2025 (5) TMI 2009 - HC - Companies Law

Seeking review of judgement - request for corrections of some minor typographical errors - existence of justifiable grounds for declaring classifying or categorizing the petitioner as fraud merely on account of non-payment of institutional loans - HELD THAT - There are indeed certain typographical errors which are quite apparent on the face of the record. In paragraph (11) it is inadvertently recorded that the petitioner in Ratan Puri v. Bank of Baroda passed by the Review Committee. There is an inadvertent omission to the effect that the aforesaid writ petition was decided vide judgment dated 01.03.2024 in favour of the petitioner and categorization of the petitioner as wilful defaulter was struck down/quashed for the same being not only in derogation to the Master Circular of the RBI but also falling foul of decision in the case of State Bank of India v. Rajesh Aggarwal 2023 (3) TMI 1205 - SUPREME COURT . It appears that inadvertently the judgment of Supreme Court Supreme Court in the case SBI v. Jah Developers (P) Ltd. 2019 (5) TMI 862 - SUPREME COURT was not quoted which was in fact cited with affirmation in the case of State Bank of India v. Rajesh Aggarwal. The aforesaid two mistakes are corrected and this order may be read as an addendum of the earlier Judgment dated 25.10.2024 which is sought to be reviewed. It is necessary to note that the learned counsel for the applicant/petitioner took this Court through the company s balance sheets for the financial years 2006 07 to 2011 12. These documents evidently demonstrate significant cash accruals in the form of credit bank balances and accounts receivable which facilitated all transactions with related as well as third parties including investments sales services and lease rentals. Notably the value of these accruals was substantially higher than the cumulative value of the transactions. Upon perusal of the balance sheets this Court is of the view that the respondent Bank s plea that the company utilized borrowed funds for these transactions and thereby diverted borrowed funds lacks merit and fails on the face of the record. The proposition of law that emerges is that once the aforementioned grounds which clearly emanated from the Forensic Audit Report of M/s Hari Bhakti Company LLP were found to be insufficient or unsustainable on merits for declaring the petitioner s account as wilful defaulter the same grounds cannot be re-agitated to lay the foundation for declaring the petitioner s account as fraud in terms of Circulars 8.9.4 and 8.95 in the absence of additional independent material. No such additional independent material has been evidently pleaded and produced in the instant matter. The declaration of the account of a person or entity as fraud requires a greater degree of criminality. The bottom line is that once the very substratum of the imputations is held to be unsustainable for lesser civil consequences such as being labelled a wilful defaulter under the RBI Master Guidelines the same grounds or imputations cannot form the foundation for declaring a person s or entity s account as fraud which requires a greater degree of proof to be established. Conclusion - i) The petitioner s classification as fraud by the respondent Bank is quashed and set aside. ii) The grounds relied upon by the respondent Bank which were earlier found unsustainable for wilful defaulter classification cannot sustain a fraud classification in the absence of additional independent material. The earlier judgment is hereby reviewed and thus apart from correcting the typographical mistakes as indicated in paragraph (17) above the discussion on merits of the purported impugned action by the respondent Bank in declaration the account of the petitioner as fraud vide Show Cause Notice dated 20.06.2019 is hereby held to be arbitrary unfair illegal and untenable in law - Petition disposed off.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Court in the present matter are:

(a) Whether the petitioner's account could be validly declared and classified as 'fraud' by the respondent Bank based on the allegations and forensic audit report relied upon;

(b) Whether the grounds on which the petitioner was earlier declared a 'wilful defaulter' under the RBI Master Circular of 2015, which were found unsustainable by Coordinate Benches of this Court, could be re-agitated to sustain a classification of 'fraud' against the petitioner;

(c) Whether the procedural and substantive requirements under the RBI Master Circular and related circulars concerning classification of accounts as 'wilful defaulter' or 'fraud' were complied with by the respondent Bank;

(d) Whether the petitioner's resignation from the company MBSL prior to the alleged events disentitles the respondent Bank from holding him liable for the alleged defaults or fraudulent acts;

(e) Whether the forensic audit findings and other documentary evidence substantiate the allegations of diversion, siphoning of funds, or other fraudulent conduct attributed to the petitioner;

(f) Whether the actions of the respondent Bank in declaring the petitioner's account as 'fraud' without independent material beyond the forensic audit report and without proper application of mind were arbitrary, illegal, and untenable in law;

(g) Whether the petitioner is entitled to a review of the earlier judgment dated 25.10.2024 to include detailed findings on the allegations levelled by the respondent Bank.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (a) and (b): Validity of 'fraud' classification and reliance on grounds of wilful default

Relevant legal framework and precedents: The RBI Master Circular of 2015 and related circulars govern the classification of accounts as 'wilful defaulter' or 'fraud'. The circulars require that the Identification Committee examine evidence carefully before issuing show cause notices and that classification as 'fraud' demands a higher standard of proof than wilful default. The Supreme Court's decision in the cited State Bank of India v. Rajesh Aggarwal and SBI v. Jah Developers (P) Ltd. emphasize the need for adherence to procedural safeguards and proper application of mind.

