Audi Alteram Partem in RBI’s Leading Circulars on Willful Default and Fraud

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Non-performing assets (NPAs) have plagued the Indian economy over the past decade. According to the 22nd Financial Stability Report released by the Reserve Bank of India in January (RBI) 2021, NPAs are expected to drop from 7.5% in September 2020 to 13.5% in September 2021 in the baseline scenario which could get even worse due to the second crown wave in India. Apart from the real business failures resulting in the transformation of accounts to NPA, many accounts also become NPA due to bad actions of borrowers. The RBI, through its circulars and instructions, has gone to great lengths to ensure that these stray borrowers are identified promptly and face consequences under the law. In this regard, two circulars dealing with “willful defaulters” dated July 1, 2015 and dated “fraud” July 1, 2016 are of particular importance and will be discussed in this article in light of the issue of audi alteram partem regarding the classification of the account as fraud being under judicial control of the High Courts and Supreme Court of India.

The RBI Master Circular, dated July 01, 2015, in clause 2.1.3 sets out certain circumstances, the occurrence of which results in the identification of a unit as voluntary default, which are as follows:

a) The unit has defaulted on its payment / repayment obligations to the lender even when it has the capacity to honor said obligations.

b) The unit defaulted on its payment / repayment obligations to the lender and did not use the lender’s funding for the specific purpose for which the funding was used, but diverted the funds for other purposes.

vs) The unit defaulted on its payment / repayment obligations to the lender and siphoned the funds so that the funds were not used for the specific purpose for which the financing was used, nor the funds available with the unit in the form of other assets.

D) The unit has defaulted on its payment / repayment obligations to the lender and has also disposed of or removed the donated movable or immovable property in order to secure a term loan without the knowledge of the bank / lender…

The circular further specifies that for the defect to be qualified as voluntary, it must be intentional, deliberate and calculated and must not have been an isolated incident. The clause 3 circular provides for the mechanism for identifying voluntary defaults in which, in sub-clause (b), a justification notice must be given to the borrower concerned and, based on the response, the identification of the needs of voluntary defaults to be done and on a case-by-case basis even a personal hearing can be granted to the borrower.

On the other hand, the qualification of an account as “fraud” is handled by the General instructions on fraud of 01.07.2016. Article 2.2 of these instructions, which defines and deals with fraud classification, based on the provisions of the Indian Penal Code, states that:

a. Embezzlement and criminal breach of trust.

b. Fraudulent collections by falsified acts, manipulation of account books or by fictitious accounts and conversion of goods.

vs. Unauthorized credit facilities granted for reward or unlawful gratification.

D. Lack of cash.

e. Cheating and forgery.

F. Fraudulent Transactions Involving Foreign Currency.

g. Any other type of fraud not falling under the specific headings above.

With regard to the cases under d) and f) above, liquidity shortages resulting from negligence and fraudulent foreign exchange transactions involving irregularities / regulatory violations should also be reported as fraud if the intention to cheating / fraud is suspected or proven. Notwithstanding the above, the following cases will be treated as fraud and reported accordingly:

a. case of lack of liquidity more than ?? 10,000 / -, (including ATMs) and

b. case of lack of liquidity more than ?? 5,000 / – if detected by management / auditor / inspection officer and not reported on the day of the event by cash handlers.

However, to identify a unit as ‘fraud’ no possibility of hearing is foreseen in the circular even if the latter is a much more serious matter.

Consequences in the event of willful default vs. Consequences of fraud

Under the main circular on voluntary defaults, the fundamental objective is to ensure that basic bank financing is not available to them, as expressly stated in the head objective. The penal measures of the circular on willful defaults provided for in clause 2.5 stipulate that a) no additional facility should be granted to the willful defaulter, b) legal proceedings to recover the contributions should be initiated against the willful defaulter and criminal proceedings can be engaged if necessary, c) Banks / FIs should take a proactive approach to changing borrower management and d) loan agreements should include a clause prohibiting companies from having people on their boards. that have been declared in willful default and in the event that such a person is on the board of directors, he would take measures for its removal. In addition, under clause 4.2 (iii), banks and FIs have been invited to initiate criminal proceedings against willful violators under applicable law and in specific cases under sections 403 and 405 of the CPI.

