Fraud Classification of a Company Account and the Position of Its Directors

This article examines whether a bank's classification of a company's account as fraud under the RBI fraud-risk framework extends to the company's directors without a separate process.

It is relevant now because the RBI Master Directions on fraud risk management of July 2024 and recent Bombay High Court writ decisions have changed how lenders may proceed. Directors who were routinely tagged along with the company, and advisers who act for them, need to know what procedure must be followed against an individual.

The issue

A bank classifies a borrower company's account as fraud. Does that classification make each director a person classified as fraudulent for banking purposes, with the same consequences?

The governing framework

Classification and its consequences. Banks classify an account as fraud on evidence, such as misrepresentation in financial statements or unethical or fraudulent use of credit facilities, not on suspicion. After classification the bank reports to the RBI and to investigating agencies such as the CBI, and the account is placed on a caution list that makes the borrower ineligible for fresh credit. These are serious civil consequences, affecting access to credit and reputation.

The July 2024 Master Directions. RBI overhauled its directions on fraud risk management in July 2024, after Supreme Court scrutiny of the civil consequences of classification in State Bank of India v. Rajesh Agarwal. The Directions incorporate natural justice: a detailed show-cause notice, at least 21 days to respond, consideration of the response and a reasoned order. They are in force.