In the first part of this Article, we traced how the principle of audi alteram partem, i.e., the right to be heard was incorporated into the framework for determination of ‘fraud’ by banks. The RBI (Frauds Classification and Reporting by Commercial Banks and Select Fis) Directions, 2016 (“the Master Direction 2016”) allowed a borrower’s account to be classified as fraudulent without providing an opportunity of hearing to the said borrower. Thereafter, the Supreme Court in the State Bank of India vs. Rajesh Agarwal, read the principles of natural justice into the framework leading to the RBI Fraud Risk Management in Commercial Banks and All India Financial Institutions Directions, 2024 (“the Master Directions 2024”). The Master Directions 2024 made a show-cause notice (“SCN”), a written reply by the borrower and a reasoned order a pre-condition to the classification of accounts as fraudulent. In State Bank of India vs. Amit Iron Private Limited, the Hon’ble Supreme Court held that a written reply to SCN suffices and that, there is no inherent right to an oral hearing to the affected borrowers. However, the complete forensic audit report should be disclosed to the borrower.
An account being classified as fraud is not an ordinary banking event. It can not only debar the borrower, but its promoters, directors from the institution credit for five years. It also invites scrutiny from the investigative agencies, and may lead to a plethora of litigations. The judgment of Amit Iron widely settles the law on the principles of natural justice in the classification of accounts as frauds. However, the practicality of it is not yet settled and has not been dealt in this case. For instance, for corporates, especially MNCs and conglomerates with layered group structures, this judgment leaves several questions open. This second part sets out the gaps that have been left unanswered and the reforms that would make it practical.
i. Civil death without a personal hearing: Treating a fraud classification as a bank’s internal ‘housekeeping’ understates its severity, and its consequences extend far beyond an ordinary banking relationship. As stated above, such classification triggers a five (5)-year debarment from the entire financial system, invites scrutiny from investigative agencies, and may form the basis for prosecution under the law. For promoters and directors, it can mean personal disqualification and reputational ruin. However, the Amit Iron judgment permits all of this to unfold on the strength of written pleadings alone.
The way forward- Rather than a 5-year debarment, a proportionate, reasoned debarment in line with the SCN and a reply by the entity should be taken into consideration to avoid the ‘civil death.'
ii. A related gap- No criteria for discretionary oral hearings: Neither the 2016 nor the 2024 Directions specify when an oral hearing is warranted, even where the underlying facts are genuinely disputed or the forensic methodologies are contested by the affected parties. For instance, let us consider a scenario wherein the forensic auditor relies on sampling techniques that the borrower’s experts dispute, or where the alleged fraud turns on contested interpretations of complex financial instruments. In such cases, a written reply may be wholly inadequate. The Master Directions 2024 are silent on whether banks have any residual discretion to grant oral hearings in exceptional cases, and if so, what factors should guide that discretion.
The way forward- RBI should amend the Master Directions 2024 to specify circumstances when an oral hearing must be granted. A clear criterion would reduce litigation and provide certainty to both banks and borrowers.
iii. No standard for a reasoned order: Neither the apex court nor the Master Directions 2024 list out the mandatory ingredients of a reasoned order. Till the time such a vacuum exists, the bank shall engage with each ground raised in the reply to the SCN and must give a detailed finding as to why the forensic audit’s conclusions are preferred over the borrower’s stand. As things stand, the absence of any prescribed standard creates a ground for challenge, i.e., writ proceedings in waiting. Without such clarity, every classification order becomes a potential battleground, leaving courts to develop the standard on a case-to-case basis, resulting in an unpredictable outcome for all stakeholders.
The way forward- RBI should issue guidance specifying what a ‘reasoned order’ must contain. This would ensure consistency across banks and reduce scope for challenge.
iv. Ripple effects on group companies: Once an account is tagged as fraud, banks are required to examine the accounts of group and associated companies that share common directors or promoters, especially causing an acute exposure for MNCs and conglomerates, where one classification can cascade across subsidiaries and affiliates. The Master Directions 2024 acknowledge this ripple effect but fail to lay down any such rules for applying “audi alteram partem” to each affected person/ entity. This leaves several questions open: (a) shall banks issue a separate SCN to each group entity, (b) is each company entitled to its own forensic audits, or can the original audit be relied upon, (c) are all group accounts automatically tainted as fraudulent, or does each require independent determination. Potentially, even a single classification of any of its entities can now freeze all credit lines, trigger cross-default provisions, and cause an impediment to ongoing transactions across the entire group. Practically, all the above can happen well before the affected entity/ group gets its chance before the courts.
The way forward- RBI should issue specific guidance on how “audi alteram partem” applies to group and associated companies. As a bare minimum, each affected entity should receive its own show-cause notice and an opportunity to respond before any adverse consequences attach to its accounts.
v. Treatment of inconclusive forensic findings: A forensic audit may identify ‘red flags’ without definitively establishing fraud, yet the Master Directions 2024 do not address how banks should proceed where the evidence is inconclusive. In such a scenario, can a classification be made on the basis of doubts/ suspicious patterns alone? If at all, the standard of proof must be well defined even before the bank considers issuance of an SCN.
The way forward- RBI should prescribe a standard of proof for fraud classification and guidance on how banks should proceed when forensic evidence is equivocal. A ‘preponderance of evidence’ standard, coupled with a requirement that the forensic audit definitively establish (rather than merely suggest) fraud, would protect borrowers from classification on the basis of suspicion alone.
vi. Absence of an appellate or review mechanism: The Master Directions 2024 do not provide for any in-house appellate or review mechanism. Once a bank classifies an account as fraud, the borrower’s only recourse is to approach the courts. The absence of such a mechanism places the entire burden of error correction on the courts and delays justice for aggrieved parties.
The way forward- India should establish a specialised appellate forum either within the RBI’s structure or as an independent tribunal to hear such challenges to fraud classifications. This would provide faster, more expert review than civil courts, and reduce the burden on an already strained judiciary.
But the journey is far from over. For corporate borrowers, and especially multinational corporations with layered group structures, the practical takeaway is clear: engage as soon as an SCN is received, insist on the full forensic audit report, and map legal and financial risks across group and affiliate companies before any classification is concluded. These suggestions point towards a framework that is not merely fairer but genuinely fit for purpose. The next round of litigation, or better still, the next round of regulatory reform, will determine whether India takes that path.
About the authors: Palash Taing is a Partner and Manaswi Kosuri is a Senior Associate at TLH, Advocates & Solicitors.
Disclaimer: The opinions expressed in this article are those of the author(s). The opinions presented do not necessarily reflect the views of Bar & Bench.
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