STATE BANK OF INDIA & ORS versus RAJESH AGARWAL & ORS

[2023] 7 S.C.R.

STATE BANK OF INDIA & ORS

RAJESH AGARWAL & ORS

(Civil Appeal No. 7300 of 2022)

BMARCH 27, 2023

[DR. DHANANJAYA Y CHANDRACHUD, CJI ANDHIMA KOHLI, J.]

Reserve Bank of India Act, 1934 – Banking Regulation Act,1949 – Reserve Bank of India (Frauds Classification and ReportingCby Commercial Banks and Select FIs) Directions 2016 – MasterDirections on Frauds – Principle of Natural Justice – Rule of AudiAlteram Partem – The civil appeals arise out of challenge to theReserve Bank of India (Frauds Classification and Reporting byCommercial Banks and Select FIs) Directions 2016 – TheseDdirections were challenged before different High Courts primarilyon the ground that no opportunity of being heard is envisaged toborrowers before classifying their accounts as fraudulent – Whetherthe principles of natural justice should be read into the provisionsof the Master Directions on Frauds – Held : The principles of naturaljustice demand that the borrowers must be served notice, givenEan opportunity to explain the conclusions of the forensic auditreport, and be allowed to represent by the banks/ JLF before theiraccount is classified as fraud under the Master Directions on Frauds– In addition, the decision classifying the borrower’s account asfraudulent must be made by reasoned order; and since the MasterFDirections on Frauds do not expressly provide an opportunity ofhearing to the borrowers before classifying their account as fraud,audi alteram partem has to be read into the provisions of thedirections to save them from the vice of arbitrariness.

Reserve Bank of India Act, 1934 – Banking Regulation Act,G1949 – Reserve Bank of India (Frauds Classification and Reportingby Commercial Banks and Select FIs) Directions 2016 – Principleof Natural Justice – Civil consequences to borrowers – Whetherthe classification of borrower’s account as fraudulent under theMaster Directions on Frauds entails civil consequences toborrowers – Held: Clause 8.12 of the Master Directions on FraudsH

deals with the penal measures for borrowers – Clause 8.12.1provides that penal provisions as applicable to wilful defaulterswould apply to fraudulent borrowers, including the promoters anddirectors of the borrower company – In addition, borrowers arealso liable to suffer the following consequences under the MasterDirections on Frauds : a) No restructuring may be made in the caseof an RFA or fraud accounts (clause 8.12.2); b) No compromise onsettlement involving fraudulent borrower is allowed unless theconditions stipulate that the criminal complaint will be continued(clause 8.12.3) – The classification of borrower’s account as fraudunder the Master Directions on Frauds has difficult civilconsequences for the borrower – Classification of the borrower’saccount as fraud under the Master Directions on Frauds virtuallyleads to credit freeze for the borrower, who is debarred from raisingfinance from financial markets and capital markets – The bar fromraising finances could be fatal for the borrower leading to its ‘civildeath’ in addition to the infraction of their rights under Article19(1)(g) of the Constitution – Since, debarring disentitles personor entity from exercising their rights and/or privileges, it is elementarythat the principles of natural justice should be made applicableand the person against whom an action of debarment is soughtshould be given an opportunity of being heard.Reserve Bank of India Act, 1934 – Banking Regulation Act,1949 – Reserve Bank of India (Frauds Classification and Reportingby Commercial Banks and Select FIs) Directions 2016 – No impliedexclusion of audi alteram partem – The RBI and the lender bankshave contended that the Master Directions on Frauds impliedlyexclude the right to be heard – Held: The Master Directions onFrauds do not expressly exclude right of hearing to the borrowersbefore action to class their account as frauds is initiated – Theprinciples of natural justice can be read into statute or anotification where it is silent on granting an opportunity of hearingto party whose rights and interests are likely to be affected by theorders that may be passed.

Principles/Doctrines – Principles of natural justice – Twofundamental principles of natural justice are entrenched in Indianjurisprudence: (i) nemo judex in causa sua, which means that noperson should be judge in their own cause; and (ii) audi alterampartem, which means that person affected by administrative,

ABCD

Ajudicial or quasi-judicial action must be heard before decision istaken – The courts generally favor interpretation of statutoryprovision consistent with the principles of natural justice becauseit is presumed that the statutory authorities do not intend tocontravene fundamental rights.

BDisposing of the appeals, the Court

HELD: Audi Alteram Partem

1. The principles of natural justice are not mere legalformalities. They constitute substantive obligations that need tobe followed by decision-making and adjudicating authorities. TheCprinciples of natural justice act as guarantee against arbitraryaction, both in terms of procedure and substance, by judicial,quasi-judicial, and administrative authorities. Two fundamentalprinciples of natural justice are entrenched in Indianjurisprudence: (i) nemo judex in causa sua, which means that noDperson should be judge in their own cause; and (ii) audi alterampartem, which means that person affected by administrative,judicial or quasi-judicial action must be heard before decisionis taken. The courts generally favor interpretation of statutoryprovision consistent with the principles of natural justice becauseit is presumed that the statutory authorities do not intend toEcontravene fundamental rights. Application of the said principlesdepends on the facts and circumstances of the case, expresslanguage and basic scheme of the statute under which theadministrative power is exercised, the nature and purpose forwhich the power is conferred, and the final effect of the exerciseFof that power. [Para 29][502-E-G]

2. Chapter VIII of the Master Directions on Fraud providesdetailed procedures to be followed by the banks before formingan opinion to proceed with criminal complaint against theborrowers. Under the said chapter, the lender banks have toGreport borrower to the CBI after classifying the borrower’saccount as fraudulent. However, the classification of theborrower’s account does not simpliciter lead to reporting ofcriminal complaint with the enforcement authorities; it also entailspenal consequences for the borrowers as laid down under Clause8.12. The process of forming an informed opinion under theH

Master Directions on Frauds is administrative in nature. Thishas also been acceded to by RBI and lender banks in their writtensubmissions. It is now settled principle of law that the rule ofaudi alteram partem applies to administrative actions, apart fromjudicial and quasi-judicial functions. It is also settled position inadministrative law that it is mandatory to provide for anopportunity of being heard when an administrative action resultsin civil consequences to person or entity. [Paras 31, 32][503-D-G]3. The RBI and lender banks have argued that the civilconsequences contemplated in Clause 8.12.1 of the MasterDirections on Frauds are reasonable. Under the said clause, theborrower, including the promoters and directors of the company,are barred from availing credit from financial markets and creditmarkets for period of five years, and possibly even beyond.According to RBI and lender banks, such restriction has to beperceived from the perspective of public interest. Whileacknowledging that the procedure which has been laid down inthe Master Directions on Frauds is conceived in public interest,to protect the banking system, it cannot be ignore the seriouscivil consequences which emanate to the borrowers. [Para38][505-G; 506-A-B]

4. Classification of the borrower’s account as fraud underthe Master Directions on Frauds virtually leads to credit freezefor the borrower, who is debarred from raising finance fromfinancial markets and capital markets. The bar from raisingfinances could be fatal for the borrower leading to its ‘civil death’in addition to the infraction of their rights under Article 19(1)(g)of the Constitution. Since debarring disentitles person or entityfrom exercising their rights and/or privileges, it is elementarythat the principles of natural justice should be made applicableand the person against whom an action of debarment is soughtshould be given an opportunity of being heard. Indeed, debarmentis akin to blacklisting borrower from availing credit. [Para42][509-A-C]

No implied exclusion of audi alteram partem

5. The Master Directions on Frauds do not expresslyexclude right of hearing to the borrowers before action to class

Atheir account as frauds is initiated. The principles of natural justicecan be read into statute or notification where it is silent ongranting an opportunity of hearing to party whose rights andinterests are likely to be affected by the orders that may be passed.[Para 53][513-E]

B6. Audi alteram partem, therefore, entails that an entityagainst whom evidence is collected must: (i) be provided anopportunity to explain the evidence against it; (ii) be informed ofthe proposed action, and (iii) be allowed to represent why theproposed action should not be taken. Hence, the mereparticipation of the borrower during the course of the preparationCof forensic audit report would not fulfil the requirements ofnatural justice. The decision to classify an account as fraudinvolves due application of mind to the facts and law by the lenderbanks. The lender banks, either individually or through JLF,have to decide whether borrower has breached the terms andDconditions of loan agreement, and based upon such determinationthe lender banks can seek appropriate remedies. Therefore,principles of natural justice demand that the borrowers must beserved notice, given an opportunity to explain the findings inthe forensic audit report, and to represent before the account isclassified as fraud under the Master Directions on Frauds. [ParaE65][520-F-H]

7. The conclusions are summarized as follows: i. Noopportunity of being heard is required before an FIR is lodgedand registered; ii. Classification of an account as fraud not onlyresults in reporting the crime to investigating agencies, but alsoFhas other penal and civil consequences against the borrowers;iii. Debarring the borrowers from accessing institutional financeunder Clause 8.12.1 of the Master Directions on Frauds resultsin serious civil consequences for the borrower; iv. Such adebarment under Clause 8.12.1 of the Master Directions onGFrauds is akin to blacklisting the borrowers for beinguntrustworthy and unworthy of credit by banks. This Court hasconsistently held that an opportunity of hearing ought to beprovided before person is blacklisted; v. The application of audialteram partem cannot be impliedly excluded under the MasterDirections on Frauds. In view of the time frame contemplatedunder the Master Directions on Frauds as well as the nature ofthe procedure adopted, it is reasonably practicable for the lenderbanks to provide an opportunity of hearing to the borrowersbefore classifying their account as fraud; vi. The principles ofnatural justice demand that the borrowers must be served anotice, given an opportunity to explain the conclusions of theforensic audit report, and be allowed to represent by the banks/JLF before their account is classified as fraud under the MasterDirections on Frauds. In addition, the decision classifying theborrower’s account as fraudulent must be made by reasonedorder; and vii. Since the Master Directions on Frauds do notexpressly provide an opportunity of hearing to the borrowersbefore classifying their account as fraud, audi alteram partem hasto be read into the provisions of the directions to save them fromthe vice of arbitrariness. [Para 81][528-A-H]

Maneka Gandhi v. Union of India (1978) 1 SCC 248 :[1978] 2 SCR 621; Union of India v. Tulsiram Patel(1985) 3 SCC 398 : [1985] 2 Suppl. SCR 131; OlgaTellis v. Bombay Municipal Corporation (1985) 3 SCC545 : [1985] 2 Suppl. SCR 51; Gautam v. Union ofIndia (1993) 1 SCC 78 : [1992] 3 Suppl. SCR 12 –followed.

State of Orissa v. Dr (Miss) Binapani Dei AIR 1967 SC1269 : [1967] SCR 625; Canara Bank v. V K Awasthy(2005) 6 SCC 321 : [2005] 3 SCR 81; ErusianEquipment & Chemicals Ltd v. State of West Bengal(1975) 1 SCC 70 : [1975] 2 SCR 674; JosephVilangandan v. Executive Engineer (1978) 3 SCC 36 :[1978] 3 SCR 514; Raghunath Thakur v. State of Bihar(1989) 1 SCC 229 : [1988] 3 Suppl. SCR 867; GorkhaSecurity Services v. Govt (NCT of Delhi) (2014) 9 SCC105: [2014] 13 SCR 617; State of Maharashtra v. PublicConcern for Governance Trust (2007) 3 SCC 587 :[2007] 1 SCR 87; Swadeshi Cotton Mills v. Union of

India (1981) 1 SCC 664 : [1981] 2 SCR 533; Mangilalv. State of Madhya Pradesh (2004) 2 SCC 447 : [2004]1 SCR 1; K I Shephard v. Union of India (1987) 4 SCC431 : [1988] 1 SCR 188; Union of India v. Col. J NSinha (1970) 2 SCC 458 : [1971] 1 SCR 791; KesarEnterprises Ltd v. State of Uttar Pradesh (2011) 13 SCC733 : [2011] 9 SCR 19 – relied on.

