Right to be heard before fraud classification

Fraud Classification: Right to be heard

Recently Supreme Court (SC)  upheld the decision of the Telengana High Court that the borrower must be given an opportunity and heard before declaring his account as fraud. Normally there is a time difference between 'fraud occurrence' and 'fraud detection'. Since internal sanctions and legal formalities take their own time for completion, there is again a gap of six months at least  before filing a complaint with the law enforcement agencies, after a fraud is detected. So naturally, bankers of yesteryears and those operating to-day are concerned, as any delay in action against unscrupulous borrowers by the investigative agencies impact, to a greater degree, the recovery aspects. Assets becoming non-available, borrowers vanishing from the scene, money trail getting cold for effective tracking are usually witnessed in cases of frauds. Delay in reporting to the regulator also delays the alerting of other FIs, which might be dealing with the same borrower, involved in the fraud. As an ex-banker, equally interested in knowing the implications, I read the operative part of the judgement and the relevant circulars issued by the regulator. My understanding and views are as under:

SC held that while there is no need for a bank to provide an opportunity to a borrower before filling of a complaint/ lodging an FIR with law enforcing agencies, the borrower must be heard prior to imposing penal provisions affecting his civil rights like raising of funds from the banking system or from the capital markets. The Court also held that the borrower must be served a notice, explained the conclusions of the forensic audit report and be allowed to represent his views, before a final decision is taken to classify his accounts as fraud. 

Throughout the operative part of the judgement, SC repeatedly referred to Clauses 8.9.4, 8.9.5 and 8.12.1 of the Master Direction on Frauds issued by Reserve Bank of India (RBI) on 1st July 2016 (and updated as on July 3, 2017). 

• Clause 8.9.4 empowers JLF (Joint Lender's Forum), based on the inputs from an individual bank, to red flag all the accounts of the borrowers with all the banks  and subject them to a forensic audit or declare them as fraud straight away.  
• Clause 8.9.5 empowers the JLF to decide by a 60% majority (in aggregate lending), based on the findings of the forensic report, to change the red flagged status as 'fraud'  in all the banks’ accounts, lodge a complaint with CBI and report the matter in CRILC platform and RBI.
• Clause 8.12.1 refers to the penal provisions that may be imposed on the borrower by placing restrictions on raising funds from the entire banking system/capital markets for a specific period, even after full payment of the defrauded amount.

Impact of the judgement:

1. Providing an opportunity to be heard: After reading the judgement, I felt that while SC is in agreement with the argument that the lender bank, being an injured party in the case of fraudulent accounts, has the right to report the crime to the law enforcement agencies, without giving an opportunity to the borrower concerned, it did not favour the penal actions imposed in respect of other accounts of the borrower with other banks, without being heard. In this regard, the penal provisions imposed on the borrower including the promoter and whole time directors like barring them from raising of funds from the banks/capital markets, etc. are similar to those applicable for 'wilful' defaulters, defined under Master Circular on Wilful defaulters issued by RBI on 01.07.2015. The Master circular on 'wilful defaulter' says 'issue of show cause notice' to the borrower, as to why his default be not construed as 'wilful' is mandatory. The banker may also consider, at his option, to give an opportunity of 'personal hearing' to the borrower. However the Master Direction on Frauds, which made similar penal provisions as applicable for wilful defaulters, is silent on the opportunity to be provided to the borrower for being heard/represent.  SC held that since penal provisions are administrative in nature, it is mandatory to provide an opportunity to the borrower for being heard, especially when the administrative action results in difficult consequences to the borrower concerned.

2. Providing a copy of the forensic audit report: SC also held 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 before the banks/ JLF prior to classifying their accounts as fraud under the Master Directions on Frauds. Newspapers have reported that SBI has filed a petition before SC seeking exemption from sharing the entire report and to share only the relevant extracts.

My views: Since the bank, which is aggrieved due to loss on account of fraud perpetrated, is permitted to prefer a complaint/ lodge a FIR , without providing an opportunity of hearing to the 'fraudster', suitable guidelines can be drafted detailing the standard operating procedure to be followed, prior to imposing penal actions in respect of his other accounts with other banks. There are 'transparent' frauds to the 'naked eye' like availing loans against 'fake' gold ornaments/ properties, availing multiple loans on the same property, crediting the loan proceeds to personal accounts/group accounts/round tripping, etc. The guidelines should narrate instances, where an opportunity shall be made available to the borrower before declaring his account as fraud and impose restrictions on raising funds from the banks/market. After the draft guidelines are prepared by IBA (Indian Banks Association) in consultation with its member banks, non-member banks and the regulator, RBI should file a review petition before SC seeking clarity on application of the judgement on 'fraud classification' and the regulator's intention to issue revised guidelines, which take care of the rights of the borrower in instances to be specified. This (application of the judgement) is necessary as otherwise, multiple suits may be filed for obtaining a stay in the courts even in respect of frauds, which are straight forward and transparent for initiating criminal legal action with the relevant enforcing agencies,  on the plea that the borrower was not given the right to be heard before declaring the account as fraud.

Regards

V. Viswanathan

27th April 2023.