Bank Classifies Your Account as Fraud: Your Rights After the 2023 Ruling

What did the Supreme Court decide in SBI v Rajesh Agarwal?

The Court held that the principles of natural justice must be read into RBI's Master Directions on frauds. Under the 2016 directions then in force, banks could classify an account as fraud based on internal findings or a forensic audit, and the borrower would often learn of it only when the account was reported. The Court said that is not permissible, because classification as fraud has serious civil consequences, which it compared to blacklisting: the borrower is cut off from institutional finance and its reputation is damaged.

So before classifying an account as fraud, the bank must serve a notice on the borrower, give it an opportunity to explain the findings of the forensic audit report, allow it to make a representation, and pass a reasoned order. The Court also drew a distinction that is often missed: no hearing is needed before a bank lodges an FIR. The criminal law can be set in motion on information; the hearing requirement applies to the administrative act of classifying the account as fraud.

The judgment upheld High Court decisions that had set aside fraud classifications made without notice. It did not stop banks from classifying accounts as fraud. It required them to do it fairly. That distinction matters for anyone facing a notice now: the question is rarely whether the bank can proceed at all, and almost always whether it has given you a real chance to answer.

What the RBI's 2024 fraud directions now require

RBI issued revised Master Directions on Fraud Risk Management on 15 July 2024, separately for commercial banks, cooperative banks and NBFCs, replacing the 2016 directions. They build the Rajesh Agarwal requirements into the process. Before classifying an account as fraud, the bank must issue a detailed show cause notice to the borrower and to its promoters, whole-time directors and others in charge of its affairs. The notice must set out the transactions, actions or events on which the proposed classification rests.

The borrower must be given not less than 21 days to reply. The bank must have a board-approved system for issuing notices, examining replies and passing reasoned orders, and the order must be served on the persons concerned. The directions also require an early warning signals framework and a red flagging process: an account showing signs of possible fraud is first flagged as a red flagged account, investigated, often through a forensic audit, and only then considered for classification.

The directions carry the consequences forward as well. Once an account is classified as fraud, the bank reports it to the RBI and to law enforcement agencies, and the borrower and the persons associated with it are debarred from raising finance from banks and financial institutions for five years from the date of full payment of the defrauded amount. The same directions allow the fraud tag to fall away for an entity that is resolved under the IBC or an RBI framework with a change of management, though the former management's criminal liability remains.

Do you have a right to a personal hearing and the full forensic audit report?

No to the first, yes to the second, in most cases. After Rajesh Agarwal, the High Courts differed on whether the borrower must be heard in person. Some, including the Delhi and Calcutta High Courts in 2025, held that a personal hearing was required and that the full forensic audit report had to be supplied. The Supreme Court settled the question in State Bank of India v Amit Iron Pvt Ltd in 2026.

The Court held that Rajesh Agarwal did not recognise a right to an oral hearing. A show cause notice, the supporting material, an opportunity to reply in writing and a reasoned order meet the requirements of fairness. But the Court upheld the directions to supply the forensic audit report: the bank must ordinarily furnish the full report it relies on, not just its conclusions or extracts. Parts that affect third parties may be withheld if the bank records its reasons, and the borrower may seek access if it needs that material for its defence. Supplying the report in digital form is acceptable.

In practice this shifts all the weight onto the written reply. You will not get a chance to explain things across a table to a committee. Whatever you want the bank to consider must be in writing, supported by documents, and filed within time. A reply that says 'we deny all allegations and request a hearing' is a wasted opportunity.

Fraud classification, wilful default and NPA: how they differ

Borrowers often receive notices for more than one of these at once. They are separate processes with separate consequences.

What is a red flagged account, and should you act at that stage?

A red flagged account is one where the bank suspects fraud because of early warning signals: unexplained transfers to related parties, frequent changes in auditors, stock statements that do not match the books, sales not routed through the account, delays in submitting financial statements, or a sudden fall in turnover in the account while the company reports rising sales. Red flagging is an internal step; the bank does not have to tell you. It usually leads to a forensic audit by an external firm appointed by the bank or the consortium.

If you learn that a forensic audit has been ordered, cooperate and engage. The auditor will ask for ledgers, bank statements, invoices, stock records and explanations of specific transactions. A borrower who refuses access or ignores requests usually finds the report full of adverse findings based on gaps, and those gaps become the bank's case. A borrower who answers in writing, with documents, often finds the report records the explanation, and some findings fall away before any show cause notice is issued.