State Bank of India v. Jah Developers (2019) 6 SCC787: [2019] 7 SCR 701; Union of India v. Col. J NSinha (1970) 2 SCC 458 : [1971] 1 SCR 791; AnjuChaudhary v. State of UP (2013) 6 SCC 384 : [2012]13 SCR 901; K Kraipak v. Union of India (1969) 2SCC 262 : [1970] 1 SCR 457; Governing Body, StAnthony’s College, Shillong and Ors v. Rev. Fr. PaulPetta of Shillong (1988) Supp SCC 676 : [1988] Suppl.SCR 507; Uma Nath Pandey and Ors v. State of UttarPradesh (2009) 12 SCC 40 : [2009] 4 SCR 374;Mohinder Singh Gill v. Chief Election Commissioner,New Delhi (1978) 1 SCC 405 : [1978] 2 SCR 272; KYadav v. J M Industries (1993) 3 SCC 259 : [1993] 3SCR 930; Peerless General Finance and InvestmentCo. Ltd v. Reserve Bank of India (1992) 2 SCC 343 :[1992] 1 SCR 406; Joseph Kuruvilla Vellukunnel v.Reserve Bank of India AIR 1962 SC 1371 : [1962]Suppl. SCR 632; Internet and Mobile Association ofIndia v. Reserve Bank of India (2020) 10 SCC 274 :[2020] 2 SCR 297; Ajit Kumar Nag v. General Manager(PJ), Indian Oil Corp. Ltd. (2005) 7 SCC 764 : [2005]3 Suppl. SCR 314; Keshav Mills Co. Ltd. v. Union ofIndia (1973) 1 SCC 380 : [1973] 3 SCR 22; Delhi ClothMills & General Mills v. Union of India (1983) 4 SCC166 : [1983] 3 SCR 438; P Royappa v. State of TamilNadu (1974) 4 SCC 3 : [1974] 2 SCR 348; State of APv. McDowell (1996) 3 SCC 709 : [1996] 3 SCR 721;Om Kumar v. Union of India (2001) 2 SCC 386 : [2000]4 Suppl. SCR 693; Chairman and Managing Director,United Commercial Bank v. P Kakkar (2003) 4 SCC364 : [2003] 1 SCR 1034; Cantonment Board v.Taramani Devi 1992 Supp (2) SCC 501; Delhi TransportCorporation v. DTC Mazdoor Congress 1991 Supp (1)SCC 600 : [1990] 1 Suppl. SCR 142; Sahara India(Firm), Lucknow v. Commissioner of Income Tax,Central-I (2008) 14 SCC 151 : [2008] 6 SCR 427;Kranti Associates (P) Ltd. v. Masood Ahmed Khan(2010) 9 SCC 496 : [2010] 10 SCR 1070 – referredto.

Black’s Law Dictionary, 5th edn (1979); P RamanathaAiyar, ‘The Law Lexicon : The Encyclopedic LawDictionary’ (1997 edn) – referred to.

[2023] 7 S.C.R.

From the Judgment and Order dated 10.12.2020 of the High Courtfor the State of Telangana at Hyderabad in WP No. 19102 of 2019.

GWith

Civil Appeal Nos. 7301, 7302, 7303, 7304, 7305, 7306, 7307 of2022 and Writ Petition no. 138 of 2022.

Tushar Mehta, SG, Gopal Jain, Ranjit Kumar, Dhruv Mehta, Dr.HAbhishek Manu Singhvi, Navin Pahwa, Arunabh Chowdhury, Gopal Jain,

Sr. Advs., Sanjay Kapur, Ms. Megha Karnwal, Arjun Bhatia, Ms. AkshataJoshi, Ms. Shubhra Kapur, Ms. Pragya Baghel, Ramesh Babu M.R.,Ms. Manisha Singh, Ms. Nisha Sharma, Ms. Jagrati Bharti, MaheshAgarwal, Sumesh Dhawan, Rishi Agrawala, Vastala Kak, HimanshuSatija, Pranjit Bhattacharya, Kailashnath, V. Murali Manohar, NishantRao, E.C. Agrawala, Suraj Prakash, Mrinal Litoriya, Ms. PriyankaSolanki, Ms. Nidhi Mohan Parashar, Ravi Pahwa, Ms. Monisha Handa,Rajul Shrivastav, Mohit D. Ram, Anubhav Sharma, Kanu Agrawal, Ms.Neela Kedar Gokhale, Ms. Akanksha Kaul, Ms. Praveena Gautam,Arvind Kumar Sharma, M.K. Maroria, Mayank Pandey, AnnamVenkatesh, Ms. Sairica Raju, Ms. Swati Ghildiyal, Jasmeet Singh,Mahinder Singh Hura, Saif Ali, Divjot Singh Bhatia, Pushpendra SinghBhadoriya, Ms. Rusheet Saluja, Ms. Mandeep Kaur, Siddharth Handa,Karma Dorjee, Dechen W. Lachungpa, Anirudh M. Sethi, SiddharthSeem, Sourabh Tandon, Ms. Richa Kapoor, Kunal Anand, Ms. ShivaniSharma, Ms. Jyoti Zongluju, M/s. Coac, Ms. Suvarna Kashyup, PankajVivek, Krishan Kumar, Nitin Pal, Swikirtimala Dubey, Anand ShankarJha, Arpit Gupta, Ms. Meenakshi S. Devgan, Girish Bhardwaj, AbhilekhTiwari, Alok Kumar, G.N. Reddy, Manan Gambhir, Ms. Garima Soni,Ms. Neetu Rahi, Rohil Pandit, A. Radhakrishnan, Ms. Astha Deep, Ms.Ruma Sarasani, PBA Srinivasan, Parth Tandon, Ms. Prerana Sabharwal,Ms. Srishti Bansal, Parth Kumar, V. Aravind, Amit K. Nain, BrijeshKumar Tamber, Yashu Rustagi, Advs. for the appearing parties.

ABC

The Judgment of the Court was delivered by

DR. DHANANJAYA Y CHANDRACHUD, CJI

*Ed. Note: Pagination is as per the original judgment.

AA. Background

1. The civil appeals arise out of challenge to the Reserve Bankof India (Frauds Classification and Reporting by Commercial Banks andSelect FIs) Directions 2016.[1 ]Issued by the Reserve Bank of India[2],these directions were challenged before different High Courts primarilyBon the ground that no opportunity of being heard is envisaged to borrowersbefore classifying their accounts as fraudulent. The High Court ofTelangana has heldin the impugned judgment[3 ]that the principles of naturaljustice must be read into the provisions of the Master Directions onFrauds. The decision has been assailed by the RBI and lender banksthrough these civil appeals.C

2. In this background the court has to consider whether theprinciples of natural justice should be read into the provisions of theMaster Directions on Frauds. For the reasons to follow, we hold that theprinciples of natural justice, particularly the rule of audi alteram partem,has to be necessarily read into the Master Directions on Frauds to saveDit from the vice of arbitrariness. Since the classification of an account asfraud entails serious civil consequences for the borrower, the directionsmust be construed reasonably by reading into them the requirement ofobserving the principles of natural justice.

B. FactsEI. SLP (C) No. 3931 of 2021; SLP (C) No. 4922 of 2021;SLP (C) No. 5056 of 2021

3. S Limited is company engaged in the business of powertransmission and distribution, passive telecom infrastructure, renewableenergy, and mineral resources. It availed loans amounting to Rs. 1406Fcrores from various banks. The company failed to meet its paymentobligations to lender banks, thereby defaulting in repayment of creditfacilities. In accordance with the Master Directions on Frauds, all thelender banks formed Joint Lenders Forum[4] with State Bank of Indiaas the lead bank.

G4. The JLF declared the company’s assets as Non-PerformingAssets[5] on 29 August 2016. The lender banks decided to adopt the

1 “Master Directions on Frauds”

2 “RBI”

3 Writ Petition No. 19102 of 2019

4 “JLF”H5 “NPA”

Sustainable Structuring of Stressed Assets Scheme[6] and suggested aforensic audit report and Techno Economic Viability[7] study in its meetingheld on 11 July 2016. Based on the conclusions of the forensic auditreport, the JLF closed the issue stating that there were no irregularities.However, based on the TEV study it was concluded that the companywas not eligible for the S4A scheme and requested it to submit analternative plan for regularization of its account. In the meanwhile, IDBIBank - one of the lender banks - red-flagged the account of the company.Additionally, proceedings under the Insolvency and Bankruptcy Code,2016 were also initiated against the company. On 15 February 2019, theJLF declared the account of the company as fraud by invoking Clause2.2.1(g) of the Master Directions on Frauds. Subsequently, the FraudIdentification Committee[8] passed resolution on 31 July 2019 identifyingthe company’s account as fraud. The company filed writ petitionchallenging both the decision of the JLF dated 15 February 2019 and theresolution of the FIC dated 31 July 2019 before the High Court ofTelangana.

5. By judgment dated 10 December 2020, Division Bench ofthe High Court allowed the writ petition by holding that the principle ofaudi alteram partem ought to be read into Clauses 8.9.4 and 8.9.5 of theMaster Directions on Frauds. The High Court further directed the lenderbanks: (i) to give an opportunity of hearing to the borrowers afterfurnishing copy of the forensic auditreport; and (ii) to provide anopportunity of personal hearing to the borrower before classifying theiraccount as fraud. The judgment of the High Court was challenged inSLP (C) No. 3931 of 2021. On 15 April 2021, this Court, while issuingnotice, partially stayed the directions issued by the Telangana High Courtin the following terms:

“Meanwhile, the Minutes/Order dated 15.02.2019 passed by theJoint Lenders Meeting is not to be acted upon. The High Courtinsofar as it observed that personal hearing be given is stayed.”

II. SLP (C) No. 762 of 2022; SLP (C) No. 873 of 2022; andSLP (C) No. 1514 of 2022

6. The appellant is company involved in the manufacture ofedible oils, fats, rice and semolina products in the State of Telangana.

6 “S4A Scheme”

7 “TEV”

8 “FIC”

AFrom 2003 to 2015, the appellant availed of credit facilities to the tune ofRs. 675 crores from consortium of banks led by the Andhra Bank(now merged with the Union Bank of India). The appellant was declaredas an NPA on 14 May 2018 with effect from 31 March 2018. Thereafter,the consortium of lenders in meeting of the JLF decided to conduct aforensic audit of the appellant for the period till 31 March 2019. TheBappellant participated in the audit process and submitted all the informationrequired by the auditor from time to time. In September 2019, the appellantlearnt that its account has been declared as fraud by the Union Bank ofIndia (erstwhile Andhra Bank). Aggrieved by that classification, theappellant filed writ petition before the High Court of Telangana. TheCHigh Court declined to deal with the issues pertaining to the principles ofnatural justice and fair play considering the fact that they were pendingbefore this Court in SLP (C) No. 3931 of 2021. By its judgment dated 22December 2021, the High court dismissed the writ petitions. The courtheld that the appellant’s account was rightly classified as fraud becausethe forensic audit report contained adverse findings against the appellant.D

7. On 24 January 2022, this Court, while issuing notice in SLP(C)No. 762 of 2022, directed that the matter may not be reported to theCentral Bureau of Investigation[9] for the time being. On 28 March 2022,this Court passed similar ad-interim order in SLP(C) No. 873 of 2022and SLP(C) No. 1514 of 2022.E

III. SLP (C) No. 2980 of 2022

8. The appellant is promoter and director of Golden Jubilee HotelsPvt Ltd.[10] GJHPL availed financial assistance from the respondent banksfor the construction and development of hotel in Hyderabad. GJHPL’saccount was declared as NPA from 31 December 2015 because of itsFinability to service its debts to the respondent banks. At its meeting on 21April 2016, the JLF decided to carry out special audit of the appellant’scompany. Thereafter, the appellant participated in series of meetingsbetween the JLF and was consulted by the forensic auditor during thepreparation of the audit report. Bank of Baroda red-flagged the appellant’sGaccount on 03 May 2019 based on the observations in the forensic auditreport. The appellant’s account was classified as fraud on 14 August2019. criminal complaint was also lodged with the CBI. The appellantcame to know about the classification of their account as fraud in 2021,

9 “CBI”H10 “GJHPL”

when they received copy of the FIR. The appellant filed writ petitionbefore the High Court of Telangana challenging the validity of the MasterDirections on Frauds. The High Court by its judgment dated 31 December2021 held that no relief could be granted to the appellant on the issue ofpersonal hearing since SLP (C) No. 3931 of 2021 was pending beforethis Court. The High Court also held that the appellant’s account wasrightly classified as fraudulent in view of the adverse findings in theforensic audit report.

