'Prior Hearing Mandatory': J&K&L High Court Sets Aside Bank's Fraud Declaration Against Borrower

The Court observed that the requirement of issuing a prior notice before classifying an account as fraud forms an integral part of the principles of natural justice, and any declaration of fraud without affording a Show Cause Notice violates fundamental rights

The Court was hearing a petition challenging the declaration of the petitioner's loan account as fraud under the RBI Master Directions governing fraud classification. The petitioner asserted that no notice or opportunity of representation had been afforded prior to the declaration.

A Bench comprising Justice Wasim Sadiq Nargal, while referring to the Supreme Court's ruling in State Bank of India vs. Rajesh Aggarwal, held that “no financial institution/bank can declare the account of any person/s who had borrowed facilities from the bank/financial institution as “fraud” unless and until a detailed show cause notice is not issued prior and a reasonable time is given to the said person/s for placing on record the reply”.

The petitioner, a borrower company, approached the High Court challenging the Bank's decision to classify its account as 'fraud'. The petitioner contended that the Bank had not issued a show-cause notice or afforded an opportunity of hearing before making the declaration.The record reflected that the Bank had relied upon the RBI Master Directions while issuing the impugned communication.

The petitioner submitted that the Supreme Court had read into the Master Directions the requirement of notice and hearing, and had held that the absence of such an opportunity would render the decision contrary to natural justice.

It was contended that the Bank's communication had far-reaching civil consequences, including debarment from financial facilities, and therefore could not have been issued without strict compliance with the applicable procedural safeguards.

The Bank, however, argued that it had acted in accordance with the Master Directions and suggested that the primary responsibility to prescribe the procedure lay with the Reserve Bank of India.

The High Court extensively examined the Supreme Court's decision in State Bank of India v. Rajesh Agarwal, holding that the law declared therein is binding and squarely applicable. It was observed that the classification of an account as fraud results in serious civil and penal consequences and therefore cannot be undertaken without adherence to natural justice.

The Court emphasised that the Master Directions, once interpreted by the Supreme Court, necessarily include the obligation to issue notice and allow representation before any adverse action.

The Court noted that the Supreme Court had held that the consequences of fraud classification are substantial and require judicial safeguards. It highlighted that the Supreme Court had characterised debarment from institutional finance as a measure akin to blacklisting, thereby attracting the obligation of prior hearing.

The judgment reproduced the Supreme Court's observation that “the principles of natural justice demand that the borrowers must be served a notice, given an opportunity to explain… and be allowed to represent before the classification of the account as fraud.”

The High Court further observed that the Bank had not disputed the fact that no show-cause notice was issued before classifying the petitioner's account as fraud. This omission, in the Court's view, struck at the root of the decision.

The Court rejected the Bank's contention that the responsibility for ensuring procedural compliance lay with the RBI, holding that the Bank's action must be consistent with the interpretation placed upon the Master Directions by the Supreme Court.

Accordingly, the Court allowed the petition and quashed the communication by which the petitioner's account had been classified as 'fraud'.

The Court, however, clarified that while the impugned action could not be sustained, the Bank was at liberty to initiate fresh proceedings in accordance with law after issuing a show-cause notice and affording a reasonable opportunity of hearing.

Case Title: Aman Hospitality Pvt. Ltd. v. Jammu & Kashmir Bank Ltd.

Citation: 2025 LiveLaw (JKL)

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