Court's interpretation and reasoning: The Court noted that Coordinate Benches had already quashed the petitioner's classification as a wilful defaulter on grounds that the respondent Bank failed to examine relevant material such as loan sanction letters, flash reports, minutes of lender meetings, and restructuring agreements before issuing show cause notices. The Court emphasized that the same grounds cannot sustain a 'fraud' classification, which requires a higher degree of proof. The forensic audit report relied upon by the respondent Bank did not verify the source of funds invested in subsidiaries, a crucial element to establish diversion of borrowed funds, which is a prerequisite for invoking the Master Circular.

Key evidence and findings: The forensic audit report by M/s Haribhakti & Co. LLP did not verify whether the investments in subsidiaries were made from borrowed funds or internal accruals. The lender banks' own documents, including the Final Restructuring Scheme (FRS), acknowledged the investments were made from substantial cash surpluses generated by the company in earlier years. The petitioner's resignation from MBSL was recorded prior to the period of alleged defaults.

Application of law to facts: Given that the investments were made from internal accruals and not from borrowed funds, the Master Circular's provisions on diversion and siphoning of funds were not triggered. The respondent Bank's failure to consider relevant documents and the absence of independent material beyond the forensic audit report rendered the 'fraud' classification arbitrary and without jurisdiction.

Treatment of competing arguments: The respondent Bank contended that forensic audit revealed irregularities justifying the fraud classification. However, the Court found that the forensic audit itself did not conclude diversion of funds and that the Bank failed to discharge the burden of proof. The petitioner's counsel argued that the Bank had knowledge and acquiesced to the investments and transactions for years and that the allegations were belated and unsustainable.

Conclusions: The Court concluded that the grounds for wilful default being unsustainable preclude their use to sustain a fraud classification. The 'fraud' declaration was held to be illegal and untenable in law.

Issue (c): Compliance with procedural and substantive requirements under RBI Master Circular

Relevant legal framework and precedents: The RBI Master Circular requires the Identification Committee to carefully examine all material before issuing show cause notices and classifying accounts. The Circulars 8.9.4 and 8.9.5 prescribe procedures for forensic audits, reporting to RBI, and lodging complaints with investigative agencies.

Court's interpretation and reasoning: The Court observed that the respondent Bank failed to consider relevant documents such as the loan sanction letter, flash reports, minutes of lender meetings, and restructuring agreements before issuing the show cause notice. The Bank's reliance solely on the forensic audit report without independent verification of the source of funds was insufficient. The procedural safeguards mandated by the circulars were not complied with.

Key evidence and findings: The Identification Committee and Review Committee orders reflected that certain allegations were dropped or found unsustainable by the Bank's own internal processes. The forensic audit report itself acknowledged that the source of funds for investments was not verified.

Application of law to facts: The Bank's failure to discharge the obligations of examination and consideration of material evidence rendered the show cause notice and subsequent classification invalid.

Treatment of competing arguments: The Bank argued that the forensic audit justified the classification. The Court found this reliance misplaced and contrary to the Master Circular's requirements.

Conclusions: The procedural non-compliance and lack of substantive basis invalidated the fraud classification.

Issue (d): Effect of petitioner's resignation from MBSL on liability

Relevant legal framework and precedents: Liability for acts of default or fraud generally requires that the person held liable was in control or management at the relevant time.

Court's interpretation and reasoning: The petitioner resigned as Executive Director on 30.04.2012 and as Full Time Director w.e.f. 16.11.2012, prior to the alleged defaults and forensic audit period. The Joint Lenders' Meetings acknowledged this resignation. No material was produced to link the petitioner to acts of diversion or fraud after his resignation.

Key evidence and findings: Letters from MBSL to lenders informing about the petitioner's resignation; Joint Lenders' Meeting minutes; absence of SCN on grounds related to post-resignation period.

Application of law to facts: The petitioner cannot be held liable for alleged acts occurring after his resignation, as he was no longer in control or management.

Treatment of competing arguments: The Bank did not produce evidence to rebut the petitioner's resignation or link him to subsequent acts.

Conclusions: The petitioner's resignation disentitles the Bank from holding him liable for the alleged defaults or fraudulent acts post-resignation.

Issue (e): Substantiation of allegations of diversion, siphoning, and fraudulent conduct

Relevant legal framework and precedents: Diversion or siphoning of funds under the Master Circular requires that borrowed funds be used for unauthorized purposes. Mere transactions with related parties or subsidiaries are not fraudulent if made transparently and with lender knowledge.

Court's interpretation and reasoning: The Court extensively analyzed the forensic audit findings and related documents. It found that:

• Investments in subsidiaries were funded through private equity or internal accruals, not borrowed funds;
• Lease agreements and security deposits were disclosed and known to lender banks;
• Transactions between MBSL and related entities were part of strategic business decisions;
• Expired lease agreements did not result in fraudulent transactions;
• Supplier advances and loans were adequately accounted for, with no evidence of loss or misappropriation;
• Forensic audit did not conclude diversion or siphoning of funds;
• Lender banks classified MBSL as Class-B borrower, indicating external factors and no diversion of funds.

