Natural Justice Principles have to be read into RBI Master Circular on Frauds: Telangana High Court [Read Judgment]

The Telangana High Court has ruled that before an account/borrower is declared fraudulent on applying the RBI's 2016 Master Circular on the classification of accounts as frauds, an opportunity of hearing must be given to the account holder, considering the principle of natural justice, lest the circular be unconstitutional (Rajesh Agarwal v. RBI and ors). .An order to this effect was passed earlier this month by a Bench of Chief Justice RS Chauhan and Justice B Vijaysen Reddy on a plea moved by Rajesh Agarwal, the former Chairman and Managing Director of BS Limited. ."The principles of natural justice, especially the principles of audi alteram partem (opportunity of hearing) would have to be read into Clauses 8.9.4 and 8.9.5 of the Master Circular," the Court said. .Before a person or entity is obliterated, or is subjected to civil and penal consequences, the person or entity must be given an opportunity of hearing. Without giving an opportunity of hearing, without giving an opportunity to explain the intricacies of the accounts, or of the business dealings, to denounce a person is to act unfairly, unjustly, unreasonably, and arbitrarily, the Court added. ."Even in an administrative action, justice should not only be done, but also must appear to be done to the satisfaction of all the parties. Therefore, the principles of audi alteram partem, howsoever short, have to be applied before declaring a party as 'a fraudulent borrower', or as 'a holder of fraudulent account'," the judgment said..In rendering its verdict, the Court also waxed eloquent about the significance of natural justice principles, terming them as "clear sunshine which pervade and permeate into the deepest dark corners, and kill the germs of injustice.".The Bench proceeded to cull out the following principles to be borne in mind when it comes to the application of the principles of natural justice.Principles of natural justice have brooding omnipresence; Although the principles of natural justice are not codified, nonetheless, they are applicable both to administrative and quasi-judicial decisions;They do not supplant the law, but merely supplement the law; Unless expressly ousted by a legislation, or by a circular, invariably they will have to be read into the provisions of the law, especially where a decision, administrative or otherwise, would have civil consequence;In order to see whether the principles of natural justice are impliedly ousted or not, certain factors would have to be kept in mind, namely the language and the basic scheme of the provision conferring the power, the nature of the power, purpose for which it is conferred, and the effect of the exercise of the power; andThe principles of natural justice may be impliedly ousted in cases of urgency where obligation to give notice and an opportunity of personal hearing would obstruct the taking of appropriate action, or a preventive, or remedial nature. The purpose of provision would need to be examined. But while seeing the existence of urgency, the Court is required to balance between 'hurry' and 'hearing'. Since the principles of natural justice are not contained in a straight jacket formula, they can be adapted to urgent situations. In an urgent situation, it is not necessary to give an elaborate hearing to the affected person. The hearing can be short but substantive, prompt but effective. But it is imperative to bear in mind that even the administrative bodies must act in a just, fair and a reasonable manner. For, fair play in administrative action is the heartbeat of good governance..Case background.In this case, Rajesh Agarwal had challenged the decision to classify the account of BS Limited as "fraud" in 2019 by the State Bank of India's Fraud Identification Committee (FIC) and the Joint Lender's Forum (JLF). .Pertinently, he had also challenged the non-inclusion of principles of natural justice in the RBI's 2016 Master Circular i.e. the Reserve Bank of India (Frauds Classification and Reporting by Commercial Banks and Select Fls) Directions, 2016..Senior Advocate Mukul Rohatgi along with AOR Tarun G Reddy appeared for the petitioner. Standing counsel Nalin Kumar appeared for the RBI whereas Senior Advocate BS Prasad, along with AOR K Surender, appeared for the State Bank of India (SBI). .Advocates AB Ganga Reddy, Maheswara Rao Kunchem, MV Ramana appeared for various respondent-banks. Assistant Solicitor General Namavarapu Rajeshwar Rao appeared for the Union Ministry of Corporate Affairs, the SFIO, Hyderabad and the Registrar of Companies, Telangana.Contentions made by the parties.The petitioner contended, inter alia,: The classification of an account as "fraud" under the 2016 Master Circular would affect not only the company/borrower but also the promoter, directors and other whole-time directors of the company. These directors would be debarred from availing finance from scheduled commercial banks, development financial institutions, government owned non-banking financial companies, investment institutions, etc. for five years. Even after this five year period, a stigma would follow and such directors could be denied the right to borrow finances, perhaps, for the rest of their lives, affecting their fundamental right to carry out trade or business. Therefore, such persons must have a right to challenge the decisions taken under the Master Circular, it was contended. It was also pointed out that third parties such as builders, warehouse/cold storage owners, motor vehicle/tractor dealers, travel agents etc., and professionals such as architects, valuers, chartered accountants, advocates etc. if held to be involved in the case, are given an opportunity of hearing under Clause 8.12.5 of the Master Circular. Thus, the petitioner contended that while others remotely related to the alleged fraud are provided with an opportunity of hearing, the same is denied to the borrower..On the other hand, the RBI and the SBI (respondents in the matter) contended: An opportunity of hearing to the borrower before declaration of fraud is dispensed with given that