Can A Bank Tag An Account As Fraudulent If A Borrower Defaults In Repayment?

The Bombay High Court held in a recent case that tagging an account as fraudulent without serving a show-cause notice on the defaulter is invalid. The court noted that when financial institutions classify accounts as fraudulent, for accountholders, this is not merely a technical label, but can lead to severe legal consequences and the freezing of credit facilities.  

The court passed the judgment in a writ petition filed by Kamlesh M Kanungo, the proprietor of M/s. Trison Impex, against Union Bank of India and the Reserve Bank of India (RBI). The petitioner raised the question of whether banks can unilaterally tag a client’s account as fraudulent without providing the accountholder an opportunity to be heard. While protection against fraud is necessary, the court emphasised providing fair treatment to accountholders.

In this case, the petitioner approached the High Court to challenge Union Bank of India’s decision (Respondent No. 2) that had classified the petitioner’s proprietorship bank account as fraudulent in the records. The bank took the action based on the RBI’s “Master Directions on Frauds – Classification and Reporting by Commercial Banks and Select FIs”. The petitioner sought to quash this declaration and halt any further actions due to such classification of his account.

Argument

The counsel of the petitioner argued that the bank’s action was a result of applying the RBI’s Master Direction incorrectly. The counsel argued that the RBI guidelines issued on July 15, 2024, mandated banks to provide a chance to a hearing to such an accountholder before flagging their account as fraudulent. He argued that the decision is against the principle of natural justice, which mandates the right to be heard. He said the bank had failed to provide the petitioner with a notice or a chance to explain his position before tagging the account as ‘Fraudulent’.   

According to Union Bank, the petitioner cheated the bank with Rs 21.80 crore between 2008 and 2018, according to a report in Hindustan Times. The proprietorship firm (Trison Impex), engaged in steel products and steel scrap business, opened a cash credit account with a credit facility of Rs 10 crore in 2008. The account was renewed till October 2018, but after that, it turned into a non-performing asset (NPA) on October 31, 2028, for not repaying the credit.   

The bank sent notice to the accountholder regarding his account turning into NPA, and then, in February 2019, tagged it as a ‘Red Flag Account’. 

The bank argued that the proprietor had withdrawn around Rs 9.5 crore from his personal account from 2016-2018, and his company’s turnover was also shifted to other banks (Yes Bank and Axis Bank) instead of through Union Bank’s Cash Credit Account. The bank further noted discrepancies in the Firm’s documents, as the firm has extended the advances to suppliers without receipts and an outstanding debit balance of Rs 49.43 crore against M/s Trison Agencies.

Court Observation

The division bench, comprising Justice Bharati Dangre and Justice Manjusha Deshpande, referred to the precedents, the orders of the Supreme Court. The court noted that adherence to natural justice is ‘part and parcel’ of the procedures stipulated by the RBI, and thus, cannot be ignored. It also noted that declaring an account as fraudulent has serious legal and economic ramifications for the individual or the organisation, if it’s a current account. Therefore, the banks need to follow a procedural safeguard to avoid such hurried and arbitrary actions against the accountholders. 

Court’s Judgment

The court held that compliance with natural justice is mandatory before tagging accounts for fraud or taking an adverse action. The court quashed the bank’s order and asked to initiate fresh proceedings under the revised guidelines issued by RBI, while ensuring strict compliance with natural justice and the stipulated procedure.