IV. Writ Petition (C) No. 138 of 2022 and SLP (C) No. 3388of 2022

9. The appellant is one of the directors of company called M/sVimal Oil & Foods Limited. The said company availed of loan facilitiesfrom various financial institutions over period of time. In 2015, theauditor of the respondent bank flagged certain irregularities in the accountsof the company. Based on special audit, the respondent bank declaredthe account of the company as NPA on 30 September 2015. Thereafter,on 05 July 2016, the company’s account was red-flagged by therespondent bank. In the meantime, the Corporate Insolvency ResolutionProcess[11] was initiated against the company on 19 December 2017 andthe appellant was suspended as Managing Director of the company.Upon suspension, the appellant was not invited to attend the meetings ofthe JLF. The appellant allegedly learnt that the respondent bank hadclassified their account as fraud on 21 February 2018 though withoutany intimation. Further, based on letter addressed by the respondentbank to the CBI, an FIR came to be registered against the appellant.The appellant alleges that they acquired knowledge about their accountbeing classified as fraud and registration of the FIR only when searchwas carried out at their residential premises in pursuance of the FIR.The appellant filed Special Civil Application challenging the actions ofthe respondent bank, which was dismissed by the Single Judge of theHigh Court of Gujarat. The Division Bench partly allowed LettersPatent Appeal by its judgment dated 23 December 2021 by permittingthe appellant to address representation tothe respondent bank butdeclined to allowa personal hearing. The appellant/ petitioner has alsoinvoked the writ jurisdiction of this Court by challenging the validity ofthe Master Directions on Frauds.

AC. Submissions

10. On behalf of the borrowers, we have heard Dr Abhishek ManuSinghvi, Mr Ranjit Kumar, Mr Dhruv Mehta, Mr Arunabh Chowdhury,Mr Navin Pahwa, Senior Advocates and Mr Suraj Prakash, learnedcounsel. The counsel submit that the procedure for classification of anBaccount as fraud under the Master Directions on Frauds suffers fromillegalities because:

a.Under Clauses 8.9.4 and 8.9.5 of the Master Directions onFrauds, no notice is given to the borrowing company or itspromoters, and directors including whole-time directors.CThey are not given an opportunity to present defense andeven copy of the final decision is not provided to them.

b.The classification of the borrower’s bank accounts as fraudunder the Master Directions on Frauds carries serious civilconsequences. The penal provisions under Clause 8.12 ofDthe Master Directions on Frauds are also applicable to thepromoters, directors, and other whole-time directors. Oncea bank account is classified as fraudulent, it carriessignificant consequences according to the Master Directionson Frauds such as filing of complaint with the CBI anddebarment of the promoters and directors from accessingEinstitutional finance. Further, the action of the banks ofclassifying an account as ‘fraud’ is stigmatic, akin toblacklisting the borrower, which affects their right toreputation. Thus, there is direct impact on the fundamentalrights of the individuals concerned, as consequence ofthe classification of an account as fraud.F

c.The Master Directions on Frauds are violative of Articles14, 19, and 21 of the Constitution of India as they debar acompany and its promoters and directors from accessingfinancial and credit markets for period of five years withouteven providing show cause notice or opportunity of beingheard.

d.There are other facets to the principle of audi alterampartem apart from personal hearing. The MasterDirections on Frauds does not stand good on other facetsof audi alteram partem such as notice of allegations levelledH

STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS[DR. DHANANJAYA Y CHANDRACHUD, CJI]

and evidence collected,notice of the penalty proposed,among others. According to the procedure laid down underthe Master Directions on Frauds, company or its promotersand directors are not even informed that they have beenclassified as fraud and that penalty has been imposedupon them.

e.The Master Directions on Frauds are silent on whether ornot the borrower is entitled to an opportunity of being heardafter the receipt of forensic audit report and before decidingwhether the borrower’s account should be classified asfraud. Since the decision to classify the account as fraudentails significant civil consequences, principles of naturaljustice ought to be read into the Master Directions on Frauds.

f.Clause 8.12.5 of the Master Directions on Frauds expresslystipulates that an opportunity of hearing be provided to thirdparties. The directionsare manifestly arbitrary since on theone hand they provide an opportunity of hearing to thirdparties, but such an opportunity is denied to borrowers.

g.Although the purpose and object of the Master Directionson Frauds is speedy detection and reporting of fraud to lawenforcement agencies, such exigencies cannot be validground to exclude the applicability of the principles of naturaljustice.

h.The decision of this Court in State Bank of India v. JahDevelopers[12] read in the requirement of natural justicefor the purposes of declaring borrower as willfuldefaulter. The principles laid down in Jah Developers(supra) would be squarely applicable to the present matters.

i.The participation of the borrower during the preparation ofthe forensic audit report does not in itself fulfil therequirement of the principles of natural justice under theMaster Directions on Frauds. Those directions do notexpressly provide for the participation or inputs from aborrower during the preparation of the forensic audit report,giving rise to the possibility that in some cases, the borroweris completely excluded from the forensic audit process.

EFG

A11. On behalf of the RBI and lender banks, we have heard MrTushar Mehta, Solicitor General of India, Mr Gopal Jain, Senior Counseland Mr Ramesh Babu M R and Mr N Reddy, learned counsel. Counselsubmitted that the challenge to the classification of loan account asfraudulent on the ground of violation of the principles of natural justiceis devoid of merit for the following reasons:B

a.The Master Directions on Frauds were necessitated toprotect the interests of depositors and banks from thegrowing instances of frauds. RBI is duly empowered totake pre-emptive measures in public interest to ensure thatfraudulent borrowers are brought to justice and loss causedCto the banks is mitigated. The clauses of the MasterDirections on Frauds, therefore, must be interpreted in lightof their purpose and objective, that is, timely detection anddissemination of information and reporting about the fraud.

b.The provisions of the Master Directions on Frauds must beDconstrued keeping in mind the following thresholds: (i)justness; (ii) fairness towards the parties aggrieved; (iii)reasonability; and (iv) proportionality between the mischiefand the corrective measure. Considering that the MasterDirections on Frauds is an economicpolicy decision, thisECourt must exercise greater latitude while construing itsprovisions.

c.The procedure for classifying an account as fraud underthe Master Directions on Frauds is not arbitrary. Theclassification is done only for reporting the matter to lawFenforcement agencies. The banks already have in place astructured organizational setup to identify and investigatefraudulent activities in bank accounts. Banks file complaintsbefore law enforcement agencies, who conduct aninvestigation. The ultimate decision on fraud is rendered bya competent court of law.

d.Principles of natural justice are not applicable at the stageof setting the process of criminal law in motion. Since thelender bank is an injured party in case of fraudulent accounts,it has the right to report the crime to the law enforcementagencies without giving an opportunity of being heard to

STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS[DR. DHANANJAYA Y CHANDRACHUD, CJI]

the fraudulent borrower. Issuing of show cause notice tofraudulent borrowers may forewarn them and hamper theinvestigation by law enforcement agencies.

e.Debarring fraudulent borrowers from availing bank financesis preventive measure without which the Master Directionson Frauds will be rendered toothless. Such measure isnecessary to prevent fraudulent borrower fromcommitting frauds in other banks.

f.The requirement of notice or prior hearing could be excludedif it impedes the taking of prompt action. Further, it is not aninviolable rule that personal hearing ought to be given in allCcases.

g.The process for classification of borrower as willfuldefaulter under the Master Circular on Willful Defaulters[13]significantly differs from the process of classification of anaccount as fraud under the Master Directions on Frauds.Therefore, the decision of this Court in Jah Developers(supra) will not be applicable to the facts of the presentappeal.

D. Analysis

D.1 Regulatory Framework

12. RBI is statutory body constituted under Section 3 of theReserve Bank of India Act, 1934. The RBI has been constituted for thepurpose of taking over the management of currency from the CentralGovernment, regulating the issue of bank notes, keeping of reserveswith view to securing monetary stability, and operating the currencyand credit system of India.RBI is entrusted with the statutory obligationof administering the provisions of the Banking Regulation Act, 1949[14].The BR Act vests RBI with various powers with respect to bankingcompanies such as granting licenses, conducting inspections and givingdirections.

13. Section 35A of the BR Act empowers RBI to issue directionsto banking companies. Such directions are statutory in nature. Section35A is extracted below:

13 Master Circular on Wilful Defaulters, 201514 “BR Act”

A“35A. Power of the Reserve Bank to give directions – (1)Where the Reserve Bank is satisfied that –

(a)in the public interest; or

(aa)in the interest of banking policy; or

(b)to prevent the affairs of any banking company beingconducted in manner detrimental to the interests of thedepositors or in manner prejudicial to the interests of thebanking company; or

(c)to secure the proper management of any banking companygenerally,

it is necessary to issue directions to banking companies generallyor to any banking company in particular, it may, from time to time,issue such directions as it deems fit, and the banking companiesor the banking company, as the case may be, shall be bound tocomply with such directions.

(2) The Reserve Bank may, on representation made to it or on itsown motion, modify or cancel any direction issued under sub-section (1), and in so modifying or cancelling any direction mayimpose such conditions as it thinks fit, subject to whichmodifications or cancellation shall have effect.”

14. RBI has been issuing ‘master directions’ on diverse issuessince 2016. These directions encompass the instructions on that particularsubject. The master directions are updated whenever there is changein policy, and such changes get reflected on RBI’s website. In exerciseof the power conferred by Section 35A, RBI issued the Master DirectionsFon Frauds on 01 July 2016 to consolidate and update seven earliercirculars on classification of fraud, reporting and monitoring issuedbetween June 2009 and January 2016. The Master Directionson Fraudswere updated on 03 July 2017. The purpose of the Master Directions isextracted below:

G“1.3 Purpose

These directions are issued with view to providing frameworkto banks to enable them to detect and report frauds early andtaking timely consequent actions like reporting to the Investigativeagencies so that fraudsters are brought to book early, examining

STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS[DR. DHANANJAYA Y CHANDRACHUD, CJI]

staff accountability and do effective fraud risk management. Thesedirections also aim to enable faster dissemination of informationby the Reserve Bank of India (RBI) to banks on the details offrauds, unscrupulous borrowers and related parties, based on thebanks’ reporting so that necessary safeguards / preventivemeasures by way of appropriate procedures and internal checksmay be introduced and caution exercised while dealing with suchparties by banks.”

15. The above directions were issued to achieve specific purposes:(i) early and timely detection and reporting of fraud; (ii) early and timelyreporting of fraud to investigative agencies; (iii) quicker dissemination ofinformation pertaining to details of fraud and fraudulent borrowers tobanks; and (iv) to facilitate the adoption of preventive measures by banks.These purposesare reflected in Clause 2.1.1 of the Master Directionson Frauds:

“Clause 2.1.1 The Chairmen and Managing Directors/ChiefExecutive Officers (CMD/CEOs) of banks must provide focuson the “Fraud Prevention and Management Function” to enable,among others, effective investigation of fraud cases andprompt as well as accurate reporting to appropriateregulatory and law enforcement authorities includingReserve Bank of India.”

(emphasis supplied)

16. Clause 2.2.1 classifies frauds based on the provisions of theIndian Penal Code, 1860:

“Clause 2.2.1 In order to have uniformity in reporting, frauds havebeen classified as under, based mainly on the provisions of theIndian Penal Code:

a.Misappropriation and criminal breach of trust

b.Fraudulent encashment through forged instruments,manipulation of books of account or through fictitiousGaccounts and conversion of property.

c.Unauthorised credit facilities extended for reward or forillegal gratification

d.Cash shortages.

