2021 (5) TMI 218 - HC - Companies Law

Non-inclusion of principles of natural justice especially audi alteram partem (giving opportunity of hearing to the other side) in the Master Directions on Fraud dated 01.07.2016 - Section 35-A of the Banking Regulation Act 1949 - borrower Company is holder of fraudulent account or not? - resolution of the Fraud Identification Committee (FIC) dated 31.07.2019 whereby both the JLF and the FIC have classified the account of M/s. B. S. Limited of which the petitioner was the former Chairman and Managing Director as fraud and willful defaulter . HELD THAT - The argument of urgency is belied by the record. For the Company s account was declared as NPA on 29.06.2016; the JLF declared the Company s account as fraud on 15.02.2019 yet the FIC did not declare the Company s account as fraud till 31.07.2019. Thus there is a gap of 4 months between the decision of the JLF and the FIC. Hence obviously the decision to declare the account as fraud has not been taken on an urgent basis - Furthermore if the requirement of principle of nature justice is not read into the Master Circular it would suffer from vagueness. For on the 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. Yet Clause 8.12.1 of the Master Circular clearly states that the procedure for declaring a borrower as a willful defaulter has to be followed. In the case of Jah Developers (supra) the Hon ble Supreme Court has already declared that prior to declaring a borrower as a willful defaulter an opportunity of hearing has to be given. If the principle of audi alteram partem were not read into Clauses 8.9.4 and 8.9.5 of the Master Circular there would be a contradiction between the procedure adopted for declaring a borrower as a willful defaulter and the procedure adopted for declaring an account as fraud . Obviously the Master Circular could not speak in self-contradictory terms. Therefore to erase the self-contained contradiction and to save the Master Circular from the virus of vagueness the principles of natural justice perforce would have to be read into Clauses 8.9.4 and 8.9.5 of the Master Circular. Since the right to livelihood is part and parcel of fundamental right to life under Art. 21 of the Constitution of India the fundamental right can be deprived only by a reasonable procedure established by law. However to deny the said fundamental right without giving an opportunity of hearing would be highly unreasonable unfair and unjust. Thus the Master Circular as interpreted by the RBI would be in violation of Article 21 of the Constitution of India. Therefore to save Clauses 8.9.4 and 8.9.5 of the Master Circular from being declared as unconstitutional it is essential to read the principle of natural justice into the said Clauses - since the Master Circular also imposes a duty on the banks to lodge a complaint with the CBI / criminal investigating agency within a short period after detecting / declaring an account as fraud obviously the borrowing Company its Promoter / Director would quickly be embroiled in criminal investigation and in criminal proceedings. Such involvement in criminal proceedings not only affects the social standing of an individual and the goodwill of a Company but also forces 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. The right to be heard has been given to 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 they have played a vital role in sanction/disbursement or facilitated for preparation of fraud. Hence while those who are allegedly the peripheral accomplices are granted an opportunity of hearing the main actor is denied the right to speak and to defend his position. Considering the grave civil consequences and penal action which would be followed as a result of classifying a borrower as a fraudulent borrower or a holder of a fraudulent account it is imperative that principles of natural justice must be read into Clauses 8.9.4 and 89.9.5 of the Master Circular - Fair play in governance is the gravitational force which binds the entire State. Therefore 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. 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 . Once the JLF was of the opinion that further clarification is required from the Forensic Auditor once it is in the process of taking a decision once it has decided to wait till further clarification is submitted the JLF is not justified in concluding that the account be treated as fraud . In fact the JLF was legally required to wait for further clarification or non-clarification from the Forensic Auditor - A bare perusal of the resolution of FIC dated 31.07.2019 also reveals that the said resolution is based on the Report submitted by Dr. K.V. Srinivas IRP. However there is no evidence available on record to establish the fact that a copy of the said Report was furnished to the borrower Company or to the petitioner. Thus neither the borrower Company nor the petitioner nor any other Director was given a chance to explain or to challenge the finding of the said Report. A copy of the said Report has not been placed even before this Court by the respondents. 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 - the decision dated 15.02.2019 passed by the JLF and the resolution dated 31.07.2019 passed by the FIC are hereby set aside - the JLF is directed to give an opportunity of hearing by furnishing copies of both the Reports namely the Forensic Auditor Report dated 06.04.2018 and the subsequent Report submitted by Dr. K.V. Srinivas IRP to the petitioner and to the OL - the JLF is directed to give an opportunity of personal hearing both to the petitioner and to the OL before taking any decision on the issue whether the account should be classified as fraud or not? - after the JLF has taken its decision the FIC is directed to pass its resolution whether the decision of the JLF should be confirmed or not? Application disposed off.

