The Supreme Court order directing banks and financial institutions to give borrowers an opportunity to make a representation before their accounts are classified as ‘fraud’ comes as a major relief for borrowers and will inspire higher level of confidence in the entire decision-making process.

In 2016, the RBI issued a circular allowing banks to unilaterally classify accounts of wilful defaulters as fraudulent, a move that was challenged in several high courts.

Abhimanyu Kampani, Partner, Luthra and Luthra Law Offices India, said it would be interesting to the see the effect of this judgment on the decisions already taken by banks and challenged by borrowers before various courts.

As per current practice, unless and until specifically mentioned the Supreme Court judgments are understood to operate retrospectively, he added.

Upholding the Telangana High Court of December, 2020, the Bench of Chief Justice of India DY Chandrachud and Justice Hima Kohli in their verdict on Monday said borrowers have the right to be heard before banks classify their accounts as fraud. The principles of natural justice must be followed and read into the Reserve Bank of India’s master circular on fraud.

The court held that when an account is classified as fraud, it results in civil and criminal consequences for the borrower. It amounts to “blacklisting” a borrower from availing of any credit, hence a hearing must be granted under the Master Directions on Fraud, said the judgement.

“Though there is a system of hearing out borrowers before they are tagged wilful defaulter/fraud, there are violations, whereby banks take unilateral decisions. So, the SC judgment will ensure that banks follow the established procedure,” said a senior public sector bank official.

In most cases, the bank staff responsible for sanction of default loan retires and no one wants to take responsibility. So, forensic audit is done to examine whether there has been wilful default and fraud, he said.

Auditors on their part do not want authorities to go after them if there is something amiss, so they read flag even a minor inter-company transaction, he added.

Against this background, fearing action by investigating agencies, State-owned banks have been declaring borrower accounts as “wilful defaulter and fraud” even for minor transgressions, he said.

Vijay Trimbak Gokhale, lawyer and former investment banker, said the Supreme Court has not debarred banks from declaring accounts as fraud. “All that it means is that without hearing borrowers, their account cannot be classified as fraud. So, banks have to give borrowers an opportunity to be heard before declaring them as fraud. They have to adhere to the principles of natural justice,” he added.