Ae.Cheating and forgery

f.Fraudulent transactions involving foreign exchange

g.Any other type of fraud not coming under the specific headsas above.”

B17. Clause 3 advises banks to make full use of the Central FraudRegistry[15] (a database created by RBI to enable banks to shareinformation on fraudulent accounts) for timely identification, control,reporting, and mitigation of risks associated with fraud. Clause 3.3 ofthe said directions emphasizes theneed to provide timely information onfrauds and penalizes banks for non-adherence to timelines:C

“3.3.1 Banks should ensure that the reporting system is suitablystreamlines so that delays in reporting of frauds, submission ofdelayed and incomplete fraud reports are avoided. Banks mustfix staff accountability in respect of delays in reporting fraud casesto RBI.

3.3.2. Delay in reporting of frauds and the consequent delayin alerting other banks about the modus operandi anddissemination of information through Caution Advice/ CFRagainst unscrupulous borrowers could result in similarfrauds being perpetrated elsewhere. Banks should therefore,Estrictly adhere to the timeframe fixed in this circular for reportingof fraud cases to RBI failing which they would be liable for penalaction prescribed under Section 47(A) of the Banking RegulationAct, 1949.”

(emphasis supplied)

18. The Master Directions on Frauds provides regulatoryframework for four types of frauds: (i) Chapter IV deals with attemptedfraud; (ii) Chapter VII deals with cheque related frauds; (iii) ChapterVIII deals with loan frauds; and (iv) Chapter X deals with cases relatingto theft, burglary, dacoity, and bank robberies. The dispute in the presentGbatch of cases is concerned with Chapter VIII dealing with loan frauds.

19. Chapter VI states that as general rule, cases involving fraud/embezzlement should invariably be referred to the state police or CBI.Chapter VIII provides for more robust safeguards which ensure that

banks report frauds to investigating agencies after forming an informedopinion. The framework for dealing with loan frauds was put in place bya circular dated 07 May 2015. The objective of the framework has beenenumerated in Clause 8.2:

“8.2 Objective of the framework

The objective of the framework is to direct the focus of banks onthe aspects relating to prevention, early detection, prompt reportingto the RBI (for system level aggregation, monitoring &dissemination) and the investigative agencies (for institutingcriminal proceedings against fraudulent borrowers) and timelyinitiation of the staff accountability proceedings (for determiningnegligence or connivance, if any) while ensuring that the normalconduct of business of the banks and their risk taking ability is notadversely impacted and no new and onerous responsibilities areplaced on the banks. In order to achieve this objective, theframework has stipulated time lines with the action incumbent ona bank. The time lines / stage wise actions in the loan life-cycleare expected to compress the total time taken by bank to identifya fraud and aid more effective action by the law enforcementagencies. The early detection of Fraud and the necessarycorrective action are important to reduce the quantum of losswhich the continuance of the Fraud may entail.”

20. Clause 8.3 deals with Early Warning Signals[16] and Red FlaggedAccounts.[17] Under Clause 8.3.1, RFA is one where suspicion offraudulent activity is thrown up by the presence of one or more EWS.EWS which should alert bank officials about wrong doings in loanaccount are set out in Annexure II. Some of those enumerated are setout below:

i.a. Default in undisputed payment to statutory bodies asdeclared in the annual report;b. Dishonour of high value cheques;ii.Delay in payment of outstanding dues;iii.Funds coming from other banks to liquidate theoutstanding loan amount except in the normal course;

17 “RFA”

Aiv.Exclusive collateral charged to number of lenderswithout NOCs of existing charge holders;

v.Dispute on title to collateral securities; and

vi.Critical issues in the stock audit report.

B21. EWS provide indications of wrongdoing which may later turnout to be frauds. bank is put on alert by the presence of EWS andmust use them to trigger detailed investigation into the concerned bankaccount. According to Clause 8.3.5, the officer responsible for operationsin the account should promptly report any manifestation of EWS to theFraud Monitoring Group[18] constituted by the bank. The clause directsCbanks to take cognizance of EWS and launch detailed investigationinto an RFA.

22. Clause 8.8 deals with situations where bank is the sole lender.In such situations, the FMG is entrusted with the responsibility to take acall on whether bank account in which EWS are observed should beDclassified as RFA. The bankis permitted to use external auditors beforetaking final call on RFA status. However, within six months the bank isrequired to either lift the RFA status or classify the account as fraud inaccordance with the investigation or forensic audits.

23. Clause 8.9 deals with lending under consortium or multipleEbanking arrangements[19]. Clause 8.9.2 provides that all banks which havefinanced borrower under an MBA should take coordinated action basedon commonly agreed strategy for subsequent legal actions, follow-ups,exchange of details and information on consistent basis. Clauses 8.9.4and 8.9.5 provide the procedure for classification of borrower’s accountas fraud:F

“8.9.4 The initial decision to classify any standard account orNPA account as RFA or Fraud will be at the individual level andit would be the responsibility of this bank to report the RFA orFraud status of the account on the CRILC platform so that otherbanks are alerted. In case it is decided at the individual bankGlevel to classify the account as fraud straightaway at this stageitself, the bank shall then report the fraud to RBI within 21 daysof detection and also report the case to CBI/Police, as it is being

STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS[DR. DHANANJAYA Y CHANDRACHUD, CJI]

done hitherto. Further, within 15 days of RFA/Fraud classification,the bank which has red flagged the account or detected thefraud would ask the consortium leader or the largest lender underMBA to convene meeting of the JLF to discuss the issue. Themeeting of the JLF so requisitioned must be convenedwithin 15 days of such request being received. In casethere is broad agreement, the account should beclassified as fraud; else based on the majority rule ofagreement amongst bank with at least 60% share in thetotal lending, the account should be red flagged by all thebanks and subjected to forensic audit commissioned orinitiated by the consortium leader or the largest lenderunder MBA. All banks, as part of the consortium of multiple-banking arrangement, shall share the costs and provide thenecessary support for such an investigation.8.9.5 The forensic audit must be completed within maximumperiod of three months from the date of the JLF meetingauthorizing the audit. Within 15 days of the completion of theforensic audit, the JLF shall reconvene and decide on the statusof the account, either by consensus or the majority rule as specifiedabove. In case the decision is to classify the account as afraud, the RFA status shall be changed to Fraud in all banksand reported to RBI and on the CRILC platform within aweek of the said decision. Besides, within 30 days of theRBI reporting, the bank commissioning/ initiating theforensic audit should lodge complaint with the CBI onbehalf of all banks in the consortium/MBA. For thispurpose, if the bank initiating the forensic audit is privatesector bank, the complaint shall be lodged with the CBI bythe PSU bank with the largest exposure to the account inthe consortium/MBA. If there is no PSU bank in theconsortium/MBA or it is solo bank lending by privatesector bank/ foreign bank, the private bank/foreign bankshall report to the Police as per extant instructions. Thiswould be in addition to the complaint already lodged by the firstbank which had detected the fraud and informed the consortium/MBA.”

(emphasis supplied)

A24. Clause 8.9.4 stipulates that the initial decision to classify anaccount as RFA or fraud vests with the individual bank. Once the bankclassifies the account as fraud, it is the responsibility of that bank toreport the RFA or fraud status on the account on the Central Repositoryof Information on Large Credits[20] platform to alertother banks. In casethe individual bank decides to straightaway classify the account as fraud,Bit is obligated to report the fraud to RBI within 21 days of detection andalso report the case to CBI/Police. Further, within 15 days the individualbank could ask the consortium leader or the largest lender under theMBA to convene meeting ofthe JLF to discuss the issue. The meetingof the JLF has to be convened within 15 days of the request beingCreceived. The JLF can classify an account as fraud in case there is abroad consensus. Otherwise, the clause indicates that based on anagreement amongst banks with at least 60 percent share in total lending,the account should be red-flagged by all banks and subjected to forensicaudit commissioned or initiated by the consortium leader or the largestlender under MBA.D

25. Clause 8.9.5 states that the forensic audit has to be completedwithin 3 months from the date of the JLF meeting authorizing the audit.Within 15 days of the completion of the audit, the JLF has to decide toclassify the account as fraud and report it to the RBI. The clause alsorequires the bank commissioning the audit to lodge complaint with CBIEon behalf of all banks in the consortium within 30 days of reporting to RBI.

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

27. The penal measures for fraudulent borrowers are set out inClause 8.12 which reads as follows:

8.12 Penal measures for fraudulent borrowersG

8.12.1 In general, the penal provisions as applicable to wilfuldefaulters would apply to the fraudulent borrowers includingthe promoter director(s) and other whole time directors ofthe company insofar as raising of funds from the banking

[DR. DHANANJAYA Y CHANDRACHUD, CJI]

system or from capital markets by companies with whichthey are associated is concerned, etc. In particular,borrowers who have defaulted and have also committed afraud in the account would be debarred from availing bankfinance from Scheduled Commercial Banks, DevelopmentFinancial Institutions, Government owned NBFCs,Investment Institutions, etc., for period of five years fromthe date of full payment of the defrauded amount. After thisperiod, it is for individual institutions to take call on whether tolend to such borrower. The penal provisions would apply to non-wholetime directors (like nominee directors and independentdirectors) only in rarest of cases based on conclusive proof oftheir complicity.

8.12.2 No restructuring or grant of additional facilities maybe made in the case of RFA or fraud accounts. However, incases of fraud/malfeasance where the existing promoters arereplaced by new promoters and the borrower company is totallydelinked from such erstwhile promoters/management, banks andJLF may take view on restructuring of such accounts based ontheir viability, without prejudice to the continuance of the criminalactions against the erstwhile promoters/management.

8.12.3 No compromise settlement involving fraudulent borroweris allowed unless the conditions stipulate that the criminal complaintwill be continued.

8.12.4 In addition to above borrower – fraudsters, third partiessuch as builders, warehouse/ cold storage owners, motor vehicle/tractor dealers, travel agents, etc. and professionals such asarchitects, valuers, chartered accountants, advocates, etc. are alsoheld accountable if they play vital role in credit sanction/disbursement or facilitated the perpetration of frauds. Banks areadvisable to report to Indian Banks Association (IBA) the detailsof such parties involved in frauds.

8.12.5 Before reporting to IBA, banks have to satisfy themselvesof the involvement of third parties concerned and also providethem with an opportunity of being heard. In this regard the banksshould follow normal procedures and the processes followed shouldbe suitably recorded. On the basis of such information, IBA would,

502SUPREME COURT REPORTS

Ain turn, prepare caution lists of such third parties for circulationamong the banks.”

(emphasis supplied)

28. Clause 8.12.1 provides that the penal provisions as applicableto willful defaulters would apply to fraudulent borrowers as regards theBraising of funds from the banking system and financial institutions.Importantly, under the clause, fraudulent borrowers include promoters,directors, and other whole-time directors of the borrowing company. Itdebars fraudulent borrowers from availing banking finance fromscheduled commercial banks, development financial institutions,Cgovernment owned NBFCs, investment institutions, etc. for period offive years from the date of full payment of the defrauded amount. Evenafter the completion of the five-year period, it is for the individual financialinstitutions to decide whether to lend to fraudulent borrowers, includingdirectors and promoters of the borrowing company. Additionally, underClause 8.12.2, fraudulent borrowers are denied restructuring or grant ofDadditional facilities by banks and other such financial institutions.

