Banks/NBFCs Not Obliged To Initiate Restructuring Process Before Classifying MSME Account As NPA Sans Application From MSME: Bombay High Court

The Bombay High Court recently held that banks and non-banking financial companies (NBFCs) are not obligated to initiate restructuring process before classifying accounts of Micro, Small, and Medium Enterprises as Non-Performing Assets (NPA) in the absence of any application from the MSMEs seeking restructuring.

A division bench of Justice BP Collabawalla and Justice MM Sathaye held that notification dated May 29, 2015, under Section 9 of the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act) allowing for restructuring only applies when MSMEs approach the banks/NBFCs.

The court dismissed a group of writ petitions challenging the classification of the accounts of petitioner MSMEs, who have taken financial assistance from banks and NBFCs, as NPAs under Section 13(2) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act). The challenge was on the ground that the respondent banks/NBFCs did not adhere to the procedure for restructuring outlined in the notification before classifying the MSMEs as NPAs.

“since we have found that the Banks/NBFCs are not obliged to adopt the restructuring process on its own without there being any application by the Petitioners/MSMEs, it is not necessary to deal with the arguments of the Respondent Banks /NBFCs about the effects of the subsequent Notifications and Circulars. In that view of the matter, the limited argument of the Petitioners under consideration, fails. There is no merit in these petitions and the same are dismissed”, the court held.

Petitioners' Submissions

Advocate Mathews Nedumpara for the petitioners contended that the Notification mandates the constitution of a committee consisting of bank officers and independent experts on MSME. Banks/NBFCs are obligated to make an application for a corrective action plan, and only if unsuccessful, recovery steps can be adopted. The decision of the committee is binding, and the committee can review its decision for initiating recovery. None of the respondent banks/NBFCs constituted the committee, and therefore, no recovery could be initiated in violation of the Notification, he said.

Union of India's Submissions

Advocate Advait Sethna for the Union of India contended that the Notification is issued under Section 9 of the MSMED Act, providing measures for MSME promotion and development, and is in the nature of either instructions or guidelines and does not have the force of law. The MSME has the option to initiate proceedings under the framework provided, and no such initiation was made by the petitioners, he said.

Respondent Banks' Submissions

The Respondent Banks contended that the Notification provides for a 90-day period before an MSME is classified as an NPA. During this period, the MSME is expected to recognize financial stress and apply for the constitution of a committee for restructuring efforts. Once the 90-day period ends and an account is classified as NPA, action under the SARFAESI Act must follow. Further, the MSMEs involved never invoked the notification for restructuring.

Court's Ruling

The court noted that under the Notification, the restructuring process is commenced based on the identification of 'Incipient Stress' in MSME accounts and subsequent classification into three sub-categories. The court interpreted the term "incipient stress," as the beginning of financial difficulties for MSMEs. It concluded that banks and NBFCs cannot identify this stress independently and need the MSME's application, as those managing the MSMEs are more likely to be aware of their financial conditions.

Additionally, the court cited Clause 1(3) of the Notification, stating that the application for initiating proceedings under the framework requires an affidavit from an authorized person, typically the person in charge of the MSME. Therefore, the court asserted that the Notification comes into play only when the MSME approaches banks/NBFCs with an application and supporting affidavit, following which the institutions categorize the MSMEs into sub-categories.

The court concluded that banks and NBFCs are not obligated to independently adopt the restructuring process without an MSME application and dismissed the petitions. However, the court allowed the petitioners to address other issues in their petitions through alternate remedies, clarifying that no opinion is expressed on those matters.

The court directed that any stay granted passed in any of the Writ Petitions shall continue for two weeks from the date of the judgment before getting automatically vacated, considering Nedumpara's submission that he intended to challenge the judgment in the Apex court.

Case no. – Writ Petition No. 4620 of 2022

Case Title – M/s. A. Navinchandra Steels Pvt. Ltd v. Union of India and Ors. with connected matters

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