Keep copies of everything you give the auditor, with a covering letter listing it. If the final report says 'no explanation was provided' for a transaction you did explain, your covering letter is the proof. That one document has turned more fraud classifications than any argument about natural justice.

How to reply to a fraud show cause notice

You have at least 21 days. Use all of them, and start on the first.

1. Read the notice for what it alleges

   List every transaction, event or finding the notice relies on. A good reply answers each one specifically, in the same order, rather than making general denials.

2. Ask for the full material at once

   Write to the bank within days asking for the complete forensic audit report, its annexures, and any other material referred to in the notice, citing the Supreme Court's ruling on supply of the full report. Ask for more time if the material arrives late or is voluminous.

3. Collect your documents

   Gather ledgers, bank statements, invoices, contracts, board minutes, stock records, GST returns and correspondence that explain each transaction. Related-party payments need especially clear paper: the contract, the goods or services received and the price.

4. Separate fraud from business failure

   Much of what banks call diversion is ordinary business: paying suppliers through group companies, using working capital for capital expenditure in an emergency, or losses on a contract. Explain the commercial reason for each transaction and show where the money went.

5. Point out defects in the audit

   Note where the auditor ignored documents you gave, relied on assumptions, used the wrong period, or reached conclusions without asking you. Attach your covering letters to the auditor.

6. Reply for each noticee

   The notice usually goes to the company and each promoter or director. A director who was non-executive, joined late or had no role in the transactions should say so in a separate reply with proof.

7. File on time and keep proof

   Send the reply by email and by hand or post with acknowledgement before the deadline. Ask in the reply that the bank consider each point and pass a reasoned order, and request a personal hearing even though it is not a right; some banks still give one.

The reply is also the record a High Court will read if you later file a writ petition. Write it for that reader as much as for the bank.

Documents to gather before you reply

What are the consequences once an account is classified as fraud?

The consequences fall on the company and on the individuals named. The bank reports the fraud to the RBI and, depending on the amount and its policy, to the police, the Economic Offences Wing or the CBI. Other banks learn of it through RBI's systems and the central repository of large credits. The borrower and its promoters and directors are debarred from raising finance from banks and financial institutions for five years from the date the defrauded amount is fully paid, and borrowers involved in fraud are generally not eligible for restructuring.

A criminal case usually follows: cheating under section 318 of the Bharatiya Nyaya Sanhita, criminal breach of trust, forgery, and, for public sector banks, sometimes offences under the Prevention of Corruption Act involving bank officers. Because cheating is a scheduled offence under the Prevention of Money Laundering Act, a large fraud can also bring the Enforcement Directorate in. Banks and agencies may seek a Look Out Circular against promoters; our post on checking whether there is an LOC against you explains what to do.

The commercial consequences are often the worst. Suppliers and buyers hear of it, other lenders recall facilities, and promoters find their other companies cannot borrow. This is why the reply to the show cause notice deserves more effort than almost any other step: once the order is passed, undoing it takes years.

How to challenge a fraud classification order

The 2024 directions do not provide an internal appeal, so the usual remedy is a writ petition under Article 226 of the Constitution before the High Court. Writ petitions against public sector banks are routinely entertained in these matters. Against private banks the question of maintainability is argued more often, though High Courts have examined such classifications because they are made under RBI's statutory directions. In Delhi, the petition goes to the Delhi High Court if the bank's decision or the account has the necessary connection with Delhi.

The strongest grounds are procedural. No show cause notice, or a notice that did not specify the transactions; the forensic audit report not supplied, or supplied only in part without recorded reasons; less than 21 days given; the reply not considered; or an order that does not deal with the reply and gives no reasons. Courts have set aside orders on these grounds and directed the bank to start again. Challenges to the bank's actual finding of fraud are harder: the High Court does not re-audit the accounts, and will interfere only if the finding is perverse, ignores material evidence or rests on no evidence.

Be realistic about what a successful writ achieves. Setting aside a classification for a procedural defect usually means the bank can restart the process properly. And setting aside the classification does not automatically end a criminal case already registered; the FIR has to be dealt with on its own merits, through anticipatory bail, a discharge application or a quashing petition under section 528 of the Bharatiya Nagarik Suraksha Sanhita.

What should the bank's reasoned order contain?

A reasoned order is one that shows the bank actually considered your reply. At a minimum it should identify the transactions it treats as fraudulent, state your explanation for each, and say why that explanation was rejected. An order that recites the notice, records that 'the reply was found unsatisfactory' and then classifies the account is not reasoned in any real sense, and High Courts have set aside orders of exactly that kind.