D.2 Audi Alteram Partem

29. We need to bear in mind that the principles of natural justiceare not mere legal formalities. They constitute substantive obligationsthat need to be followed by decision-making and adjudicating authorities.EThe principles of natural justice act as guarantee against arbitraryaction, both in terms of procedure and substance, by judicial, quasi-judicial,and administrative authorities. Two fundamental principles of naturaljustice are entrenched in Indian jurisprudence: (i) nemo judex in causasua, which means that no person should be judge in their own cause;Fand (ii) audi alteram partem, which means that person affected byadministrative, judicial or quasi-judicial action must be heard before adecision is taken.The courts generally favor interpretation of statutoryprovision consistent with the principles of natural justice because it ispresumed that the statutory authorities do not intend to contravenefundamental rights. Application of the said principles depends on theGfacts and circumstances of the case, express language and basic schemeof the statute under which the administrative power is exercised, thenature and purpose for which the power is conferred, and the final effectof the exercise of that power.[21]

30. While the borrowers argue that the actions of banks inclassifying borrower accounts as fraud according to the procedure laiddown under the Master Directions on Frauds is in violation of the principlesof natural justice, the RBI and lender banks argue that these principlescannot be applied at the stage of reporting criminal offence toinvestigating agencies. At the outset, we clarify that principles of naturaljustice are not applicable at the stage of reporting criminal offence,which is consistent position of law adopted by this Court. In Union ofIndia v. W N Chadha, two-judge bench of this Court held that thatproviding an opportunity of hearing to the accused in every criminalcase before taking any action against them would “frustrate theproceedings, obstruct the taking of prompt action as law demands, defeatthe ends of justice and make the provisions of law relating to theinvestigation lifeless, absurd, and self-defeating.”[22 ]Again, two-judgebench of this Court in Anju Chaudhary v. State of UP[23] has reiteratedthat the Code of Criminal Procedure, 1973 does not provide for right ofhearing before the registration of an FIR.

31. Chapter VIII of the Master Directions on Fraud providesdetailed procedures to be followed by the banks before forming anopinion to proceed with criminal complaint against the borrowers.Under the said chapter, the lender banks have to report borrower tothe CBI after classifying the borrower’s account as fraudulent.However, the classification of the borrower’s account does notsimpliciter lead to reporting of criminal complaint with the enforcementauthorities; it also entails penal consequences for the borrowers aslaid down under Clause 8.12.

32. The process of forming an informed opinion under the MasterDirections on Frauds is administrative in nature. This has also been accededto by RBI and lender banks in their written submissions. It is now asettled principle of law that the rule of audi alteram partem applies toadministrative actions, apart from judicial and quasi-judicial functions.[24]It is also settled position in administrative law that it is mandatory toprovide for an opportunity of being heard when an administrative actionresults in civil consequences to person or entity.

22 1993 Supp (4) SCC 260

23 (2013) 6 SCC 384

24 K Kraipak v. Union of India, (1969) 2 SCC 262; Governing Body, St Anthony’sCollege, Shillong and Ors v. Rev. Fr. Paul Petta of Shillong, (1988) Supp SCC 676; UmaNath Pandey and Ors v. State of Uttar Pradesh, (2009) 12 SCC 40.

A33. In State of Orissa v. Dr (Miss) Binapani Dei[25], two-judge bench of this Court held that every authority which has the powerto take punitive or damaging action has duty to give reasonableopportunity to be heard. This Court further held that an administrativeaction which involves civil consequences must be made consistent withthe rules of natural justice:B

“9. […] The rule that party to whose prejudice an order isintended to be passed is entitled to hearing applies alike to judicialtribunals and bodies of persons invested with authority to adjudicateupon matters involving civil consequences. It is one of thefundamental rules of our constitutional set-up that every citizen isCprotected against exercise of arbitrary authority by the State orits officers. Duty to act judicially would therefore arise from thevery nature of the function intended to be performed: it need notbe shown to be super-added. If there is power to decide anddetermine to the prejudice of person, duty to act judicially isDimplicit in the exercise of such power. If the essentials of justicebe ignored and an order to the prejudice of person is made, theorder is nullity. That is basic concept of the rule of law andimportance thereof transcends the significance of decision inany particular case.”

E34. In Maneka Gandhi v. Union of India[26], seven-judge benchof this court held that any person prejudicially affected by decision ofthe authority entailing civil consequences must be given an opportunityof being heard. This has been reiterated in catena of decisions of thisCourt. In view of the settled position of law, the next question that arisesFbefore us is the scope and definition of the phrase ‘civil consequences’.

35. In Mohinder Singh Gill v. Chief Election Commissioner,New Delhi[27], Constitution Bench of this Court held that ‘civilconsequences’ cover infraction of not merely property or personal rightsbut of civil liberties, material deprivations, and non-pecuniary damages.GIn that case, the Court held that denial of democratic right to cast avote inflicts civil consequences. In K Yadav v. J M Industries[28],

25 AIR 1967 SC 126926 (1978) 1 SCC 248

27 (1978) 1 SCC 405H28 (1993) 3 SCC 259

three-judge bench of this Court observed that “everything that affectsa citizen in his civil life inflicts civil consequence.”

36. In Canara Bank v. V K Awasthy[29], two-judge bench ofthis Court succinctly summarized the history, scope, and application ofthe principles of natural justice to administrative actions involving civilconsequences in the following terms:

14. Concept of natural justice has undergone great deal of changein recent years. Rules of natural justice are not rules embodiedalways expressly in statute or in rules framed thereunder. Theymay be implied from the nature of the duty to be performed undera statute. What particular rule of natural justice should be impliedand what its context should be in given case must depend to agreat extent on the fact and circumstances of that case, theframework of the statute under which the enquiry is held. The olddistinction between judicial act and an administrative act haswithered away. Even an administrative order which involvescivil consequences must be consistent with the rules ofnatural justice. The expression “civil consequences”encompasses infraction of not merely property or personalrights but of civil liberties, material deprivations and non-pecuniary damages. In its wide umbrella comes everythingthat affects citizen in his civil life.

(emphasis supplied)

There is consistent pattern of judicial thought that civilconsequences entail infractions not merely of property or personal rights,but also of civil liberties, material deprivations, and non-pecuniarydamages. Every order or proceeding which involves civil consequencesor adversely affects citizen should be in accordance with the principlesof natural justice.

37. The next question that requires our consideration is whetherthe classification of borrower’s account as fraudulent under the MasterDirections on Frauds entails civil consequences to borrowers.

38. The RBI and lender banks have argued that the civilconsequences contemplated in Clause 8.12.1 of the Master Directionson Frauds are reasonable. Under the said clause, the borrower, including

Athe promoters and directors of the company, are barred from availingcredit from financial markets and credit markets for period of fiveyears, and possibly even beyond. According to RBI and lender banks,such restriction has to be perceived from the perspective of publicinterest. While acknowledging that the procedure which has been laiddown in the Master Directions on Frauds is conceived in public interest,Bto protect the banking system, we cannot ignore the serious civilconsequences which emanate to the borrowers.

39. Clause 8.12 of the Master Directions on Frauds deals withthe penal measures for borrowers. Clause 8.12.1 provides that penalprovisions as applicable to wilful defaulters would apply to fraudulentCborrowers, including the promoters and directors of the borrowercompany. The consequences that apply to wilful defaulter under theMaster Circular on Wilful Defaulters have been culled out in JahDevelopers (supra):

“9. […] serious consequences follow after person has beenDclassified as wilful defaulter. These consequences are as follows:(a) No additional facilities to be granted by any bank/financialinstitution [para 2.5(a)].

(b) Entrepreneurs/Promoters would be barred from institutionalEfinance for period of 5 years [para 2.5(a)].(c) Any legal proceedings can be initiated, including criminalcomplaints [para 2.5(b)].

(d) Banks and financial institutions to adopt proactive approach inchanging the management of the wilful defaulter [para 2.5(c)].F(e) Promoter/Director of wilful defaulter shall not be inducted byanother borrowing company [para 2.5(d)].

(f) As per Section 29-A of the Insolvency and Bankruptcy Code,2016, wilful defaulter cannot be resolution applicant.”G40. In addition to the above consequences, borrowers are alsoliable to suffer the following consequences under the Master Directionson Frauds:

a)No restructuring may be made in the case of an RFA orfraud accounts (clause 8.12.2)H

STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS[DR. DHANANJAYA Y CHANDRACHUD, CJI]

b)No compromise on settlement involving fraudulentborrower is allowed unless the conditions stipulate that thecriminal complaint will be continued (clause 8.12.3)

The above consequences show that the classification of aborrower’s account as fraud under the Master Directions on Frauds hasdifficult civil consequences for the borrower. The classification of anaccount as fraud not only results in reporting the fact to investigatingagencies, but has other penal and civil consequences as specified inClauses 8.12.1 and 8.12.3. The borrowers have placed reliance on JahDevelopers (supra) to submit that debarring them from accessinginstitutional finance under Clause 8.12.1 of the Master Directions affectsthe fundamental right of the borrower to carry on business. On the otherhand, the RBI and lender banks have argued that reliance on theobservations in Jah Developers (supra) is misplaced because thedecision dealt with the classification of borrower as wilful defaulter,whereas the present batch of appeals deal with the classification of aborrower’s account as fraud.41. The question in Jah Developers (supra) was whether aperson who is declared to be wilful defaulter according to the procedurelaid down in the Master Circular on Wilful Defaulters is entitled to berepresented by lawyer of their choice before sucha declaration is made.The Court held that borrower does not have the right to be representedby lawyer in the course of in-house proceedings envisaged in Paragraph3 of the Master Circular on Wilful Defaulters. Paragraph 3 of the MasterCircular on Wilful Defaulters provides two-tier process for identificationof wilful defaulter. At the first stage, First Committee headed by anExecutive Director or equivalent and consisting of two other seniorofficers of the bank must, after examining the evidence of wilful defaultand concluding that wilful default has occurred, issue show-cause noticeto the concerned borrowers and promoters/ whole-time directors callingfor their submissions. The First Committee has to consider thesubmissions before recording the fact of wilful default with reasons. Ifthe Committee deems it necessary, it could also provide personal hearingto the borrower and the promoter/ whole-time director of the borrowingcompany. The second stage is that the order of the First Committee isreviewed by another Committee, known as the Review Committee. Thus,it is clear that the procedure for declaration of borrower as wilfuldefaulter is different from the procedure envisaged under the Master

ADirections on Frauds for classifying borrower’s account as fraud.However, by virtue of Clause 8.12.1 of the Master Directions on Frauds,the penal provisions applicable to wilful defaulters also apply tofraudulent borrowers. Thus, although the procedure adopted fordeclaration of wilful defaulter is different from that envisaged forclassifying the borrower’s account as fraud, they will face similarBconsequences. In fact, as mentioned above, the borrowers’ accountsclassified as fraud under the Master Directions on Frauds will facecertain additional consequences which have been laid down in Clauses8.12.2 and 8.12.3. Since the consequences flowing from the twocirculars are similar, the observations in Jah Developers (supra) onCthe effect of declaring borrower as wilful defaulter will be squarelyapplicable to the present case. The observations of the Court are extractedbelow:

24. However, we are of the view that Article 19(1)(g) isattracted in the facts of the present case as the moment aDperson is declared to be wilful defaulter, the impact on itsfundamental right to carry on business is direct andimmediate. This is for the reason that no additional facilitiescan be granted by any bank/financial institutions, andentrepreneurs/promoters would be barred from institutionalfinance for five years. Banks/financial institutions can evenEchange the management of the wilful defaulter, and apromoter/director of wilful defaulter cannot be madepromoter or director of any other borrower company. Equally,under Section 29-A of the Insolvency and Bankruptcy Code, 2016,a wilful defaulter cannot even apply to be resolution applicant.FGiven these drastic consequences, it is clear that theRevised Circular, being in public interest, must beconstrued reasonably.

(emphasis supplied)

In Jah Developers (supra), this Court construed the MasterGCircular on Wilful Defaulters by harmonizing it with the principles ofnatural justice. Particularly, it was directed that: (i) the First Committeemust give its order to the borrower as soon as possible; (ii) the Borrower,thereafter, can file written representation against the order of FirstCommittee to the Review Committee; and (iii) the Review CommitteeHmust pass reasoned order which must be provided to the borrower.

42. Classification of the borrower’s account as fraud under theMaster Directions on Frauds virtually leads to credit freeze for theborrower, who is debarred from raising finance from financial marketsand capital markets. The bar from raising finances could be fatal for theborrower leading to its ‘civil death’ in addition to the infraction of theirrights under Article 19(1)(g) of the Constitution. Since debarring disentitlesa person or entity from exercising their rights and/or privileges, it iselementary that the principles of natural justice should be made applicableand the person against whom an action of debarment is sought should begiven an opportunity of being heard.Indeed, debarment is akin toblacklisting borrower from availing credit. Black’s Law Dictionary[30]explains the term ‘blacklist’ has been defined in the following terms:

“A list of persons marked out for special avoidance, antagonism,or enmity on the part of those who prepare the list or those amongwhom it is intended to circulate; as where trades-union“blacklists” workmen who refuse to conform to its rules, or wherea list of insolvent or untrustworthy persons is published bya commercial agency or mercantile association.”

