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...

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

Yash Mittal

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