Branded Before Being Heard: Audi Alteram Partem and the Journey from Rajesh Agarwal to Amit Iron

Introduction

In the year 2022-2023, the banks in India reported 13,530 fraud cases involving INR 30,252 crores. Behind each of these numbers lies a classification decision, and behind each classification, a business teetering on the edge. A single word, ‘fraud’, can quietly shut down an enterprise. The moment a bank classifies a borrower’s account as fraudulent under Clause 2.2 of the RBI (Frauds Classification and Reporting by Commercial Banks and Select FIs) Directions, 2016 (“Master Directions 2016”), the consequences are swift and severe. The borrower company, its promoters and whole-time directors can be shut out of the entire banking system for five years, the group’s other accounts are pulled in for scrutiny, and there are prospects for criminal prosecution as well as insolvency proceedings. For an Indian corporate, including multinational corporations and conglomerates, a single classification can ripple across subsidiaries and affiliates before the accused is even heard on the charges against them.

This is precisely why the Hon’ble Supreme Court’s (“SC”) recent judgment in State Bank of India v. Amit Iron Private Limited is pertinent: it offers borrowers the fairness they are due under the RBI’s evolving Master Directions and seeks to settle a decade-old tussle between banks and borrowers.

The Master Directions 2016 said nothing about hearing the borrower before classifying them as fraudulent. This was challenged before the Hon’ble SC in State Bank of India v. Rajesh Agarwal as a violation of Article 14 of the Constitution on the ground that borrowers faced serious prejudice without being given an opportunity to be heard. The SC held the Master Directions 2016 violative of Article 14 and directed the RBI to read the principles of audi alteram partem into the framework.

Thereafter, the RBI amended the framework and issued the Fraud Risk Management in Commercial Banks (including Regional Rural Banks) and All India Financial Institutions Directions, 2024 (“Master Directions 2024”). These directions made due process a pre-condition to any fraud classification. However, that did not end the debate. The Master Directions 2024 were challenged before the Hon’ble SC, on grounds strikingly similar to Rajesh Agarwal, in the recent Amit Iron matter.

The Starting Point: Master Directions 2016

The Master Directions 2016 built a framework to detect and report fraudulent accounts early, the better to contain the systemic risk they pose. As soon as a bank account is classified as fraud, among other things: (a) a five-year ban on the borrower, its promoters and whole-time directors from raising bank finance, counted from the date the defrauded amount was fully repaid, in effect cutting an entire corporate group off from institutional credit across the Indian banking system, and (b) a bar on fresh credit and on restructuring, unless the promoters were replaced. At the time, these were considered as potent tools for protecting the financial system. However, the framework carried a glaring blind spot as it said nothing about hearing the borrower before imposing consequences this drastic.

Reading Audi Alteram Partem into the 2016 Framework

In Rajesh Agarwal, the SC addressed that blind spot head-on. The borrowers’ accounts had been classified as fraudulent with no notice, no chance to respond and no reasoned order. The borrowers argued that the principles of natural justice must be read into every governmental rule and direction, including the Master Directions 2016. As soon as an account is classified as fraudulent, it freezes access to both domestic and cross-border funding, damages reputation across the corporate group, and can foreclose any prospect of revival.

The Hon’ble SC held that natural justice cannot be excluded from the Master Directions 2016; its absence would render the process arbitrary, unfair and violative of Article 14. Before classifying an account as fraud, a bank must therefore (a) serve a notice on the borrower, (b) allow the borrower to explain the conclusions of the forensic audit report, (c) permit a representation, and (d) pass a reasoned order.

But Rajesh Agarwal left one question unanswered: did ‘an opportunity of being heard’ include a right to an oral or personal hearing? The judgment did not address this aspect, and various High Courts took divergent positions. This judicial divergence set the stage for testing the scope of a hearing in the Amit Iron matter.

RBI’s Response: Master Directions 2024

RBI incorporated the principles of natural justice into the new regime. Under the Master Directions 2024, a bank must now (a) issue a show-cause notice (“SCN”) setting out the full particulars of the alleged fraud, (b) give the borrower a reasonable period, no less than 21 days to reply, and (c) pass a reasoned order on classification. Significantly, before that notice can even go out, the bank must complete an internal audit of the account, including a detailed forensic audit. In short, “audi alteram partem” was no longer bolted on judicially; it was written into the directions themselves.

Amit Iron: SC Calibrates the Right to be Heard

In this matter, the Apex Court took up a challenge to the very framework built to comply with its earlier ruling. The three key issues to be determined were: (a) whether Rajesh Agarwal had recognised an inherent right to a personal or oral hearing before an account is classified as fraud; (b) whether a written reply to the SCN, as prescribed by the Master Directions 2024, by itself satisfies the test of natural justice; and (c) whether lender banks must disclose the entire forensic audit report to the borrower.

No Inherent Right to a Personal Hearing

The SC held that “audi alteram partem” stands satisfied once a bank (a) serves an SCN along with a detailed forensic audit, (b) gives the borrower an opportunity to file a written reply, and (c) passes a reasoned order. There is no inherent right to a personal or oral hearing.

