Can a Bank Declare Fraud Without Hearing You?

B S Limited ran businesses in power transmission and distribution, passive telecom infrastructure, renewable energy and mineral resources. It borrowed Rs. 1,406 crores from several banks and then failed to repay. The lenders formed a Joint Lenders Forum (JLF) with State Bank of India as lead bank. On 29 August 2016, the JLF declared the company's assets Non-Performing Assets.

The story then took a strange turn. The lenders suggested a forensic audit and a techno-economic viability study at a meeting on 11 July 2016. On the audit's conclusions, the JLF closed the issue, saying there were no irregularities. The viability study, however, found the company ineligible for the S4A restructuring scheme. IDBI Bank red-flagged the account, and insolvency proceedings began. On 15 February 2019, the JLF declared the account fraud, and the Fraud Identification Committee passed a resolution to the same effect on 31 July 2019. The company went to the Telangana High Court.

Other borrowers in this batch of appeals told similar stories.

• An edible-oil manufacturer in Telangana had taken Rs. 675 crores from a consortium led by Andhra Bank, now merged with Union Bank of India. It was declared an NPA on 14 May 2018 and took part in the forensic audit, handing over every document the auditor asked for. In September 2019 it learnt that its account had been declared fraud.
• A Hyderabad hotel promoter, a director of Golden Jubilee Hotels Pvt Ltd, attended a series of JLF meetings and was consulted by the forensic auditor. Bank of Baroda red-flagged the account on 3 May 2019. It was classified as fraud on 14 August 2019, and a complaint went to the CBI. The promoter learnt of the classification only in 2021, when he received a copy of the FIR.
• A director of Vimal Oil & Foods Limited was suspended as Managing Director after insolvency proceedings began on 19 December 2017. He was no longer invited to JLF meetings. He says he learnt of the fraud classification, said to date from 21 February 2018, only when his home was searched under an FIR.

The High Courts did not agree with one another. On 10 December 2020, a Division Bench of the Telangana High Court read the hearing rule into Clauses 8.9.4 and 8.9.5. It told lenders to give borrowers a copy of the forensic audit report and a hearing, including a personal hearing. On 15 April 2021, the Supreme Court partly stayed that order. It directed that the JLF's minutes of 15 February 2019 not be acted upon, and it stayed the personal-hearing observation. Later, other Telangana High Court benches dismissed the oil manufacturer's and the hotel promoter's petitions, in judgments of 22 December 2021 and 31 December 2021, finding adverse audit findings and leaving the hearing question to the Supreme Court. Gujarat's Division Bench let the Vimal Oil director send a representation but refused a personal hearing.

The banks and RBI offered three main excuses.

• They said the directions exist to protect depositors and banks, and that speed matters.
• They said a notice could forewarn borrowers and hamper investigators.
• They said borrowers already took part in the forensic audit, so the hearing requirement was satisfied.

The borrowers answered that the label carries a CBI complaint, a five-year bar on institutional finance, and damage to reputation. They also pointed out that no one tells them the label has been applied.

RBI issued the Master Directions on Frauds on 1 July 2016 under Section 35A of the Banking Regulation Act, 1949. That section lets RBI issue directions that banks must follow. Chapter VIII covers loan frauds. Under Clause 8.9.4, an individual bank can make the first call to classify an account as red-flagged or fraud. Within 15 days of that classification, the bank asks the consortium leader or largest lender to convene a JLF meeting, and that meeting must be convened within 15 days of the request. Under Clause 8.9.5, the forensic audit must finish within three months of the JLF meeting authorising it. The JLF must reconvene within 15 days of the audit's completion to decide the account's status. Clause 8.9.6 caps the whole exercise at six months.

The consequences sit in Clause 8.12. Under Clause 8.12.1, the penal provisions for wilful defaulters apply to fraudulent borrowers, including promoters and whole-time directors. They are debarred from bank finance for five years from the date of full payment of the defrauded amount. Clause 8.12.2 bars restructuring and additional facilities. Clause 8.12.3 allows no compromise settlement unless the conditions say the criminal complaint will continue.

The directions are silent on one point. Clause 8.12.5 expressly says banks must give third parties, such as valuers or chartered accountants, a chance to be heard before reporting them to the Indian Banks' Association. Nothing similar exists for the borrower. The banks argued that this silence meant a borrower's hearing was excluded by implication. The borrowers argued that the silence made the directions arbitrary. The Supreme Court had to decide which reading was right, and whether the borrowers' parity argument with third parties held up.

Audi alteram partem simply means "hear the other side". The Court first drew a line. It accepted that natural justice does not apply when a crime is reported, and that no hearing is needed before an FIR is registered. But it held that classifying an account as fraud is an administrative step with its own consequences, and it noted that the banks themselves accepted the process is administrative. Under Clause 8.12.1, the borrower is virtually frozen out of financial and capital markets. The Court called this debarment akin to blacklisting. It held that such a result needs a prior hearing, and it linked this to Article 19(1)(g) and Article 14 of the Constitution.

The Court then rejected the banks' urgency plea. Clause 8.9.6 gives six months for the whole exercise, which leaves room to serve a notice and take a reply. A hearing would not obstruct prompt action.

The Court closed two loopholes:

• Taking part in the audit is not a hearing. The borrower must be told of the proposed action, be able to explain the evidence, and be allowed to argue why the action should not be taken.
• Silence in the directions is not permission to skip a hearing. Where a rule is silent and a person's rights are at stake, the hearing requirement is read in. The final decision must also be a reasoned order, which may be brief but must show the bank applied its mind.

The Court rejected the borrowers' argument based on Clause 8.12.5. It said borrowers and third parties stand on a different footing: the borrowers are the main perpetrators and face the Clause 8.12.1 and 8.12.2 consequences, while third parties are merely referred to the Indian Banks' Association. It added that this did not change its conclusion that borrowers must be heard.

• Gather the paper trail first. Collect your loan agreements, any red-flag communication, JLF minutes or resolutions, the forensic audit report, the Fraud Identification Committee's resolution, any FIR copy, and every letter from the bank. These show whether you received a notice, the audit findings, and a reasoned order.
• Check what the bank gave you before the decision. The Court expects a notice, a copy of the audit report, a reasonable chance to submit a representation, and a reasoned order replying to your objections. Write down the date you received each one, or note that you never did.
• Know where these disputes went. In this batch, borrowers challenged fraud classifications through writ petitions in the Telangana and Gujarat High Courts. The judgment decided those challenges, so this is the forum route it shows. The Court held that classifications made without a hearing were vitiated, and it left banks free to take fresh steps in accordance with its decision.
• Avoid the mistake the borrowers were told they could not rely on. Do not treat cooperating with the auditor as your defence. The Court held that participation in the audit does not replace a hearing. The judgment sets no filing deadline for challenging a classification, and none is invented here.