Borrowers Vs Banks: The Commercial Impact Of Supreme Court Ruling On Fraud Tag
Borrowers get a right to be heard before 'fraud' classification of accounts. Banks will now have to up the ante on fraud detection
In a significant ruling, the Supreme Court has held that borrowers must be given a chance to be heard before a decision is made on classifying their account as ‘fraud’.
Since the consequences of such a classification are severe, the apex court noted that this is akin to blacklisting the borrowers for being untrustworthy and unworthy of credit by banks. It emphasised on the importance of principles of natural justice, specifically audi alteram partem. Meaning the right to be heard must be granted to the parties involved and no party must go unheard before a decision is taken.
Any negative classification by a bank of a borrower can have significant impact on the day to day functioning of the borrower, including the ability to avail credit in the Indian market, Veena Sivaramakrishnan, partner at Shardul Amarchand Mangaldas, told BQ Prime. Some financial institutions were following this in practice, but now this will need to be imbibed into their processes too, she added.
The common law principle of right of being heard and therefore a right of representation before a negative classification takes place, has now been enshrined as the law of the land itself.Veena Sivaramakrishnan, Partner, Shardul Amarchand Mangaldas
In saying so, the apex court held that audi alteram partem has to be read into the provisions of RBI’s Master Directions on Frauds to save the borrowers from the vice of arbitrariness.
Currently, a fraud is reported by banks in a prescribed format that doesn't require them to specify the reasons as to why the decision was taken. Nor do the master directions provide for a right of hearing to the aggrieved party.
Banks go by their internal policy for fraud risk management and fraud investigation which is formalised after an approval from their respective boards.
The court found this to be unfair. It said that borrowers must be given an opportunity to explain the conclusions arrived at by the bank. Additionally, classification of an account as fraudulent must be accompanied by a reasoned order. The reasons need not be placed on the same pedestal as a judgement of a court and they may be brief but they must indicate a due application of mind, the apex court said.
From a commercial perspective, this will impact the banks’ ability to report counts of fraud in a timely manner as the process will take longer due to banks needing to adhere to certain procedures to ensure compliance with the principles of natural justice, such as the right of borrowers to hearings and making representations, Tirthankar Datta, partner at JSA, said.
Although this ruling has the noble intention of safeguarding constitutionally granted rights, there’s a flip side to it as well.
Fraudulent borrowers will now have the ability to delay this classification because they now have the right to be heard.Tirthankar Datta, Partner, JSA
However, the Supreme Court has sided with fairness in permitting the other party to be heard. It may be better for the economy and banks from an NPA prevention perspective to ensure early detection and reporting of fraud but there are certain inalienable principles which make the Indian legal system just and fair and that’s what the court has reiterated in the present judgment, Datta said.
