Banks must disclose forensic audit findings and provide a hearing before classifying accounts as fraud.

Canara Bank issued a show-cause notice dated 21 January 2025 concerning the petitioner company’s account.

The Bank later classified the account as fraudulent by order dated 3 April 2025, relying on a forensic audit that reported, among other matters, discrepancies in debtor balances and alleged diversion or misappropriation of funds.

The petitioner challenged both the notice and the fraud-classification order, contending that the forensic audit findings had not been disclosed before the classification decision.

The Bank submitted that the petitioner had received the show-cause notice but had not responded.

Whether the Bank could classify the petitioner’s account as fraudulent when the show-cause notice did not communicate the forensic audit findings relied upon in the final order.

Whether the petitioner was entitled to an opportunity to respond to those findings and to be heard before any further order was passed.

In State Bank of India v. Rajesh Agarwal, (2023) 6 SCC 1, the Supreme Court held that classifying a borrower’s account as fraudulent has serious civil consequences and that the principles of natural justice require the borrower to be given notice, an opportunity to explain the conclusions of the forensic audit report, and an opportunity to make representations before the account is classified as fraud; the classification decision must also be reasoned.

The High Court applied these principles to the Bank’s fraud-classification process.

Although the Bank’s order set out reasons for classifying the account as fraudulent, the earlier show-cause notice did not disclose the forensic audit’s findings or particulars.

The petitioner therefore learned of the findings only through the order that had already classified its account as fraudulent.

Applying Rajesh Agarwal, the Court held that the borrower must be informed of the audit conclusions and allowed to explain them before the Bank makes its decision.

The petitioner was permitted to respond by 28 October 2026, after which the Bank must afford it an opportunity of hearing before passing any further order.

Until then, the 3 April 2025 order must not be acted upon or precipitated in any manner.

The Court did not finally determine whether the account was properly classifiable as fraudulent.