The crux of the recent Supreme Court ruling in State Bank of India vs Rajesh Agarwal is that it affirms the right of a borrower to be given a fair hearing before his NPA account is declared as fraud. The reasons given are rather convincing: first, the principle of natural justice, where both parties must be heard, must be observed in all situations; second, there can be no reason for denying this right to a borrower who has been declared fraudulent when similar rights are extended to an NPA borrower who is a wilful defaulter.

A wilful defaulter is one who does not pay his dues despite having the capacity to do so. ‘Fraud’ is indicative of deceitful acts. It can be ‘red flagged’ if, for instance, there are irregularities such as the same collateral being charged to a number of lenders. Since both wilful defaulters and fraudsters are faced with similar punitive consequences (more so in the case of the latter), it stands to reason that due process to establish guilt be equally robust in both cases. Wilful defaulters and fraudsters will not be able to access equity and debt funds for five years. Under IBC, they will lose control over their firms. However, Para 41 of the order observes that a wilful defaulter does, in fact, get a chance to present his side and question the assessment of the committees looking into his case, whereas an NPA account holder declared fraud does not. Such a regulatory gap is open to misuse; it can be used by business interests looking to dub their competition as fraudulent in collusion with banks.

The apex court has also observed that a six-month period allowed under RBI regulations to establish fraud is good enough to allow for borrowers’ feedback — in doing so, the court annulled another case cited in this context, which suggests that where time is running out to act against mala fide interests, natural justice can be set aside. Allaying apprehensions of bankers, the court has clarified, again citing case law, that there is no need to rope in the borrower when the forensic audit is in process, as that can compromise the investigation. However, on completion of the investigation the borrower must know the grounds for being declared as fraudulent. He should be issued a show-cause notice in a duly prescribed manner. For bankers who fear lengthy processes, it is important to note that the court does not insist on a judicial process for feedback. In fact, if a due process of feedback is in place, litigation on this score will come down.

That said, the accused borrower should be given a specified time frame to respond to the show-cause notice, so that the six-month process remains undisturbed. The RBI should draw up clear rules for explicitly including borrowers’ feedback in the process of establishing fraud. As for insolvency resolution, the onus lies on banks to identify problem accounts on time and proceed accordingly. They should not cite natural justice requirements as an excuse.

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