cases of fraud must be dealt with expeditiously. Otherwise, fraudsters will continue to play fraud on other banks, it was contended. Such illegal actions on the part of fraudulent accounts will endanger the stability of the banking sector.Since the banking sector deals with the monies of the public at large, it is in the interest of the public that the decision be taken as quickly as possible without undue wastage of time. It is for these reasons, that the Master Circular purposefully does not include an opportunity of hearing being given to the borrower..What the High Court said."Whether the principles of natural justice, especially audi alteram part.em (giving opportunity of hearing to the other side) should be read into the Master Circular or not?", was the substantial legal question before the High Court. .The Bench eventually ruled in the petitioner's favour, rejecting the respondents' stance that the principles of natural justice can be dispensed with in view of the urgency involved in identifying and declaring accounts as "fraud.".The High Court reasoned:A bare perusal of Clause 8. 12 .1 of Master Circular clearly reveals that once a company is declared as a fraudulent borrower, the Director's civil and fundamental rights are adversely affected to a great extent. Such a classification would have "grave civil consequences" for the Promoter / Director of a borrowing Company. Once branded as 'a fraudster', or 'a fraudulent borrower', or 'holder of a fraud account', the stigma will continue for a considerable time.Once the civil or fundamental rights of a person are affected, the person does have the right of access to justice under Article 226 of the Constitution of India.The Master Circular has statutory force, since it has been issued by invoking the powers conferred under Section 35-A of the Banking Regulation Act, 1946.The contention that urgency demands that principles of natural justice should not be read into the Master Circular is a fallacious contention. A holistic analysis of the Master Circular reveals that while it is important to report the discovery of a fraud to the RBI and to initiate criminal investigation within a short period, nonetheless, a sufficient 'warning signal system' is built into the system, so as to alert not only the banks forming the Consortium, not only the RBI but also the other banks. Therefore, the argument that unless urgency is shown in declaring a borrower as a fraudulent borrower, the entire banking organization may be exposed to further fraud by a borrower, is bereft of any merit. Even an administrative functionary/body, like the JLF, would have to balance the twin aspects of 'hurry' and 'hearing'. The Court added that the principles of natural justice can be modified to an emergent situation. Instead of having an elaborate hearing, the proceedings can be short but substantive, prompt but effective. The argument of urgency cannot be accepted for jettisoning the applicability of principles of natural justice. If the requirement of the principle of nature justice is not read into the Master Circular, it would suffer from vagueness. On one hand, Clauses 8.9.4 and 8.9.5 of the Master Circular prima facie seem to deny the opportunity of hearing to the borrower. However, Clause 8.12.1 of the Master Circular states that the procedure for declaring a borrower as a "willful defaulter" has to be followed, which includes providing an opportunity of hearing. Since the right to livelihood is part and parcel of the fundamental right to life under Article 21 of the Constitution of India, the fundamental right can be deprived only by a reasonable procedure established by law. To deny the said fundamental right without giving an opportunity of hearing would be highly unreasonable, unfair and unjust. Criminal proceedings initiated following the declaration of an account as fraudulent would affect the social standing of the individual and the goodwill of the company. It would also force an individual to spend money, to invest energy, and to go through the rigmarole of a criminal trial. Therefore, the classification of an account as 'fraud' has devastating impact on the life of a person. Thus, considering the grave consequences and the impact on the fundamental rights of the Directors when an account is declared to be fraudulent, the principles of natural justice must be read into the Master Circular. If an opportunity of hearing were not to be read into the Master Circular, then the power bestowed under Clauses 8.9.4 and 8.9.5 of the Master Circular is an unbridled power given to the JLF for declaring a person/Company as 'a fraudulent borrower'. Such an absolute power could not be intended by the RBI. Absolute power corrupts absolutely.Even those who are allegedly the peripheral accomplices (builders, valuers, accountants etc.) are granted an opportunity of hearing, while the main actor is denied the right to speak and to defend his position. As such the principles of natural justice must be read into the Master Circular with respect to the directors, promoters etc. as well..In view of these observations, the High Court proceeded to hold:"...the principle of audi alteram partem, part of the principles of natural justice, is to be read in Clause 8.9.4 and 8.9.5 of the Master Circular.".Additionally, the Court noted that on facts, there was nothing to show any urgency as claimed by the respondents to declare the company as a fradulent account. .In this case, it was pointed out that the while account was declared a Non-Performing Asset in 2016, the JLF's declaration of "fraud" took place only in February 2019 and the FIC did not declare the account as fraudulent until 4.5 months later in July 2019. ."Hence, obviously, the decision to declare the account as fraud has not been taken on an 'urgent' basis", the Court said, while setting aside the adverse decision take against BS Limited on facts as well. .The Court proceeded to order a reconsideration of the case by the JLF, after giving the petitioner an opportunity to be heard. Timelines were also specified for the JLF and the FIC to take their decision on whether the account should be declared a fraud or not. .[Read Judgment]