Banks Cannot Penalise Borrowers For Switching Lenders, Prepaying Loans: Orissa High Court

The Orissa High Court recently held that banks cannot impose charges that restrict a borrower's freedom to switch lenders, ruling that such practices undermine fair banking standards and violate binding directions of the Reserve Bank of India.

A bench of Justice Sanjeeb K Panigrahi said banks must operate within regulatory limits set by the RBI and cannot create barriers that penalize borrowers for exercising their right to repay or refinance loans.

The bank cannot "cannot convert a borrower's right to mobility into a chargeable commodity", the court said.

"The levy of such penalties operates as a deterrent to borrowers who intend to repay their loans ahead of schedule or shift to a competing lender. The consequences of this practice are the stifling of competition in the credit market, compelling borrowers to remain tied to a particular institution and thereby imposing an unwarranted restriction and freedom of trade and choice of consumer ", it added.

The case arose from a petition filed by Maa Tarini Poultries Pvt Ltd, an MSME that had availed a credit limit of Rs 1.80 crore from Indian Bank's Berhampur Main Branch in 2022. The company alleged that bank officials pressured its managing director to buy an SBI Life insurance policy and, after he refused, dishonoured cheques and blocked NEFT transactions.

In May 2023, the petitioner's poultry unit was extensively damaged in a Kala Baisakhi storm, but the bank allegedly delayed initiating the insurance claim for more than a year until the court interfered. After the petitioner refinanced the loan through HDFC Bank and repaid Indian Bank in full in May 2024, the bank demanded foreclosure charges at 4 percent and withheld the original title deeds, including a residential property valued at about Rs 2 crore and 5.9 acres of land.

Counsel for the MSME argued that the foreclosure demand was directly contrary to RBI mandates that prohibit such charges on MSME floating-rate loans. He submitted that the RBI's directions issued under Sections 21 and 35A of the Banking Regulation Act are binding on all commercial banks and override any inconsistent contractual terms.

He also argued that the prolonged delay in processing the storm-related insurance claim and the continued retention of title deeds despite full repayment violated the petitioner's property rights under Article 300A of the Constitution.

The court rejected the bank's contention that the RBI prohibition applied only to individual-retail borrowers for purposes other than business. It held that what matters is the effect of the charge and not the terminology used.

The court said that “any similar charge which in substance operates as a foreclosure, prepayment or takeover fee on MSME credit, where regulatory prescription forbids such levy, is unlawful, arbitrary and must be quashed”.

He held that contractual clauses inconsistent with RBI directions “stands ipso jure nullified and are rendered a legal nullity in the eyes of the law”. The court further noted that such charges deter borrowers from moving to competing lenders and “operate as a mechanism of control, curtailing consumer choice and impeding healthy competition among bank and financial institutions”.

The court also found that the bank had no justification to withhold the original documents after full repayment. It described the retention as based on a “tenuous, non-est, and statutorily prohibited demand” and said it was “manifestly arbitrary and antithetical to the rule of law”.

Allowing the petition, the court directed Indian Bank to immediately return all title deeds and allied documents without insisting on any charges and to file an affidavit of compliance within one month.

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