The order should also say against whom it is passed and on what basis. If the notice went to the company and four directors and the order names all four without dealing with a director's separate reply, that is a defect specific to that director. Similarly, if your reply accepted part of the bank's case and contested the rest, the order should reflect that distinction rather than treating the whole amount as fraud.

Ask for the order in writing if it has not been served, and ask for the minutes of the committee that decided it if the order refers to them. Calculate the time from service; although there is no fixed limitation period for a writ petition, courts expect a borrower to move promptly once the order is known, and an unexplained delay of many months weakens the case for interim relief.

Mistakes borrowers make when facing a fraud notice

• Treating the notice as routine correspondence. A fraud show cause notice is the last stage before a label that lasts years. It needs a full, documented reply, not a two-paragraph letter.
• Not asking for the full forensic audit report. The Supreme Court has held you are ordinarily entitled to it. Ask in writing straight away, and record if it is refused or supplied in part.
• Replying with general denials. 'All allegations are false' answers nothing. Each finding needs a specific answer with documents.
• Letting all directors sign one reply. Directors in different positions have different defences. A non-executive or late-joining director should file a separate reply.
• Ignoring the forensic auditor. Gaps in the audit become the bank's case. Engage with the auditor and keep proof of what you supplied.
• Missing the deadline and asking for time afterwards. Ask for an extension before the 21 days run out, with reasons, and file what you can within time.
• Forgetting the criminal side. An FIR can be filed without a hearing. Prepare for that possibility while the classification process is still running.

My account was classified as fraud before 2023 without any notice. What now?

Many classifications made before Rajesh Agarwal were done without notice to the borrower. Those orders are open to challenge on that ground, and many have been set aside or withdrawn by banks. In Amit Iron itself, the Supreme Court directed the banks to supply the forensic audit reports, take written representations and pass fresh orders under the 2024 directions.

So if your account was tagged years ago without notice, the bank may well have to redo the process, but it will be able to do so. Delay in approaching the court can also count against you in a writ petition, so do not let it drift further. Before filing, ask the bank in writing for the order, the forensic audit report and the notices it says it sent, because some banks did issue notices that borrowers have since forgotten or never received at an old address.

Where the borrower company has since been through insolvency resolution with a change in management, check how the 2024 directions treat the entity. The new management is generally not tainted by the old classification, but the former promoters remain exposed, both to the debarment and to any criminal proceedings.

Can you settle with the bank after a fraud classification?

A settlement is possible, but it does not erase the fraud. Banks can enter into a compromise or one-time settlement with a borrower in a fraud account, and RBI's framework on compromise settlements permits this subject to the bank's board policy, but the criminal proceedings continue independently unless the court allows them to be closed. Repayment can be a relevant factor when a court considers bail or the nature of the dispute, and the debarment period runs from full repayment, so paying earlier can shorten how long the promoter remains shut out of bank finance.

This makes the order of steps important. A borrower who settles the dues and then contests the fraud classification is in a different position from one who argues fraud and pays nothing. Neither path is automatically better; it depends on the strength of the reply, the amount involved and the criminal exposure. Our post on negotiating a one-time settlement covers the settlement side.

When Advocate B.K. Singh is asked to look at a fraud notice, he reads the forensic audit annexures before the notice itself, because the annexures show exactly which transactions the auditor actually examined and which conclusions were simply carried forward without testing. That is usually where the reply finds its strongest points.

What to do this week if you have a fraud show cause notice

• Note the date of receipt and calculate the 21-day deadline.
• Write to the bank asking for the complete forensic audit report and all material relied on.
• List every transaction or finding in the notice in a table.
• Assign each finding to someone in the company to collect documents.
• Check whether each director received the notice and needs a separate reply.
• Request an extension in writing before the deadline if the material is late or voluminous.
• Check whether an FIR or complaint has already been filed, and plan for anticipatory bail if needed.
• Keep all correspondence in one dated file for a possible writ petition.

Getting help with a fraud classification

A fraud notice combines banking law, accounting and criminal exposure, and the reply has to work in all three settings at once. It is worth having a lawyer read the forensic audit report alongside your accountant from the first week, rather than after a reply has already been filed. The reply you send now is likely to be the main document in any writ petition and an important one in any criminal case.

If you want an advocate to read the notice and the audit report and tell you the deadline and the realistic options, the team of Advocate B.K. Singh at B.K. Singh & Associates can review the papers through our online enquiry. You can read more on our banking law practice and, for the criminal side, on CBI cases. Related reading: a guarantor's liability on default and defending a bank's case in the DRT.