Key evidence and findings: Final Restructuring Scheme, Flash Reports, audited balance sheets, Joint Lenders' Meeting minutes, forensic audit report disclaimers, and prior judgments quashing wilful defaulter classification.

Application of law to facts: The factual matrix and documentary evidence did not support allegations of diversion, siphoning, or fraud.

Treatment of competing arguments: The Bank's reliance on forensic audit findings was undermined by absence of verification of source of funds and lender knowledge of transactions.

Conclusions: Allegations of diversion, siphoning, and fraudulent conduct were found unsustainable and unsubstantiated.

Issue (f): Arbitrary and illegal nature of respondent Bank's actions

Relevant legal framework and precedents: Principles of natural justice and fair procedure require that adverse classifications be based on proper evidence and reasoned decisions.

Court's interpretation and reasoning: The Court held that the respondent Bank's actions in declaring the petitioner's account as 'fraud' based on the same grounds earlier rejected for wilful default, without independent material, were arbitrary, unfair, and illegal. The Bank failed to comply with procedural safeguards and did not produce additional evidence to justify the fraud classification.

Key evidence and findings: Absence of independent material beyond forensic audit report; prior quashing of wilful defaulter classification; no fresh evidence produced.

Application of law to facts: The Bank's action lacked jurisdiction and violated principles of natural justice.

Treatment of competing arguments: The Bank conceded that a finding on merits could be rendered for administrative convenience but maintained the fraud classification. The Court rejected this stance.

Conclusions: The fraud classification was held to be arbitrary, illegal, and untenable.

Issue (g): Review of earlier judgment to include detailed findings

Relevant legal framework and precedents: Review petitions are maintainable to correct errors apparent on record or to consider relevant material omitted earlier.

Court's interpretation and reasoning: The Court found typographical errors and omissions in the earlier judgment, including incorrect party names and incomplete reference to precedents. The petitioner's request for detailed findings on the fraud allegations was accepted as necessary for administrative clarity and future guidance.

Key evidence and findings: Earlier judgment dated 25.10.2024; counter affidavit dated 30.10.2023; rejoinder and supplementary affidavits; relevant precedents.

Application of law to facts: The Court corrected typographical errors and supplemented the earlier judgment with detailed analysis of the fraud allegations, endorsing the findings of Coordinate Benches.

Treatment of competing arguments: The respondent Bank agreed to detailed findings for administrative convenience.

Conclusions: The review petition was allowed, and the earlier judgment was modified accordingly.

3. SIGNIFICANT HOLDINGS

"Once the aforementioned grounds, which clearly emanated from the Forensic Audit Report of M/s Hari Bhakti & Company LLP, were found to be insufficient or unsustainable on merits for declaring the petitioner's account as 'wilful defaulter', the same grounds cannot be re-agitated to lay the foundation for declaring the petitioner's account as 'fraud' in terms of Circulars 8.9.4 and 8.9.5 in the absence of additional independent material."

"The declaration of the account of a person or entity as 'fraud' requires a greater degree of criminality. The bottom line is that once the very substratum of the imputations is held to be unsustainable for lesser civil consequences such as being labelled a 'wilful defaulter' under the RBI Master Guidelines, the same grounds or imputations cannot form the foundation for declaring a person's or entity's account as 'fraud', which requires a greater degree of proof to be established."

"The respondent Bank failed to discharge the obligations mandated under Clauses 3 (a) and (b) of the Master Circular before issuing the show cause notice in the present case... Non-consideration of relevant material falls short of requirement of examination."

"The Forensic Audit Report did not verify the source of funds which were invested in the subsidiaries... The respondent Bank could not have issued show cause notice to the petitioner for wilful default, without verifying the source of funds that were invested."

"The investments were made by MBIL from its substantial cash surpluses generated in earlier years of FY 2006 and FY 2008. In other words, the investments were not made from the borrowed funds. Thus, the lender banks including the respondent Bank, in their own internal document acknowledged that they were fully aware of the investments made by MBIL in its subsidiaries."

"The respondent Bank's plea, that the company utilized borrowed funds for these transactions and thereby diverted borrowed funds, lacks merit and fails on the face of the record."

"The impugned action by the respondent Bank in declaring the account of the petitioner as 'fraud' vide Show Cause Notice dated 20.06.2019 is hereby held to be arbitrary, unfair, illegal and untenable in law."

Final determinations:

• The petitioner's classification as 'fraud' by the respondent Bank is quashed and set aside.
• The grounds relied upon by the respondent Bank, which were earlier found unsustainable for wilful defaulter classification, cannot sustain a fraud classification in the absence of additional independent material.
• The respondent Bank failed to comply with procedural and substantive requirements under the RBI Master Circular.
• The petitioner's resignation prior to the alleged defaults disentitles the Bank from holding him liable for fraudulent acts.
• Allegations of diversion, siphoning of funds, and fraudulent conduct are unsubstantiated and rejected.
• The review petition is allowed with corrections of typographical errors and inclusion of detailed findings on merits.