(emphasis supplied)

Similarly, P Ramanatha Aiyar’s Law Lexicon[31] defines the term“blacklist” as follows:

“Black List is list of persons or firms against whom its compilerwould warn the public, or some section of the public; list ofpersons unworthy of credit, or with whom it is not advisableto make contracts. Thus the official list of defaulters on theStock Exchange is black list. To put man’s name on such ablack list without lawful cause is actionable; and the furtherpublication of such list will be restrained by injunction.”

(emphasis supplied)

43. blacklist is: (i) list of insolvent or untrustworthy personspublished by commercial agency or mercantile association; and (ii) alist of persons unworthy of credit, or with whom it is not advisable tomake contracts. Before this Court, the RBI and lender banks have

30 Black’s Law Dictionary, 5thedn (1979)

31 P Ramanatha Aiyar, ‘The Law Lexicon: The Encyclopedic Law Dictionary’ (1997edn)

Asubmitted that debarring borrowers from accessing institutional financeis necessary to not only prevent the same persons from committing fraudsin other banks, but also to proscribe banks from dealing with unscrupulousborrowers in public interest. Debarring borrower under Clause 8.12.1of the Master Directions on Frauds is akin to blacklisting the borrowerfor being untrustworthy and unworthy of credit by the banks. This CourtBhas consistently held that an opportunity of hearing ought to be providedbefore person is put on blacklist.

44. In Erusian Equipment & Chemicals Ltd v. State of WestBengal[32], the issue before this Court was whether person is entitledto notice to be heard before being blacklisted by the government. ThisCCourt held that since blacklisting affects the privileges of the blacklistedperson, fundamentals of fair play require that such person be providedan opportunity of being heard:

“20. Blacklisting has the effect of preventing person from theprivilege and advantage of entering into lawful relationship withDthe Government for purposes of gains. The fact that disability iscreated by the order of blacklisting indicates that the relevantauthority is to have an objective satisfaction. Fundamentals offair play require that the person concerned should be given anopportunity to represent his case before he is put on the blacklist.”

E45. In Joseph Vilangandan v. Executive Engineer[33], the issuebefore the two-judge pertained to debarment of government contractorfrom seeking any further contract with the government without providingan opportunity of being heard. The material sentence of the notice thereread as follows:F“You are therefore requested to show cause ... why the workmay not be arranged otherwise at your risk and loss, through otheragencies after debarring you as defaulter....”

(emphasis original)

This Court applied the position of law in Erusian Equipment &GChemicals Ltd (supra) to hold that the Executive Engineer ought tohave given the contractor adequate opportunity to represent against theproposed action of debarment.

32 (1975) 1 SCC 70H33 (1978) 3 SCC 36

46. In Raghunath Thakur v. State of Bihar[34], two-judge benchof this Court held that since blacklisting entails civil consequences anorder of blacklisting should be issued only after following the principlesof natural justice:

“4. […] Insofar as the contention that there is no requirementspecifically of giving any notice is concerned, the respondent isright. But it is an implied principle of the rule of law that any orderhaving civil consequence should be passed only after followingthe principles of natural justice. It has to be realised that blacklistingany person in respect of business ventures has civil consequencefor the future business of the person concerned in any event.Even if the rules do not express so, it is an elementary principle ofnatural justice that parties affected by any order should have rightof being heard and making representations against the order. […]”

47. In Gorkha Security Services v. Govt (NCT of Delhi)[35],the issue before this Court pertained to the form and content of show-cause notice that is required to be served before blacklisting the noticee.A two-judge bench of this Court observed that that an order blacklistinga person is stigmatic. The relevant observation is extracted below:

16. It is common case of the parties that the blacklisting has tobe preceded by show-cause notice. Law in this regard is firmlygrounded and does not even demand much amplification. Thenecessity of compliance with the principles of natural justice bygiving the opportunity to the person against whom action ofblacklisting is sought to be taken has valid and solid rationalebehind it. With blacklisting, many civil and/or evilconsequences follow. It is described as “civil death” of aperson who is foisted with the order of blacklisting. Suchan order is stigmatic in nature and debars such personfrom participating in government tenders which meansprecluding him from the award of government contracts.

(emphasis supplied)

48. Classification ofa borrower’s account as fraud has the effectof preventing the borrower from accessing institutional finance for the

34 (1989) 1 SCC 229

35 (2014) 9 SCC 105

Apurpose of business. It also entails significant civil consequences as itjeopardizes the future of the business of the borrower. Therefore, theprinciples of natural justice necessitate giving an opportunity of hearingbefore debarring the borrower from accessing institutional finance underClause 8.12.1 of the Master Directions on Frauds. The action of classifyingan account as fraud not only affects the business and goodwill of theBborrower, but also the right to reputation.

49. In State of Maharashtra v. Public Concern for GovernanceTrust[36], two-judge bench of this Court held that decision taken byany authority affecting the right to reputation of an individual has civilconsequences. Therefore, in such situations the principles of naturalCjustice would come into play. The Court held that any order or decisionof the authority adversely affecting the personal reputation of an individualmust be taken after following the principles of natural justice:

“41. It is thus amply clear that one is entitled to have and preserveone’s reputation and one also has right to protect it. In case anyDauthority in discharge of its duties fastened upon it under the law,travels into the realm of personal reputation adversely affectinghim, it must provide chance to him to have his say in the matter.In such circumstances, right of an individual to have the safeguardof the principles of natural justice before being adverselyEcommented upon is statutorily recognised and violation of the samewill have to bear the scrutiny of judicial review.”

50. The RBI and lender banks have relied on Peerless GeneralFinance and Investment Co. Ltd v. Reserve Bank of India[37],Joseph Kuruvilla Vellukunnel v. Reserve Bank of India[38], andInternet and Mobile Association of India v. Reserve Bank ofFIndia[39] to submit that the Master Directions on Frauds are akin to astatutory regulation and decision on economic policy, which must beaccorded level of deference.

51. The competence of the RBI to issue the Master Directions onGFrauds is not bone of contention in these appeals. The RBI, in itsestimation, has the power to determine and frame economic measures

36 (2007) 3 SCC 58737 (1992) 2 SCC 34338 AIR 1962 SC 1371H39 (2020) 10 SCC 274

STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS[DR. DHANANJAYA Y CHANDRACHUD, CJI]

in the public interest to ensure the proper management of bankingcompanies. The point however is that the implementation of decisionto secure the health of banking companies must comport with the dueprocess of law. The civil consequences which follow upon classificationof borrower’s account as fraud are serious and prejudicial to theinterests of borrower. Principles of fair play require that borrowerought to be given an opportunity of being heard before classifying theaccount as fraud in accordance with the procedure laid down under theMaster Directions on Frauds.

D.3 No implied exclusion of audi alteram partem

52. The RBI and the lender banks have contended that the MasterDirections on Frauds impliedly exclude the right to be heard. The objectiveof the Master Directions on Frauds is to ensure timely detection andreporting of cases of fraud to alert other banks and initiate criminalproceedings. The Directions contemplate an opportunity of hearing to athird party who is involved in the commission of fraudulent activity, butdo not explicitly provide for hearing to borrower. Thus, it is urged thathearing to the borrowers is excluded by necessary implication.53. The Master Directions on Frauds do not expressly exclude aright of hearing to the borrowers before action to class their account asfrauds is initiated. The principles of natural justice can be read into astatute or notification where it is silent on granting an opportunity of ahearing to party whose rights and interests are likely to be affected bythe orders that may be passed.

54. In decision of three-judge bench of this Court in SwadeshiCotton Mills v. Union of India[40], the issue was whether the Centralgovernment was required to comply with the requirements of audi alterampartem before it took over the management of an industrial undertakingunder Section 18-AA(1)(a) of the Industries (Development andRegulation) Act, 1951[41]. R S Sarkaria, J speaking for the majorityconsisting of himself and Desai, J laid down the following principlesof law:

44. In short, the general principle — as distinguished from anabsolute rule of uniform application — seems to be that where astatute does not, in terms, exclude this rule of prior hearing but

40 (1981) 1 SCC 664

41 “IDR Act, 1951”

Acontemplates post-decisional hearing amounting to full reviewof the original order on merits, then such statute would beconstrued as excluding the audi alteram partem rule at the pre-decisional stage. Conversely, if the statute conferring thepower is silent with regard to the giving of pre-decisionalhearing to the person affected and the administrativeBdecision taken by the authority involves civil consequencesof grave nature, and no full review or appeal on meritsagainst that decision is provided, courts will be extremelyreluctant to construe such statute as excluding the dutyof affording even minimal hearing shorn of all its formalCtrappings and dilatory features at the pre-decisional stage,unless, viewed pragmatically, it would paralyse theadministrative progress or frustrate the need for utmostpromptitude. In short, this rule of fair play “must not bejettisoned save in very exceptional circumstances wherecompulsive necessity so demands”. The court must makeDevery effort to salvage this cardinal rule to the maximumextent possible, with situational modifications. But, to recallthe words of Bhagwati, J., the core of it must, however, remain,namely, that the person affected must have reasonable opportunityof being heard and the hearing must be genuine hearing and notEan empty public relations exercise.

(emphasis supplied)

55. The main point for consideration before this Court in SwadeshiCotton Mills (supra) was whether the use of the phrase “immediateaction is necessary” under Section 18-AA(1)(a) of the IDR Act impliedlyFexcluded the application of the audi alteram partem rule. Sarkaria, J heldthat the expression “immediate action”, construed in light of the overallcontext, object and reasons of the legislation,did not necessarily indicatean intention to exclude the requirement of prior hearing. The Court heldthat the use of the phrase does not exclude the duty to comply with theGaudi alteram partem rule:

“77. The second reason — which is more or less facet ofthe first — for holding that the mere use of the word“immediate” in the phrase “immediate action is necessary”,does not necessarily and absolutely exclude the priorHapplication of the audi alteram partem rule, is that immediacy

STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS[DR. DHANANJAYA Y CHANDRACHUD, CJI]

or urgency requiring swift action is situational fact havinga direct nexus with the likelihood of adverse effect on fallin production. And, such likelihood and the urgency of actionto prevent it, may vary greatly in degree. The words “likelyto affect. . .production” used in Section 18-AA(1)(a) areflexible enough to comprehend wide spectrum of situationsranging from the one where the likelihood of the happeningof the apprehended event is imminent to that where it maybe reasonably anticipated to happen sometime in the nearfuture. Cases of extreme urgency where action under Section18-AA(1)(a) to prevent fall in production and consequent injuryto public interest, brooks absolutely no delay, would be rare. Inmost cases, where the urgency is not so extreme, it is practicableto adjust and strike balance between the competing claims ofhurry and hearing.”

(emphasis supplied)

Sarkaria, J observed that that the owner of an undertaking is entitledto fair hearing at the pre-decisional stage because the power of theCentral government under Section 18AA-(1)(a) to take over is far-reaching and adversely affects the rights and interests of owners.