Full Forensic Audit Report Must be Disclosed

While upholding the RBI’s 2024 framework, the Hon’ble SC held that the entire forensic audit report, and not merely its conclusions or selective extracts, must be furnished to the borrower along with the SCN. However, where the report contains any third-party interests or confidential information, the bank may withhold those parts. The bank ought to disclose such information to the borrower and afford an opportunity to seek access to them. The reasoning is clear; the real case against the borrower lies in the contents of the report, and no person can effectively rebut findings that have never been disclosed to them.

Post Amit Iron: The Gaps and the Way Forward

1. Civil death without a personal hearing

Treating a fraud classification as a bank’s internal ‘housekeeping’ understates its severity, and its consequences extend far beyond an ordinary banking relationship. As stated above, such classification triggers a five (5)-year debarment from the entire financial system, invites scrutiny from investigative agencies, and may form the basis for prosecution under the law. For promoters and directors, it can mean personal disqualification and reputational ruin. However, the Amit Iron judgment permits all of this to unfold on the strength of written pleadings alone.

The way forward: Rather than a 5-year debarment, a proportionate, reasoned debarment in line with the SCN and a reply by the entity should be taken into consideration to avoid the ‘civil death’.

2. A related gap: No criteria for discretionary oral hearings

Neither the 2016 nor the 2024 Directions specify when an oral hearing is warranted, even where the underlying facts are genuinely disputed or the forensic methodologies are contested by the affected parties. For instance, let us consider a scenario wherein the forensic auditor relies on sampling techniques that the borrower’s experts dispute, or where the alleged fraud turns on contested interpretations of complex financial instruments. In such cases, a written reply may be wholly inadequate. The Master Directions 2024 are silent on whether banks have any residual discretion to grant oral hearings in exceptional cases, and if so, what factors should guide that discretion.

The way forward: RBI should amend the Master Directions 2024 to specify circumstances when an oral hearing must be granted. A clear criterion would reduce litigation and provide certainty to both banks and borrowers.

3. No standard for a reasoned order

Neither the Apex Court nor the Master Directions 2024 list out the mandatory ingredients of a reasoned order. Till the time such a vacuum exists, the bank shall engage with each ground raised in the reply to the SCN and must give a detailed finding as to why the forensic audit’s conclusions are preferred over the borrower’s stand. As things stand, the absence of any prescribed standard creates a ground for challenge, i.e., writ proceedings in waiting. Without such clarity, every classification order becomes a potential battleground, leaving courts to develop the standard on a case-to-case basis, resulting in an unpredictable outcome for all stakeholders.

The way forward: RBI should issue guidance specifying what a ‘reasoned order’ must contain. This would ensure consistency across banks and reduce scope for challenge.

4. Ripple effects on group companies

Once an account is tagged as fraud, banks are required to examine the accounts of group and associated companies that share common directors or promoters, especially causing an acute exposure for MNCs and conglomerates, where one classification can cascade across subsidiaries and affiliates. The Master Directions 2024 acknowledge this ripple effect but fail to lay down any such rules for applying “audi alteram partem” to each affected person/ entity. This leaves several questions open: (a) shall banks issue a separate SCN to each group entity, (b) is each company entitled to its own forensic audits, or can the original audit be relied upon, (c) are all group accounts automatically tainted as fraudulent, or does each require independent determination. Potentially, even a single classification of any of its entities can now freeze all credit lines, trigger cross-default provisions, and cause an impediment to ongoing transactions across the entire group. Practically, all the above can happen well before the affected entity/ group gets its chance before the courts.

The way forward: RBI should issue specific guidance on how “audi alteram partem” applies to group and associated companies. As a bare minimum, each affected entity should receive its own show-cause notice and an opportunity to respond before any adverse consequences attach to its accounts.

5. Treatment of inconclusive forensic findings

A forensic audit may identify ‘red flags’ without definitively establishing fraud, yet the Master Directions 2024 do not address how banks should proceed where the evidence is inconclusive. In such a scenario, can a classification be made on the basis of doubts/ suspicious patterns alone? If at all, the standard of proof must be well defined even before the bank considers issuance of an SCN.

The way forward: RBI should prescribe a standard of proof for fraud classification and guidance on how banks should proceed when forensic evidence is equivocal. A ‘preponderance of evidence’ standard, coupled with a requirement that the forensic audit definitively establish (rather than merely suggest) fraud, would protect borrowers from classification on the basis of suspicion alone.

6. Absence of an appellate or review mechanism

The Master Directions 2024 do not provide for any in-house appellate or review mechanism. Once a bank classifies an account as fraud, the borrower’s only recourse is to approach the courts. The absence of such a mechanism places the entire burden of error correction on the courts and delays justice for aggrieved parties.

The way forward: India should establish a specialised appellate forum either within the RBI’s structure or as an independent tribunal to hear such challenges to fraud classifications. This would provide faster, more expert review than civil courts, and reduce the burden on an already strained judiciary.

Conclusion

But the journey is far from over. For corporate borrowers, and especially multinational corporations with layered group structures, the practical takeaway is clear: engage as soon as an SCN is received, insist on the full forensic audit report, and map legal and financial risks across group and affiliate companies before any classification is concluded. These suggestions point towards a framework that is not merely fairer but genuinely fit for purpose. The next round of litigation, or better still, the next round of regulatory reform, will determine whether India takes that path.