Banks’ Fraud Account Classification Faces Legal Challenges: No Personal Hearings, Potential Court Battles Ahead
Introduction
The process of classifying companies as ‘fraud’ accounts in India has undergone a significant change. Banks are no longer required to provide a personal hearing to the management of a company before labeling it as a ‘fraud’ account. However, if the borrower legally challenges the classification based on principles of natural justice, the decision will be comprehensively re-evaluated. This updated procedure aims to codify the steps involved in classifying companies with outstanding loans of ₹50 crore or more as fraud accounts.
Although this directive follows a Supreme Court ruling in March 2023 to provide a hearing to borrowers before such classification, it has raised concerns among some bankers and legal experts, who anticipate potential court disputes.
The Sensitivity of Labelling Borrowers as ‘Fraud’
Labelling a borrower as ‘fraud’ or ‘wilful defaulter’ holds significant consequences in the Indian banking system. Such tags practically banish borrowers from accessing institutional credit. Considering the sensitivity and contentious nature of this matter, banks have formulated a standard operating procedure to address it.
A Fair Process for Borrowers?
The procedure, which has been approved by the managing committee of the Indian Banks’ Association and shared with bank CEOs, aims to provide principles of natural justice to borrowers. While a personal hearing is not mandatory, the borrower is given an opportunity to respond within 15 days through a show-cause notice sent to their registered office. If the notice is undeliverable or the borrower refuses to accept it, a record of the attempt is kept. This procedure ensures that the borrower is provided with a fair hearing, as per the principles of natural justice.
Differing Opinions and Concerns
Opinions among senior bankers and lawyers vary regarding the procedure. Some argue that principles of natural justice do not necessitate a personal or adversarial-style hearing. However, these differing opinions do not rule out the possibility of further legal challenges.
Zulfiquar Memon, managing partner of MZM Legal, specializing in disputes related to white-collar crimes, raises concerns about the potential arbitrariness of the guidelines. He points out that there is no provision for personal hearings and that accounts can be classified as ‘red flagged’ and shared on the CRILC data platform before due process is completed. Comparatively, the process for classifying as a ‘wilful defaulter’ appears to be more effectively defined.
Steps Leading to Fraud Account Classification
The process of tagging an account as fraud begins with banks noting early warning signals in a loan account. These signals can include tax or enforcement raids on the borrower, frequent changes in the project scope, multiple transactions with interconnected entities, resignation of key personnel, and delays in payment of dues. A compilation of such alerts forms the basis for classifying an account as a ‘red flagged account’ (RFA).
Once an account is red-flagged, the bank conducts further investigations into suspicious transactions, which may involve hiring external auditors or forensic experts. The findings of these investigations are then presented to competent authorities, typically consisting of members from management committees and the board of directors. Within six months, the bank must either lift the RFA tag or classify the account as fraud.
Re-Examination of Cases
If the borrower responds within the prescribed time frame in a show-cause notice, the case can be referred back to the competent authority. However, if the borrower contests the fraud classification based on principles of natural justice, the case can be re-examined.
Potential Litigation and Banks’ Concerns
It is anticipated that the procedure may lead to multiple litigations as borrowers are likely to challenge their classification as fraud accounts in court. Despite this outcome, some industry insiders view this procedure as the best possible solution. Dealing with errant clients is not easy, and personal hearings could be exploited by dubious borrowers to buy time and derail the process, according to a PSU bank official who chose to remain anonymous.
In conclusion, the revised procedure for classifying companies as ‘fraud’ accounts in India removes the requirement for a personal hearing but ensures comprehensive re-evaluation if legally challenged. This update aims to provide principles of natural justice to borrowers, although concerns remain regarding potential court battles and the arbitrariness of the guidelines. Banks are cautious of personal hearings being used as a delay tactic. Despite potential litigation, this revised procedure is considered the industry’s best approach to handling such cases. Keywords: banks, fraud, account classification, legal challenges, personal hearings, court battles, India, borrowers, natural justice.
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