Borrowers Entitled To Audit Reports Before Fraud Classification, No Right To Full Disclosure: Supreme Court

The Supreme Court on Monday ruled that borrowers must be given access to the material relied upon by banks, including relevant portions of forensic audit reports, before their loan accounts are classified as fraud but clarified that such disclosure is not absolute and may be restricted where it affects third-party rights.

Holding that principles of natural justice require a meaningful opportunity to respond, a bench of Justices J.B. Pardiwala and K.V. Viswanathan said that where banks rely on audit findings, such material must be shared with the borrower to enable an effective representation, though sensitive portions impacting third-party interests may be withheld with reasons.

“Wherever audit reports are available, including forensic audit reports, the same shall be furnished to the borrower and their representation on the report, including on the findings and conclusions be elicited, in case the banks consider the audit report relevant for classifying the account as fraud account. In view of the same, disclosure by furnishing copies of the audit report, including the forensic audit report to the borrower is mandatory. Supply of reports in digital form will be valid compliance.”

At the same time, the court clarified that the right to disclosure is not absolute and recognised the banks' discretion to withhold portions of audit reports where disclosure would impinge on third-party rights, subject to informing the borrower and allowing them to justify the necessity of such disclosure.

“The right to disclosure is not absolute if the disclosure of any part affects third party interest. In the opinion of the bank, the bank should communicate that the disclosure of such part would affect third party rights. Thereafter the borrower will have an opportunity to respond that the information is necessary to represent effectively. If, thereafter, some portion of the forensic audit report or other material are found to impinge upon third-party rights in the opinion of the bank, the bank can withhold disclosure of those parts of the report.”

The ruling came on appeals filed by banks including State Bank of India and Bank of India against orders of the Calcutta High Court and the Delhi High Court, which had directed the furnishing of forensic audit reports and the granting of personal hearings before classifying accounts as fraud.

The cases arose from proceedings involving Amit Iron Private Limited and Liliput Kidswear Limited. In the first case, the loan account of Amit Iron Pvt. Ltd. was classified as a non-performing asset on August 20, 2019 and later declared “fraud” on March 13, 2024 by State Bank of India.

In the second matter, Bank of India classified the account of Liliput Kidswear Limited as fraud on May 14, 2025, after acting on findings from forensic audits and issuing show cause notices to the borrower.

While examining the Reserve Bank of India's Master Directions on fraud, the court underlined that borrowers must be put on notice through a detailed show cause, given adequate time to respond, and ultimately served with a reasoned order. What the law does not require, however, is a personal or oral hearing in every case.

The bench made it clear that an “opportunity of hearing” is met when the borrower is given access to the material relied upon, allowed to respond in writing, and the bank records its reasons. A mandatory oral hearing, the court said, is not part of that requirement.

At the same time, the court acknowledged the gravity of a fraud classification. Such a finding can effectively shut borrowers out of institutional finance and damage their reputation, making procedural safeguards essential.

Even so, the court cautioned against stretching those safeguards to the point where the process itself becomes unworkable, noting that compulsory oral hearings in every case could delay fraud detection and disrupt banking operations.

It further noted that such classifications are based on documented evidence such as financial records, transaction data, and audit findings, which are ordinarily within the borrower's knowledge, making written representations sufficient to meet the requirements of natural justice.

Clarifying its earlier ruling in State Bank of India vs. Rajesh Agarwal, the court held that the judgment did not mandate a personal hearing but only required notice, an opportunity to respond, and a reasoned order.

Applying these principles, the court found that in the present cases, show cause notices had been issued, replies considered, and reasoned orders passed before classifying the accounts as fraud.

The court accordingly partly allowed the appeals, setting aside the High Court's directions mandating a personal hearing, while affirming the requirement of disclosure of material relied upon, including audit findings, subject to permissible redactions, and disposed of the case.

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