Banks Can't Classify MSMEs Loan Accounts As NPAs Without Following Procedure In Centre's 2015 Notification : Supreme Court

In an important ruling concerning the revival of the entities registered under the Micro, Small and Medium Enterprises Development Act, 2006 (“MSMED Act”), the Supreme Court observed that the Banks are not empowered to classify the loan accounts of the MSMEs, as Non-Performing Assets (NPA), without following the mandatory procedure laid down in the Instructions for Framework for Revival and Rehabilitation of MSMEs issued by the Ministry of MSME.

“What is contemplated in the “Framework for Revival and Rehabilitation of MSMEs” contained in the Instructions/ Directions stated hereinabove, is required to be followed prior to the classification of the borrower's account, (in the instant case MSMEs loan account), as Non-Performing Assets (NPAs).”, the bench comprising Justice Bela M. Trivedi and Justice R. Mahadevan said.

It is worthwhile to note that the MSME Ministry, Government of India had notified a 'Framework for Revival and Rehabilitation of Micro, Small, and Medium Enterprises' on May 29, 2015, to provide a simpler and faster mechanism to address the stress in the accounts of MSMEs and to facilitate the promotion and development of MSMEs.

The notification states that before declaring the loan accounts of the MSMEs as NPAs, the banks are required to identify the incipient stress in the account of the Micro, Small, and Medium Enterprises, by creating three sub-categories under the “Special Mention Account” Category.

The Reserve Bank of India, issued a Master Circular “Reserve Bank of India [Lending to Micro, Small and Medium Enterprises (MSME) Sector] Directions, 2016,” vide the Notification dated 21st July, 2016, asking the banks to follow the above notification of the Ministry.

The Court held that these directions have a statutory binding force :

"it is absolutely clear that the Instructions for the Framework for Revival and Rehabilitation of Micro, Small and Medium Enterprises as notified by the Central Government vide the Notification dated 29th May, 2015 in exercise of the powers conferred under Section 9 of the MSMED Act, as revised by the RBI Notification dated 17th March, 2016, and the Master Directions i.e. the Reserve Bank of India (Lending to Micro, Small and Medium Enterprises Sector) Directions, 2016, issued by the Reserve Bank of India in exercise of the powers conferred by Section 21 and 35(A) of the Banking Regulation Act, having statutory force, are binding to all Scheduled Commercial Banks, licensed to operate in India by the Reserve Bank of India, as stated in the said Directions."

In the instant case, the banks/NBFCs initiated actions under the SARFAESI Act to enforce the security interest without following the mandatory requirements prescribed under the notification issued by the MSME Ministry that contained the Framework for Revival and Rehabilitation of MSMEs.

Alternatively, the Banks/NBFCs have not identified the incipient stress in the account of the Micro, Small, and Medium Enterprises, by creating three sub-categories under the “Special Mention Account” Category, therefore, the court held that it would be impermissible for the Banks/NBFCs to classify their loan accounts as Non-Performing Assets.

MSMEs' Failure To Show It Belongs To MSME Sector Would Entitle Banks To Enforce Security Interest Under SARFAESI Act

While referring to the notification, the Court added that before creating such sub-categories, the MSME are required to produce verifiable material to show that they belong to MSME sectors and the banks/secured creditor must have authenticated them; otherwise, it would be open for the banks/secured creditor to invoke the provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”) for the enforcement of the security interest.

“Therefore, the stage of identification of incipient stress in the loan account of MSMEs and categorization under the Special Mention Account category, before the loan account of MSME turns into NPA is a very crucial stage, and therefore it would be incumbent on the part of the concerned MSME also to produce authenticated and verifiable documents/material for substantiating its claim of being MSME, before its account is classified as NPA. If that is not done, and once the account is classified as NPA, the banks i.e. secured creditors would be entitled to take the recourse to Chapter III of the SARFAESI Act for the enforcement of the security interest.”, the Judgment authored by Justice Bela M. Trivedi said.

In essence, the court said that when it is obligatory upon the Banks/secured creditor to follow the requirements mentioned under the framework. It iis also incumbent upon the MSME to apprise the Banks about their eligibility to get benefits under the framework by showing that they belong to the MSME Sector.

"However, if at the stage of classification of the loan account of the borrower as NPA, the borrower does not bring to the notice of the concerned bank/creditor that it is a Micro, Small or Medium Enterprise under the MSMED Act and if such an Enterprise allows the entire process for enforcement of security interest under the SARFAESI Act to be over, or it having challenged such action of the concerned bank/creditor in the court of law/tribunal and having failed, such an Enterprise could not be permitted to misuse the process of law for thwarting the actions taken under the SARFAESI Act by raising the plea of being an MSME at a belated stage."

“Suffice it to say, when it is mandatory or obligatory on the part of the Banks to follow the Instructions/Directions issued by the Central Government and the Reserve Bank of India with regard to the Framework for Revival and Rehabilitation of MSMEs, it would be equally incumbent on the part of the concerned MSMEs to be vigilant enough to follow the process laid down under the said Framework, and bring to the notice of the concerned Banks, by producing authenticated and verifiable documents/material to show its eligibility to get the benefit of the said Framework.”, the court added.

Banks Can Adopt Restructuring Process On Its Own Without There Being Application Preferred By MSMEs

In the present case, the High Court held that the Banks/ Non-Banking Financial Companies (NBFCs) are not obliged to adopt the restructuring process as contemplated in the Notification dated 29th May 2015 issued by the Ministry of Micro, Small and Medium Enterprises, on its own without there being any application by the Petitioners/ MSMEs.

Rejecting the view taken by the High Court, the Supreme Court held as follows:

“we are of the opinion that the findings recorded by the High Court in the impugned order that the Banks are not obliged to adopt the restructuring process on its own or that the Framework contained in the Notification dated 29.05.2015, as revised from time to time could not be said to be mandatory in nature, are highly erroneous and cannot be countenanced.”

Advocate Mathews J Nedumpara argued for the Appellants.

Case Details: M/S. PRO KNITS VERSUS THE BOARD OF DIRECTORS OF CANARA BANK & ORS., SPECIAL LEAVE PETITION (C) NO. 7898 OF 2024) & Other Connected Matters.

Citation : 2024 LiveLaw (SC) 548

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