State Bank of India moves Supreme Court seeking clarity on fraud classification judgment

Borrower must be given hearing, SC had ruled

In an application filed at the Supreme Court, the State Bank of India has contended that the implementation of the judgment may forewarn the borrower and hamper future investigations, if not clarified.

AUDI alteram partem” said the Supreme Court, quipping the fundamental principle of natural justice about hearing the other side while ruling that banks must hear a borrower before classifying them as fraudulent, in a judgment on March 27.

Now, multinational public sector bank and financial services statutory body State Bank of India (SBI) has filed an application at the Supreme Court seeking exemption from disclosing the entire material against the borrower at the time of hearing, arguing that it may give an opportunity to the borrower to delay investigation, destroy evidence or abscond from the country.

The SBI has also sought that banks be allowed to decide the timeframe for adjudication, depending on the urgency of a matter. However, its plea does not seek a review of the judgment in State Bank of India & Ors. versus Rajesh Aggarwal & Ors.

A division Bench of the Supreme Court comprising Chief Justice of India Dr D.Y. Chandrachud and Justice Hima Kohli had held that the principle of audi alteram partem demands that borrowers be provided the benefit of a hearing before a bank decides on classification of an account as fraudulent. It was held that the principle be read into the Reserve Bank of India’s (RBI) ‘Master Direction on Frauds’ as the classification of an account as such “entails serious civil consequences for the borrower”.

The court had said that the principles of natural justice dictate that borrowers be served a notice, given an opportunity to explain the conclusions of the audit, and allowed to represent themselves before their account is classified as ‘fraud’ so as to “save them from the vice of arbitrariness”.

The above judgment originated from appeals filed by the RBI and other lender banks against a Telangana High Court judgment delivered in December 2020, whose conclusions on the adherence to principles of natural justice the Supreme Court upheld on March 27.

The RBI ‘Master Directions on Frauds’ is a 2016 framework for classification and reporting of fraudulent activity by scheduled commercial banks and select financial institutions. These directions were issued by the RBI under Section 35A (power of the Reserve Bank to give directions) of the Banking Regulation Act, 1949.

SBI seeks clarity

In its application, the SBI has argued that commercial banks should not be obliged to share the full forensic audit report with a borrower that is under suspicion as it could forewarn the borrower and hamper future investigations. The SBI has urged the Supreme Court to clarify that banks be allowed to share only relevant extracts of the forensic audit report and that this would sufficiently serve the purpose of natural justice, as per Mint.

In addition, the SBI has sought that commercial banks be allowed to decide the timeframe for adjudication, depending on the urgency of a matter, to prevent people under scrutiny from attempting to stall the process.

Through its application, the SBI has not sought a review of the Supreme Court’s judgment, but has sought a clarification, expressing concerns that the judgment may be misconstrued or misapplied, if not clarified by the court.

Classifying fraud

In order to have “uniformity in reporting”, the ‘Master Direction on Frauds’ states that frauds have been classified mainly on the basis of the provisions of the Indian Penal Code (IPC). The following actions are liable to be classified as fraud:

  • Misappropriation and criminal breach of trust.
  • Fraudulent encashment through forged instruments, manipulation of books of account, or through fictitious accounts and conversion of property.
  • Unauthorised credit facilities extended for reward or for illegal gratification.
  • Cash shortages.
  • Cheating and forgery.
  • Fraudulent transactions involving foreign exchange.
  • Any other type of fraud not coming under the specific heads as above.

On the implication of such classification, the Supreme Court had observed that it “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) [(the right to practise any profession, or to carry on any occupation, trade or business)] of the Constitution.”

It remains to be seen whether the Supreme Court will accept the SBI’s request for clarity on its judgment.