The Supreme Court on Monday held that the banks must hear the borrowers before classifying their accounts as fraud. The bench comprising chief justice of India (CJI) DY Chandrachud and justice Hima Kohli said that classifying accounts as fraud results in serious civil consequences for the borrowers, including "blacklisting" of the accounts.
The apex court upheld a judgement passed by the Telangana High Court in December 2020 stating that the principles of "audi alteram partem" must be applied before declaring a party as "a fraudulent borrower" or "a holder of fraudulent account".
"Audi alteram partem" means "hear the other side" or "no man should be unheard, both the parties have an opportunity of being heard".
"Declaration of fraud entails penal and civil consequences, amounts to blacklisting from accessing institutional finance...Bank order must show reasons behind the declaration of fraud, reasons will keep banks from exercising powers arbitrarily," the court said.
A 2016 circular by the Reserve Bank of India (RBI) allowed the banks to declare the willful defaulters as "fraud". The Master Circular on "Frauds – Classification and Reporting" was issued under Section 35 A of the Banking Regulation Act, 1949. It was updated on July 3, 2017.
The SC on Monday said that the declaration was "tantamount to blacklisting of borrowers from accessing institutional finance".
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Along with the RBI, the State Bank of India (SBI) had also cautioned against tweaking the circular to ensure early detection of fraud cases.
The borrowers had argued that the circular violates principles of natural justice and said that it "hurt the ability to raise fresh credit after declaration".