Fraud Classification Without Notice or Hearing Violates Fundamental Principles of Natural Justice: Delhi High Court

"Serious Civil Consequences Demand Fair Process; Audi Alteram Partem Cannot Be Ignored," Court Holds, On October 25, 2024, the Delhi High Court, in a notable judgment delivered by Justice Dharmesh Sharma, quashed Bank of Baroda's classification of businessman Ratul Puri as a "fraud" under the Reserve Bank of India's (RBI) Master Directions on Frauds. The court held that the classification, done without prior notice or an opportunity for Puri to present his case, was a violation of the principles of natural justice. The court's decision underscores the critical importance of procedural fairness in actions that have severe civil consequences.

Puri's Challenge Against Fraud Classification by Bank of Baroda
Ratul Puri, Chairman of Hindustan Power Group, filed a writ petition challenging Bank of Baroda's decision to label him as a "fraud" under RBI’s Master Directions. The classification stemmed from alleged financial irregularities in transactions involving Moser Baer Solar Limited (MBSL), a company associated with Puri’s family. Puri contended that he had resigned from MBSL's board in 2012 and was no longer involved in its operations when the alleged irregularities took place. He argued that he was never given notice or a chance to respond to the allegations before the "fraud" designation, thus violating his right to natural justice.

The Importance of Natural Justice in Fraud Classification
The court identified several crucial issues in the case, particularly around the procedural fairness required in classifying a borrower as "fraud." According to the court, the lack of a Show Cause Notice (SCN) to Puri, the absence of a hearing, and the failure to provide access to essential documents, including forensic audit reports, rendered Bank of Baroda’s actions arbitrary and procedurally unsound.

Justice Sharma emphasized that “the principles of natural justice necessitate an opportunity of hearing before classifying a borrower as fraud.” The court noted that the consequences of such a designation are equivalent to “civil death” in financial terms, as it blocks access to institutional finance, impacting the borrower’s business and reputation.

Court Relies on Rajesh Aggarwal Case: Classification as Fraud and Severe Civil Consequences
The High Court relied on the Supreme Court’s decision in State Bank of India v. Rajesh Aggarwal (2023), where it was held that the classification of borrowers as "fraud" has significant civil and penal consequences, necessitating strict adherence to natural justice principles. The Rajesh Aggarwal ruling established that the RBI’s Master Directions on Frauds, despite not explicitly requiring a hearing, must be interpreted to include such procedural safeguards to avoid arbitrary actions by banks.

Justice Sharma quoted from Rajesh Aggarwal, highlighting that “classification as fraud is akin to blacklisting, which requires an opportunity for the affected party to be heard.” The court held that the lack of a hearing before such a severe classification violates the right to fair process and undermines the credibility of the classification process itself.

Procedural Lapses in Forensic Audit and Lack of Document Disclosure
In its defense, Bank of Baroda cited findings from a forensic audit conducted by M/s Haribhakti & Company, which alleged fund diversion and irregular transactions by MBSL. However, the court found that these findings were never disclosed to Puri, denying him an opportunity to contest the conclusions. The audit reportedly revealed issues such as unauthorized transactions, irrational investments, and transfers to related entities, but none of this information was shared with Puri before his name was added to the Central Fraud Registry.

The court criticized this lack of transparency, stating, “The petitioner was not provided with relevant documents, including the forensic audit report, nor was he informed about the decision to classify him as fraud,” which is a clear violation of natural justice.

Fraud Classification Set Aside, Bank Directed to Remove Name from Central Fraud Registry
The Delhi High Court concluded that Bank of Baroda’s action lacked legal basis and failed to meet the standards of fairness required under law. Consequently, the court allowed Puri’s writ petition, setting aside the bank's decision to classify him as a fraud. The court directed Bank of Baroda to remove Puri’s name from the Central Fraud Registry within 15 days and cautioned banks to adhere to due process in future classifications.

Justice Sharma summarized, “The present writ petition is allowed, and the impugned order dated 20.06.2019 classifying the petitioner as ‘fraud’ is hereby quashed.” The court also noted that no substantive grounds existed to justify such classification, as evidenced by prior decisions in similar cases involving Puri and other banks.

This judgment reinforces the judiciary's commitment to ensuring that actions with severe civil repercussions are subject to procedural safeguards. It also serves as a reminder to banks and financial institutions of the need for transparency and fairness in actions that impact borrowers' rights, especially under RBI's stringent directions on fraud.

Date of Decision: October 25, 2024

Ratul Puri v. Bank of Baroda, W.P.(C) No. 2765 of 2023