a statutory body constituted under Section 3 of the
Reserve Bank of India Act, 1934. The RBI has been constituted for the
purpose of taking over the management of currency from the Central
Government, regulating the issue of bank notes, keeping of reserves
with a view to securing monetary stability, and operating the currency
and credit system of India.RBI is entrusted with the statutory obligation
of administering the provisions of the Banking Regulation Act, 194914.
The BR Act vests RBI with various powers with respect to banking
companies such as granting licenses, conducting inspections and 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:
13 Master Circular on Wilful Defaulters, 2015
14 "BR Act"
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"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 subsection (1), and in so modifying or cancelling any direction may
impose such conditions as it thinks fit, subject to which
modifications or cancellation shall have effect."
14. RBI has been issuing 'master directions' on diverse issues
since 2016. These directions encompass the instructions on that particular
subject. The master directions are updated whenever there is a change
in policy, and such changes get reflected on RBI's website.