56. In Mangilal v. State of Madhya Pradesh[42], two-judgebench of this Court held that the principles of natural justice need to beobserved even if the statute is silent in that regard. In other words, astatutory silence should be taken to imply the need to observe theprinciples of natural justice where substantial rights of parties are affected:

10. Even if statute is silent and there are no positive wordsin the Act or the Rules made thereunder, there could benothing wrong in spelling out the need to hear the partieswhose rights and interest are likely to be affected by theorders that may be passed, and making it requirement tofollow fair procedure before taking decision, unless thestatute provides otherwise. The principles of natural justicemust be read into unoccupied interstices of the statute,unless there is clear mandate to the contrary. No form orprocedure should ever be permitted to exclude thepresentation of litigant’s defence or stand. Even in the

Aabsence of provision in procedural laws, power inheres in everytribunal/court of judicial or quasi-judicial character, to adoptmodalities necessary to achieve requirements of natural justiceand fair play to ensure better and proper discharge of their duties.Procedure is mainly grounded on the principles of natural justiceirrespective of the extent of its application by express provision inBthat regard in given situation. It has always been cherishedprinciple. Where the statute is silent about the observanceof the principles of natural justice, such statutory silence istaken to imply compliance with the principles of naturaljustice where substantial rights of parties are considerablyCaffected. The application of natural justice becomespresumptive, unless found excluded by express words ofstatute or necessary intendment. Its aim is to secure justiceor to prevent miscarriage of justice. Principles of naturaljustice do not supplant the law, but supplement it. Theserules operate only in areas not covered by any law validly made.DThey are means to an end and not an end in themselves. […]

(emphasis supplied)

57. As counter to the above legal position, the RBI and lenderbanks have contended that the principles of natural justice could beEexcluded in cases where there is requirement of promptitude or exigentaction. In support of the submission, the RBI and banks have relied uponAjit Kumar Nag v. General Manager (PJ), Indian Oil Corp. Ltd[43],which in turn relied on the Constitution Bench decision of this Court inUnion of India v. Tulsiram Patel.[44] In Tulsiram Patel (supra), thisCourt observed that right to prior notice and an opportunity to beFheard could be excluded if allowing for such right would obstruct thetaking of prompt action:

101. […] So far as the audi alteram partem rule is concerned,both in England and in India, it is well established that where aright to prior notice and an opportunity to be heard before anGorder is passed would obstruct the taking of prompt action, such aright can be excluded. This right can also be excluded where thenature of the action to be taken, its object and purpose and thescheme of the relevant statutory provisions warrant its exclusion;

43 (2005) 7 SCC 764H44 (1985) 3 SCC 398

nor can the audi alteram partem rule be invoked if importing itwould have the effect of paralysing the administrative process orwhere the need for promptitude or the urgency of taking action sodemands, […]

58. The borrowers have dwelt on Clause 8.9.6 of the MasterDirections on Frauds according to which the entire exercise commencingfrom the detection of fraud by an individual bank upto the declaration offraud by the JLF is to be completed within six months. Clause 8.9.6provides thus:

“8.9.6 It may be noted that the overall time allowed for the entireexercise to be completed is six months from the date when thefirst member bank reported the account as RFA or Fraud on theCRILC platform.”

59. In K I Shephard v. Union of India[45], this Court was calledupon to decide the validity of amalgamation schemes drawn by the RBI,whereunder three private banks were amalgamated with nationalizedbanks. At the time of merger, some employees of the private bankswere excluded from employment as their services were not taken overby the transferee banks in view of allegations of misconduct againstthem. While noting the fact that the entire process of amalgamation wasstatutorily required to be completed within 6 months, this Court held thatthe said time frame provides scope for granting an opportunity of hearingto the affected employees:

15. […] We do not think in the facts of the case there is anyjustification to hold that rules of natural justice have been oustedby necessary implication on account of the time frame. On theother hand we are of the view that the time limited by statuteprovides scope for an opportunity to be extended to the intendedexcluded employees before the scheme is finalised so that hearingcommensurate to the situation is afforded before section of theemployees is thrown out of employment.

60. The decision of this Court in Swadeshi Cotton Mills (supra)and K I Shephard (supra) demonstrates that the exigency of situationis contextual. The Court must lean in favour of reading in the principlesof natural justice when faced with regulatory silence. Any exclusionmust be confined to the narrowest possible limits. The application of the

Arequirement of prior hearing could be excluded only in situations whereimporting it would have the effect of paralyzing the entire process. Asmentioned above, Clause 8.9.6 of the Master Directions on Fraudscontemplates that the procedure for the classification of an account asfraud has to be completed within six months. The procedure adoptedunder the Master Directions on Frauds provides enough time to the banksBto deliberate before classifying an account as fraud. During this interval,the banks can serve notice to the borrowers, and give them an opportunityto submit their reply and representation regarding the findings of theforensic audit report. Given the wide time frames contemplated underthe Master Directions on Frauds as well as the nature of the procedureCadopted, it is reasonably practicable for banks to provide an adequateopportunity of hearing to the borrowers before classifying their accountas fraud. The exclusion contemplated in the decision of this Court inTulsiram Patel (supra) would not be applicable because giving anopportunity of hearing to the borrowers will not obstruct the taking ofprompt action under the Master Directions on Frauds.D61. The RBI and lender banks have further submitted that therequirement of natural justice is already fulfilled under the MasterDirections on Frauds as the borrower is allowed to participate during thepreparation of the forensic audit report. On the other hand, the borrowershave submitted that the Master Directions do not expressly provide forEparticipation of the borrowers during forensic audit report. It was alsosubmitted that merely seeking inputs of borrowers during the preparationof the forensic audit report does not satisfy the requirements of theprinciples of natural justice as the borrowers should also be heard beforeclassifying them as fraud.F[[46]]

62. In Keshav Mills Co. Ltd. v. Union of India[[46]], this Courtwas dealing with the issue of takeover of company by the governmentunder the IDR Act, 1951 after completion of full investigation into theaffairs of the company. The issue was whether the report of aninvestigating body appointed by an administrative authority should beGmade available to the person concerned before the authority takes adecision upon that report. While deciding to lay down general principle,this Court observed that there may be certain situations where aninvestigation report is required to be furnished to the concerned party tomake an effective representation about the proposed action:

STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS[DR. DHANANJAYA Y CHANDRACHUD, CJI]

21. In our opinion it is not possible to lay down any general principleon the question as to whether the report of an investigating bodyor of an inspector appointed by an administrative authority shouldbe made available to the persons concerned in any given casebefore the authority takes decision upon that report. The answerto this question also must always depend on the facts andcircumstances of the case. It is not at all unlikely that theremay be certain cases where unless the report is given theparty concerned cannot make any effective representationabout the action that Government takes or proposes to takeon the basis of that report. Whether the report should befurnished or not must therefore depend in every individualcase on the merits of that case. We have no doubt that in theinstant case non-disclosure of the report of the InvestigatingCommittee has not caused any prejudice whatsoever to theappellants.

(emphasis supplied)

63. In Swadeshi Cotton Mills (supra), this Court held that acompany is entitled to an opportunity to explain the evidence collectedagainst it and represent why the proposed action should not be taken:

85. The contention does not appear to be well founded. Firstly,this documentary evidence, at best, shows that the Company wasin debt and the assets of some of its “units” had been hypothecatedor mortgaged as security for those debts. Given an opportunitythe Company might have explained that as result of thisindebtedness there was no likelihood of fall in production, whichis one of the essential conditions in regard to which the Governmentmust be satisfied before taking action under Section 18A-A(1)(a).Secondly, what the rule of natural justice required in thecircumstances of this case, was not only that the Companyshould have been given an opportunity to explain theevidence against it, but also an opportunity to be informedof the proposed action of take over and to represent why itbe not taken.

(emphasis supplied)

64. Audi alteram partem has several facets, including the serviceof notice to any person against whom prejudicial order may be passed

Aand providing an opportunity to explain the evidence collected. In TulsiramPatel (supra), this Court explained the wide amplitude of audi alterampartem:

96. The rule of natural justice with which we are concernedin these appeals and writ petitions, namely, the audi alteramBpartem rule, in its fullest amplitude means that personagainst whom an order to his prejudice may be passedshould be informed of the allegations and charges againsthim, be given an opportunity of submitting his explanationthereto, have the right to know the evidence, both oral ordocumentary, by which the matter is proposed to be decidedCagainst him, and to inspect the documents which are reliedupon for the purpose of being used against him, to havethe witnesses who are to give evidence against himexamined in his presence and have the right to cross-examine them, and to lead his own evidence, both oral andDdocumentary, in his defence. The process of fair hearingneed not, however, conform to the judicial process in Court oflaw, because judicial adjudication of causes involves number oftechnical rules of procedure and evidence which are unnecessaryand not required for the purpose of fair hearing within themeaning of audi alteram partem rule in quasi-judicial orEadministrative inquiry. […]

(emphasis supplied)

65. Audi alteram partem, therefore, entails that an entity againstwhom evidence is collected must: (i) be provided an opportunity to explainthe evidence against it; (ii) be informed of the proposed action, and (iii)Fbe allowed to represent why the proposed action should not be taken.Hence, the mere participation of the borrower during the course of thepreparation of forensic audit report would not fulfil the requirementsof natural justice. The decision to classify an account as fraud involvesdue application of mind to the facts and law by the lender banks. TheGlender banks, either individually or through JLF, have to decide whethera borrower has breached the terms and conditions of loan agreement,and based upon such determination the lender banks can seek appropriateremedies. Therefore, principles of natural justice demand that theborrowers must be served notice, given an opportunity to explain thefindings in the forensic audit report, and to represent before the accountHis classified as fraud under the Master Directions on Frauds.

D.4 Challenge to constitutional validity

66. The borrowers have argued that the Master Directions onFrauds will have to be struck down as arbitrary and unconstitutional forconferring unguided and unbridled powers on banks. To counter thesubmission, the RBI and lender banks have relied upon the decision inDelhi Cloth Mills & General Mills v. Union of India[47] to submitthat the provisions of the Master Directions on Frauds are not arbitraryas they have reasonable nexus to the object sought to be achieved. Itwas further argued that the Courts should not interfere with and supplanttheir wisdom in an economic policy decision unless there is blatantperversity, arbitrariness, or mala fides.

67. The RBI hasthe right to take all such measures as arenecessary to protect the health of the banking system. Hence, the MasterDirections on Frauds lay down the procedure for banks, who in case ofa breach of loan agreements by borrowers, can seek appropriate remediesby approaching law enforcement agencies and debarring borrowers fromaccessing further institutional finance. However, any policy decision whichcontemplates serious civil consequences for any person will be open tochallenge for being arbitrary if the principles of natural justice are notapplied during the process.

68. In P Royappa v. State of Tamil Nadu[48], this Court heldthat an arbitrary state action is violative of Article 14 of the Constitution.Again, in Maneka Gandhi (supra) this court reiterated that the principleof non-arbitrariness pervades Article 14.An administrative action canbe tested for constitutional infirmities under Article 14 on four grounds:(i) unreasonableness or irrationality; (ii) illegality; (iii) proceduralimpropriety;[49] and (iv) proportionality. However, the scope of such judicialreview is limited to ascertaining the deficiency in the decision-makingprocess, and not the correctness of the choice made by the administrator.[50]

69. Fairness in action requires that procedures which permitimpairment of fundamental right sought to be just, fair, and reasonable.The principles of natural justice have universal application and constitute

47 (1983) 4 SCC 16648 (1974) 4 SCC 3

49 State of AP v. McDowell, (1996) 3 SCC 709; Om Kumar v. Union of India, (2001) 2SCC 38650 Chairman and Managing Director, United Commercial Bank v. P Kakkar, (2003) 4SCC 364

Aan important facet of procedural propriety envisaged under Article 14.The rule of audi alteram partem is recognized as being part of theguarantee contained in Article 14. Constitution Bench of this Court inTulsiram Patel (supra) has categorically held that violation of theprinciples of natural justice is violation of Article 14. The court heldthat any state action in breach of natural justice implicates violation ofBArticle 14:

“95. The principles of natural justice have thus come to berecognized as being part of the guarantee contained in Article14 because of the new and dynamic interpretation given by thisCourt to the concept of equality which is the subject-matter ofCthat article. Shortly put, the syllogism runs thus: violation of ruleof natural justice results in arbitrariness which is the same asdiscrimination; where discrimination is the result of State action, itis violation of Article 14: therefore, violation of principleof natural justice by State action is violation of ArticleD14. Article 14, however, is not the sole repository of theprinciples of natural justice. What it does is to guaranteethat any law or State action violating them will be struckdown. The principles of natural justice, however, apply notonly to legislation and State action but also where anytribunal, authority or body of men, not coming within theEdefinition of State in Article 12, is charged with the duty ofdeciding matter. In such case, the principles of natural justicerequire that it must decide such matter fairly and impartially.”

