He who shall decide anything without the other side having been heard, although he may have said what is right, will not have been what is right1, is a corollary deduced from the rule of audi alteram partem.
The adherence to principles of natural justice as recognized by all civilized States is of supreme importance when a quasi-judicial body embarks on determining disputes between the parties, or any administrative action involving civil consequences is in issue. These principles are well settled. The first and foremost principle is what is commonly known as audi alteram partem rule. It says that no one should be condemned unheard. Notice is the first limb of this principle. It must be precise and unambiguous. It should appraise the party determinatively the case he has to meet. Time given for the purpose should be adequate so as to enable him to make his representation. In the absence of a notice of the kind and such reasonable opportunity, the order passed becomes wholly vitiated. Thus, it is but essential that a party should be put on notice of the case before any adverse order is passed against him. This is one of the most important principles of natural justice. It is after all an approved rule of fair play.2
On these principles, the Hon'ble Supreme Court of India adjudicated that the procedure for the classification of a borrower as a wilful defaulter3 or the classification of an account as fraudulent4 by a lender / financial institution must adhere to the principles of natural justice. The Apex Court based its conclusion on the legal principles that, firstly, the rule of audi alteram partem applies to administrative actions, apart from judicial and quasi-judicial functions. It is a settled position in administrative law that it is mandatory to provide an opportunity to be heard to a person or entity when an administrative action is taken which results in civil consequences. Secondly, classifying a borrower as a wilful defaulter or classifying an account as fraud by a lender ensues penal and civil consequences5 for the borrower. It has the effect of debarring a borrower from accessing institutional finance. The bar from raising finances could be fatal for a borrower, leading to civil death and the infraction of their fundamental rights under Article 19(1)(g) of the Constitution6. Additionally, it is imperative to mention that the Supreme Court has clarified that the proceedings conducted for the classification of a borrower as a wilful defaulter or classification of the account as fraud are deemed to be in-house proceedings, and therefore, the borrower does not have the right to be represented by a lawyer for the purpose of these proceedings.
The judgement created a ripple effect, marshalling the Reserve Bank of India ("RBI") to issue revised guidelines for governing the classification of a borrower as a wilful defaulter7 or classification of an account as fraudulent8 by a lender / financial institution. The revised procedures are discussed herein briefly:
1. Identification and Classification of Wilful Defaulters:
- Identification Committee: The Lender shall form an identification committee responsible for identifying borrowers who have defaulted and for taking and examining evidence of wilful default.
- Show Cause Notice: If the identification committee is satisfied that an event of wilful default has occurred, it shall issue a show-cause notice to such borrower9 along with all materials and information on which the show-cause notice is based. The lender shall give at least twenty-one (21)days from the date of issuance of the show cause notice to the borrower to make a submission against the notice.
- Review Committee: The lender shall also form a review committee and where the identification committee is satisfied that the borrower has committed wilful default, it shall inform the review committee of its proposal to classify the borrower as a wilful defaulter and explain the reasons inwriting. The review committee shall inform the borrower of the proposal to classify them as wilful defaulters and provide the reasons. It shall give the borrower fifteen (15) days to make a written representation to the review committee. The review committee shall consider the proposal of the identification committee along with the written representation received from the borrower. After assessing the facts or material on record, the review committee shall consider the proposal of the identification committee and make a decision. The review committee shall allow the borrower a personal hearing if required. The review committee shall pass a reasoned order, which shall be communicated to the borrower by the lender.
2. Classification of a borrower account as fraudulent:
- Show Cause Notice: The lender must issue a show cause notice to the borrower against whom the allegation of fraud is being examined. The show cause notice must contain complete details of transactions/actions/events on which the lender is contemplating declaration and reporting of a fraud.
- The borrower shall be given at least twenty-one (21) days to respond to the show cause notice. Based on the examination of the response submitted to the borrower, the lender/ financial institution shall declare a borrower as fraudulent. The lender shall serve a reasoned order to the borrower for declaration/classification of the account as fraud or otherwise.
The RBI has reinforced its role as a guardian of the financial sector, fostering an environment of public trust in the financial industry by releasing the revised guidelines. In upholding the principles of transparency, the RBI has yet again set an example for financial institutions by recognizing and mandating principles of natural justice. While many have criticized the RBI for overbalance and excessive protectionism, it is a welcome change in the interest of the public.
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Footnotes
1. Latin : Qui aliquid statuerit parte inaudita alteram actquam licet dixerit, haud acquum facerit
2. Uma Nath Pandey and Ors Vs. State of U.P. and Anr. [2009 (4) ALL LJ 515]
3. State Bank of India vs. M/s Jah Developers Pvt. Ltd. & Ors [2019 (6) SCC 787]
4. State Bank of India & Ors. Vs Rajesh Agarwal & Ors [2023 SCC OnLine SC 342]
5. Borrowers who are classified as wilful defaulters or whose accounts are classified as fraudulent, are debarred from raising of funds and / or seeking additional credit facilities from financial entities regulated by RBI, for a period of five years from the date of full repayment of the defrauded amount / settlement amount agreed upon in case of a compromise settlement or five years after the name of wilful defaulter has been removed from the List of Wilful Defaulter by the lender. Additionally, a lender may initiate criminal proceedings against the borrower under relevant provisions of law.
6. State Bank of India & Ors. Vs Rajesh Agarwal & Ors.
7. Master Direction on Treatment of Wilful Defaulters and Large Defaulters dated July 30th, 2024.
8. Master Directions on Fraud Risk Management in Regulated Entities dated July 15, 2024
9. Borrower shall include, where applicable, a guarantor and where the borrower is an entity, it shall also include the promoter, director or any persons who are in charge and responsible for the management of the affairs of the entity.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