Summary

Issues Involved:
1. Non-inclusion of principles of natural justice in the Master Directions on Fraud issued by the Reserve Bank of India.
2. Legality of the decision by the Joint Lenders Forum (JLF) to classify the Company’s account as ‘fraud’.
3. Legality of the resolution by the Fraud Identification Committee (FIC) to classify the Company’s account as ‘fraud’.
4. Impact of the Master Circular on the fundamental rights of the petitioner.

Issue-wise Detailed Analysis:

1. Non-inclusion of principles of natural justice in the Master Directions on Fraud:

The petitioner argued that the Master Circular issued by the RBI under Section 35-A of the Banking Regulation Act, 1949, does not include an opportunity of hearing before declaring an account as ‘fraud’. The petitioner contended that this omission violates principles of natural justice, particularly the principle of audi alteram partem. The Court agreed, stating that principles of natural justice are essential to prevent arbitrary, discriminatory, and irrational decisions. The Court emphasized that even administrative actions must adhere to principles of fairness and reasonableness. It concluded that the principles of natural justice, especially the right to a hearing, must be read into the Master Circular to ensure it does not violate Articles 14, 19(1)(g), and 21 of the Constitution of India.

2. Legality of the decision by the Joint Lenders Forum (JLF) to classify the Company’s account as ‘fraud’:

The JLF declared the Company’s account as ‘fraud’ based on reports from forensic auditors and the Interim Resolution Professional (IRP). However, the petitioner was not provided copies of these reports nor given an opportunity to respond to the findings. The Court found this to be a violation of the principles of natural justice. The Court noted that the JLF had previously invited the Company to its meetings but failed to do so when making the crucial decision to classify the account as ‘fraud’. The Court concluded that the JLF’s decision was legally unsustainable due to the lack of opportunity for the petitioner to be heard and to challenge the evidence.

3. Legality of the resolution by the Fraud Identification Committee (FIC) to classify the Company’s account as ‘fraud’:

The FIC’s resolution was based on the same reports used by the JLF, which were not shared with the petitioner. The Court found that the FIC also violated the principles of natural justice by not providing the petitioner an opportunity to explain or challenge the findings of these reports. The Court emphasized that decisions affecting fundamental rights must be made fairly and reasonably. Consequently, the Court set aside the FIC’s resolution as legally unsustainable.

4. Impact of the Master Circular on the fundamental rights of the petitioner:

The Court observed that the penal measures in the Master Circular, such as debarring the Company’s directors from availing bank finance for five years, have severe civil and criminal consequences. These measures adversely affect the petitioner’s fundamental rights under Articles 19(1)(g) and 21 of the Constitution of India. The Court concluded that the Master Circular must include provisions for a fair hearing to prevent arbitrary and unreasonable deprivation of fundamental rights.

Relief Granted:

1. The principle of audi alteram partem is to be read into Clauses 8.9.4 and 8.9.5 of the Master Circular.
2. The decision dated 15.02.2019 by the JLF and the resolution dated 31.07.2019 by the FIC are set aside.
3. The JLF is directed to provide copies of the forensic audit reports to the petitioner and the Official Liquidator (OL).
4. The JLF must give an opportunity of personal hearing to the petitioner and the OL before making any decision on classifying the account as ‘fraud’.
5. The FIC must pass a resolution on whether to confirm the JLF’s decision after the JLF has made its decision.
6. The entire process must be completed within a specified timeframe: three months for the JLF and two months for the FIC.

The judgment underscores the importance of adhering to principles of natural justice to ensure fairness and prevent arbitrary decisions that can have significant civil and criminal consequences.