(emphasis supplied)

F70. In Cantonment Board v. Taramani Devi[51], two-judgebench of this Court held that the rule of audi alteram partem is part ofArticle 14. Similarly, in Delhi Transport Corporation v. DTC MazdoorCongress[52], this Court observed that the rule of audi alteram partemenforces the equality clause in Article 14. Therefore, any administrativeaction which violates the rule of audi alteram partem is arbitrary andGviolative of Article 14.

71. Administrative proceedings which entail significant civilconsequences must be read consistent with the principles of natural

51 1992 Supp (2) SCC 501H52 1991 Supp (1) SCC 600

justice to meet the requirement of Article 14. Where possible, the rule ofaudi alteram partem ought to be read into statutory rule to render itcompliant with the principles of equality and non-arbitrariness envisagedunder Article 14. The Master Directions on Frauds do not expresslyprovide the borrowers an opportunity of being heard before classifyingthe borrower’s account as fraud. Audi alteram partem must then beread into the provisions of the Master Directions on Frauds.

72. In Olga Tellis v. Bombay Municipal Corporation[53], aConstitution Bench of this Court was called upon to adjudge the validityof Section 314 of the Bombay Municipal Corporation Act, 1888. Theprovision enabled the Municipal Commissioner to remove, without notice,any object, structure or fixture which was set up in or upon any street.Chief Justice Y V Chandrachud delivering the judgment of the ConstitutionBench held that the impugned provision must be construed to ensurethat the procedure contemplated is fair and reasonable. It was furtherheld:

44. […] What Section 314 provides is that the Commissioner may,without notice, cause an encroachment to be removed. It doesnot command that the Commissioner shall, without notice, causean encroachment to be removed. Putting it differently, Section314 confers on the Commissioner the discretion to cause anencroachment to be removed with or without notice. Thatdiscretion has to be exercised in reasonable manner soas to comply with the constitutional mandate that theprocedure accompanying the performance of public actmust be fair and reasonable. We must lean in favour of thisinterpretation because it helps sustain the validity of thelaw. Reading Section 314 as containing command not toissue notice before the removal of an encroachment willmake the law invalid.

(emphasis supplied)

73. In Union of India v. Col.J N Sinha[54], two-judge bench ofthis Court held that an endeavor must be made to interpret statutoryprovision consistent with the principles of natural justice:

53 (1985) 3 SCC 545

54 (1970) 2 SCC 458

524SUPREME COURT REPORTS

A8. […] It is true that if statutory provision can be readconsistently with the principles of natural justice, the courtsshould do so because it must be presumed that theLegislatures and the statutory authorities intend to act inaccordance with the principles of natural justice. But if onthe other hand statutory provision either specifically or byBnecessary implication excludes the application of any or all theprinciples of natural justice then the court cannot ignore the mandateof the Legislature or the statutory authority and read into theconcerned provision the principles of natural justice. Whether theexercise of power conferred should be made in accordanceCwith any of the principles of natural justice or not depends uponthe express words of the provision conferring the power, the natureof the power conferred, the purpose for which it is conferred andthe effect of the exercise of that power.

(emphasis supplied)

74. In Gautam v. Union of India[55], the question before aConstitution Bench of this Court was whether show cause notice mustbe issued to an intending purchaser and seller of property before makinga compulsory purchase under Section 269-UD(1) of Chapter XX-C ofthe Income Tax Act, 1961. Chief Justice M Kania speaking for theEConstitution Bench held that where the validity of provision would beopen to serious challenge for want of an opportunity of being heard,Courts have read such requirement into the provision. In Gautam(supra), this Court read the principles of natural justice into the provisionsof Chapter XX-C to save them from the vice of arbitrariness. TheConstitution Bench held:F

30. […] Again, there is no express provision in Chapter XX-Cbarring the giving of show-cause notice or reasonable opportunityto show cause nor is there anything in the language of ChapterXX-C which could lead to such an implication. The observanceof principles of natural justice is the pragmatic requirement of fairGplay in action. In our view, therefore, the requirement of anopportunity to show cause being given before an order forpurchase by the Central Government is made by an appropriateauthority under Section 269-UD must be read into the provisions

STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS[DR. DHANANJAYA Y CHANDRACHUD, CJI]

of Chapter XX-C. There is nothing in the language of Section269-UD or any other provision in the said Chapter whichwould negate such an opportunity being given. Moreover,if such requirement were not read into the provisions ofthe said Chapter, they would be seriously open to challengeon the ground of violations of the provisions of Article 14on the ground of non-compliance with principles of naturaljustice. The provision that when an order for purchase is madeunder Section 269-UD — reasons must be recorded in writingis no substitute for provision requiring reasonableopportunity of being heard before such an order is made.

(emphasis supplied)

75. In Sahara India (Firm), Lucknow v. Commissioner ofIncome Tax, Central-I[56], two-judge bench of this Court was calledupon to decide whether an opportunity of being heard has to be grantedto an assesee before any direction could be issued under section 142(2-A) of the Income Tax Act, 1961 for special audit of the accounts of theassessee. This Court held that since the exercise of power under section142(2-A) of the Income Tax Act leads to serious civil consequences forthe assesee, the requirement of observing the principles of natural justiceis to be read into the said provision.

76. In Kesar Enterprises Ltd v. State of Uttar Pradesh[57], theCourt dealt with challenge to the validity of Rule 633(7) of the UttarPradesh Excise Manual which allowed the imposition of penalty forbreach of the conditions of bond without expressly issuing show-cause notice. K Jain, J speaking on behalf of the two-judge benchheld that show-cause notice should be issued and an opportunity ofbeing heard should be afforded before an order under Rule 633(7) ismade. The Court held that the rule would be open to challenge for beingviolative of Article 14 of the Constitution unless the requirement of anopportunity to show cause is read into it. The Court observed:

30. Having considered the issue, framed in para 16, on thetouchstone of the aforenoted legal principles in regard to theapplicability of the principles of natural justice, we are of theopinion that keeping in view the nature, scope and

56 (2008) 14 SCC 151

57 (2011) 13 SCC 733

ABC

Aconsequences of direction under sub-rule (7) of Rule 633of the Excise Manual, the principles of natural justicedemand that show-cause notice should be issued and anopportunity of hearing should be afforded to the personconcerned before an order under the said Rule is made,notwithstanding the fact that the said Rule does not containBany express provision for the affected party being given anopportunity of being heard.

32. In our view, therefore, if the requirement of an opportunityCto show cause is not read into the said Rule, an actionthereunder would be open to challenge as violative ofArticle 14 of the Constitution of India on the ground thatthe power conferred on the competent authority under theprovision is arbitrary.

(emphasis supplied)

77. It has been elucidated in the preceding paragraphs that theclassification of borrower’s account as fraud in accordance with theprocedure laid down in the Master Directions on Frauds entails significantcivil consequences for the borrower. Since the Master Directions onEFrauds do not expressly provide an opportunity of being heard to theborrower before classifying an account as fraud, the rule of audi alterampartem has to be read into the provisions of the said directions to savethem from the vice of arbitrariness.

78. Before concluding, we also want to address the argument byFthe borrowers that the requirement of passing reasoned order must beread into the Master Directions on Frauds. The borrowers also relied onJah Developers (supra) where it was held that final decision of theReview Committee declaring the borrower as ‘wilful defaulter’ mustbe made by reasoned order. We agree with this contention of theborrowers because: (i) reasoned order allows an aggrieved party toGdemonstrate that the reasons which persuaded the authority to pass anadverse order against the interests of the aggrieved partyare extraneousor perverse; and (ii) the obligation to record reasons acts as check onthe arbitrary exercise of the powers.[58] The reasons to be recorded need

not be placed on the same pedestal as judgment of court. The reasonsmay be brief but they must comport with fairness by indicating dueapplication of mind

79. In light of the legal position noted above, we hold that the ruleof audi alteram partem ought to be read in Clauses 8.9.4 and 8.9.5 of theMaster Directions on Fraud. Consistent with the principles of naturaljustice, the lender banks should provide an opportunity to borrower byfurnishing copy of the audit reports and allow the borrower reasonableopportunity to submit representation before classifying the account asfraud. reasoned order has to be issued on the objections addressed bythe borrower. On perusal of the facts, it is indubitable that the lenderbanks did not provide an opportunity of hearing to the borrowers beforeclassifying their accounts as fraud. Therefore, the impugned decision toclassify the borrower account as fraud is vitiated by the failure to observethe rule of audi alteram partem. In the present batch of appeals, thisCourt passed an ad-interim order restraining the lender banks from takingany precipitate action against the borrowers for the time being. Inpursuance of our aforesaid reasoning, we hold that the decision by thelender banks to classify the borrower accounts as fraud, is violative ofthe principles of natural justice. The banks would be at liberty to takefresh steps in accordance with this decision.80. Lastly, the borrowers have argued that the Master Directionson Frauds suffer from manifest arbitrariness because they stipulate anopportunity of hearing to third parties, while denying the same toborrowers, who face significant civil consequences. Clause 8.12.5 ofthe Master Directions on Frauds provides that banks have to satisfythemselves of the involvement of third parties and provide them with anopportunity of being heard before reporting them to IndianBanks’Association. We are unable to accept this argument of theborrowers in light of the fact that the borrowers and the third partiesstand on different footing because: (i) the borrowers are the mainperpetrators of fraud, while the third parties are merely facilitators; and(ii) it is the borrowers who face the significant civil consequencesstipulated under clauses 8.12.1 and 8.12.2, while the third party serviceproviders are merely referred to the Indian Banks’ Association whichmaintains caution list of such service providers. However, this viewdoesnot affect our conclusions in view of the discussion in the precedingparagraphs.

AE. Conclusion

81. The conclusions are summarized below:

i.No opportunity of being heard is required before an FIR islodged and registered;

ii.Classification of an account as fraud not only results inreporting the crime to investigating agencies, but also hasother penal and civil consequences against the borrowers;

iii.Debarring the borrowers from accessing institutional financeunder Clause 8.12.1 of the Master Directions on FraudsCresults in serious civil consequences for the borrower;

iv.Such debarment under Clause 8.12.1 of the MasterDirections on Frauds is akin to blacklisting the borrowersfor being untrustworthy and unworthy of credit by banks.This Court has consistently held that an opportunity ofDhearing ought to be provided before person is blacklisted;

v.The application of audi alteram partem cannot be impliedlyexcluded under the Master Directions on Frauds. In viewof the time frame contemplated under the Master Directionson Frauds as well as the nature of the procedure adopted, itEis reasonably practicable for the lender banks to provide anopportunity of hearing to the borrowers before classifyingtheir account as fraud;

vi.The principles of natural justice demand that the borrowersmust be served notice, given an opportunity to explain theFconclusions of the forensic audit report, and be allowed torepresent by the banks/ JLF before their account is classifiedas fraud under the Master Directions on Frauds. In addition,the decision classifying the borrower’s account as fraudulentmust be made by reasoned order; and

vii.Since the Master Directions on Frauds do not expresslyprovide an opportunity of hearing to the borrowers beforeclassifying their account as fraud, audi alteram partem hasto be read into the provisions of the directions to save themfrom the vice of arbitrariness.

STATE BANK OF INDIA & ORS v. RAJESH AGARWAL & ORS[DR. DHANANJAYA Y CHANDRACHUD, CJI]

82. In the result, the judgment of the Division Bench of the HighCourt of Telangana dated 10 December 2020 is upheld. The judgmentsof the High Court of Telangana dated 22 December 2021 and31December 2021, and of the High Court of Gujarat dated 23 December2021 are accordingly set aside. The Civil Appeals are disposed of. WritPetition (C) No. 138 of 2022 is also disposed of in above terms. Thereshall be no order as to costs.

83. Pending application(s), if any, shall stand disposed of.

Ankit Gyan

Appeals disposed of.

(Assisted by : Mahendra Yadav, LCRA)