Borrowers Must Be Heard Before Their Account Is Classified As Fraud By A Bank: Supreme Court
By Ashish Aggarwal, Jaisal Baath

Reserve Bank of India is constituted under Section 3 of the Reserve Bank of India Act, 1934 (“RBI Act”). RBI has been vested with the powers to issue directions to banking companies in India under Section 35A of the RBI Act, in interest of public, banking policy or to ensure that banking company is properly managed and to ensure that affairs of Banking Companies are not conducted in a manner determinantal to interest of depositors and banking companies.

RBI, since June 2009, has been issuing circulars, updates, etc., on classification of accounts as fraud, reporting, and monitoring. The said circulars vest wide powers in the Banking Companies to classify an account as fraud which classification entails serious civil and criminal consequences on the borrowers. There had been numerous litigations initiated by the borrowers where Banking Companies had classified their accounts as Fraud without giving an opportunity to the borrowers to present their defence.

The principle of audi alteram partem, which means “hear the other side” in Latin, is an important legal principle that ensures fairness and justice in legal proceedings. This principle mandates that no person should be condemned unheard or denied an opportunity to present their case before a decision is made that affects their rights, interests or property.

In a landmark judgment, the Hon’ble Supreme Court of India, in “State Bank of India vs Rajesh Agarwal and Ors.” in Civil Appeal No. 7300 of 2022 has held that the principles of natural justice will have to be followed by banks before the account of the borrowers are labelled as fraud and that the principle of audi alteram partem will have to be followed by the banks.

In Indian law, the principle of audi alteram partem is of utmost importance, and is a fundamental principle of natural justice. This principle is enshrined in Article 14 and Article 21 of the Indian Constitution, which guarantees the right to equality, and the right to life and personal liberty, respectively.


The Civil Appeals arise out of a challenge to the Reserve Bank of India (Frauds Classification and Reporting by Commercial Banks and Select FIs) Directions, 2016 (hereinafter “Master Directions on Fraud”). The said Master Directions on Fraud were challenged before various High Courts of the country on the ground that the Master Directions on Fraud gives no opportunity to the borrowers facing action, of being heard before their accounts are declared as fraudulent.

The numerous Special Leave Petitions (hereinafter “SLPs”) presented substantially identical factual circumstances and therefore, the Hon’ble Supreme Court, clubbed the SLPs.



The Hon’ble Court, after considering Chapter VIII of the Master Directions on Frauds which provides for the procedures to be followed by banks before forming an opinion to proceed with a criminal complaint against the borrowers held as under:

“26. Clause 8.11 deals with the filing of complaints to law enforcement agencies. Clause 8.11.1 requires banks to lodge complaints with law enforcement agencies immediately on detecting fraud. The clause enjoins banks to avoid delay in filing a complaint as it may result in loss of documents, unavailability of witnesses, absconding borrowers, loss of money trail and asset tripping by fraudulent borrowers. 

    1. It also entails significant civil consequences as it jeopardizes the future of the business of the borrower. Therefore, the principles of natural justice necessitate giving an opportunity of a hearing before debarring the borrower from accessing institutional finance under Clause 8.12.1 of the Master Directions on Frauds. The action of classifying an account as fraud not only affects the business and goodwill of the borrower, but also the right to reputation.”

The Hon’ble Supreme Court as such, clearly held that any decision of the banking company to classify any account as fraud leads to not only criminal consequences but also significant civil consequences.


The Hon’ble Supreme Court on this aspect held as follows:

“29. …. The principles of natural justice act as a guarantee against arbitrary action, both in terms of procedure and substance, by judicial, quasi-judicial, and administrative authorities. Two fundamental principles of natural justice are entrenched in Indian jurisprudence: (i) nemo judex in causa sua, which means that no person should be a judge in their own cause; and (ii) audi alteram partem, which means that a person affected by administrative, judicial or quasi-judicial action must be heard before a decision is taken. The courts generally favor interpretation of a statutory provision consistent with the principles of natural justice because it is presumed that the statutory authorities do not intend to contravene fundamental rights. Application of the said principles depends on the facts and circumstances of the case, express language and basic scheme of the statute under which the administrative power is exercised, the nature and purpose for which the power is conferred, and the final effect of the exercise of that power.

    1. … There is a consistent pattern of judicial thought that civil consequences entail infractions not merely of property or personal rights, but also of civil liberties, material deprivations, and non-pecuniary damages. Every order or proceeding which involves civil consequences or adversely affects a citizen should be in accordance with the principles of natural justice.”

One of the contentions raised by the Appellants was that the Master Direction on Frauds impliedly exclude the right to be heard. In the opinion of the Appellants, as the Directions allow for a third party who may be involved in the commission of the offence to be heard, but do not explicitly provide for hearing to a borrower, thus hearing to borrowers is excluded by necessary implication.

On this aspect, the Hon’ble Supreme Court held the following:

“53. The Master Directions on Frauds do not expressly exclude a right of hearing to the borrowers before action to class their account as frauds is initiated. The principles of natural justice can be read into a statute or a notification where it is silent on granting an opportunity of a hearing to a party whose rights and interests are likely to be affected by the orders that may be passed.”

The Hon’ble Supreme Court of India, after considering the significant civil consequences of an order by the banking company classifying an account as fraud held that principles of natural justice should be read in the Directions even though, the Directions are silent on the same.


The Hon’ble Supreme Court of India further directed that a banking company must pass a well-reasoned order. The Hon’ble Supreme Court on this aspect held as follows:

“78. ….. We agree with this contention of the borrowers because: (i) a reasoned order allows an aggrieved party to demonstrate that the reasons which persuaded the authority to pass an adverse order against the interests of the aggrieved party are extraneous or perverse; and (ii) the obligation to record reasons acts as a check on the arbitrary exercise of the powers. The reasons to be recorded need not be placed on the same pedestal as a judgment of a court. The reasons may be brief but they must comport with fairness by indicating a due application of mind”


This landmark judgment by the Hon’ble Supreme Court will ensure that the borrowers/ aggrieved parties are given a fair chance of being heard and as such also reduce multiplicity of proceedings. The right to be heard as a principle of natural justice has a universal application and constitutes an important facet of procedural propriety envisaged under Article 14. The Hon’ble Supreme Court, through this decision, has made sure that any statute under which the impugned administrative power is exercised is not allowed to deviate from the applicability of the rule of audi alteram partem.

Furthermore, the Hon’ble Apex Court has held that the administrative authority cannot justify not providing of a hearing to the borrower on the ground that reasonable nexus of the objective sought to be achieved would have to be considered as classifying an account as fraud not only has criminal consequences but also entails grave civil consequences.