On the other hand, the main objective of the anti-fraud circular as expressed in clause 1.3 is to discover fraud committed on a bank in order to alert other banks so that they take the necessary measures against it. those parts that can be declared fraudulent and also to initiate investigations by investigative agencies. According to clause 8.12 of the master circular, the borrower and all active directors would be prohibited from raising funds from the banking system for a period of five years. In addition, they will be prevented from seeking additional funds or seeking restructuring and will not even be able to reach a compromise or settlement. Thus, once labeled as a “fraud”, the stigma will haunt for a considerable time and have very serious civil consequences as well as apart from the criminal prosecutions that result from it.

Audi Alteram Partem

The outcome of Audi Alteram Partem in the RBI Circular on fraud was the subject of immense judicial review.

The High Court of Telangana in the case Rajesh Agarwal v Reserve Bank of India and Ors supported the principle of audi alteram partem be read in clauses 8.9.4 and 8.9.5 of the main circular as if it were otherwise, this would lead to imprecision because, while under clauses 8.9.4 and 8.9.5, the possibility of being heard was refused whereas under clause 8.12.1 it was provided that the procedure for declaring a borrower as voluntary defaulter must be followed. The Court applied the consequences of the decision test to read the principle of natural justice in the main fraud circular because the declaration of fraud would result according to clause 8.12 with very harsh consequences for the borrower and its promoter / director with exclusion of the banking system for 5 years, which would be contrary to section 19 1 (g) and section 21 without the help of natural justice. Similarly, it has been observed that following the detection of an account as fraud, the Master Circular imposes on the Bank the obligation to file a complaint with the CBI / criminal investigation agency in a short period of time, which would have disastrous consequences. for the company and its promoter in the face of State criminal proceedings. The Court also ruled that without the principle of natural justice being read in clauses 8.9.4 and 8.9.5 of the main circular, the Bank would have an absolute power which is contrary to the concept of the rule of law and the fair -play in governance requires that the person / entity is heard only once before making a decision.

The Delhi High Court in the case Apple Sponge And Power Ltd and Ors v. Reserve Bank of India and Anr, in the ordinance of 15.02.2019, granted the stay of any further / subsequent action under the account declared fraudulent. It was observed by the Court that the declaration of fraud under civil law by an administrative decision would require the principles of natural justice, i.e. audi alteram partem to follow, but a bank can certainly report fraudulent transactions under criminal law to law enforcement agencies. Further, the High Court noted that for an account to be declared as fraud would occur if there was flagrant default and would be far more than the account holder being simply a willful defaulter and therefore fraud would result in an element of crime based on a certain material background that should be produced to the account holder in the spirit of audi alteram partem. The Delhi High Court relied on the order of 15.02.2019 in subsequent written motions and granted a stay of any adversarial action by the bank in accordance with this statement. All subsequent written petitions were tagged with the Apple sponge Case and are awaiting a final decision in the Delhi High Court.

The Supreme Court of India refused to suspend the judgment of the High Court of Telangana but notices have been issued and the case is now registered at 13e July 2021 for the arguments.

In order to harmonize the provisions of the Circulars on fraud and fraud, the declaration of an account in fraud entailing both civil and criminal consequences must only take place after having provided the documents to the borrower / promoter and having given him a opportunity to explain while respecting the principle of natural justice.

It is imperative that the major circulars are synchronized and that stray borrowers are brought up against the armed wing of the law by the Supreme Court of India. In light of the ongoing corona pandemic, RBI is expected to bring greater clarity on the Single Settlement Policy (OTS) for banks in light of the KV Kamath Panel report by extending it even to companies that have been NPAs before. the start of the pandemic so that borrowers have more clarity and settlements can be done transparently.

Opinions are personal.

The author is a lawyer based in New Delhi.

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