In Pro Knits Vs. The Board of Directors of Canara Bank and Others [Civil Appeal No. 8332 of 2024], the Supreme Court has ruled that Banks and Non-Banking Financial Companies (NBFCs) cannot classify MSME's Loan Accounts as NPAs without following the mandatory procedure laid down in the Centre’s 2015 notification.
CASE SUMMARY
FACTS OF THE CASE:
This case involves a group of Micro, Small, and Medium Enterprises (MSMEs) that challenged the impugned common order dated 11.01.2024 passed by the Bombay High Court in Writ Petition (L) No. 20100 of 2023 and Ors. whereby the High Court dismissed their writ petitions, ruling that banks and Non-Banking Financial Companies (NBFCs) were not obligated to adopt the restructuring process outlined in the Notification dated May 29, 2015, issued by the Ministry of Micro, Small and Medium Enterprises, unless initiated by the MSMEs themselves.
SUBMISSIONS OF THE APPELANTS:
The appellants argued that the banks and NBFCs were required to follow the restructuring process before classifying them as Non-Performing Assets (NPAs) outlined in the Notification dated May 29, 2015, issued by the Ministry of MSME and argued that the banks' failure to adhere to these procedures rendered any subsequent actions taken under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) illegal and void ab initio.
SUBMISSIONS OF THE RESPONDENTS:
The respondents contended that the restructuring process outlined in the Notification dated 29th May 2015 was not mandatory. They argued that the provisions of the SARFAESI Act take precedence over other laws, including the MSMED Act, as per Section 35 of the SARFAESI Act.
KEY PROVISIONS OF THE NOTIFICATION DATED 29TH MAY, 2015 REGARDING MSMES:
Ø The Notification issued by the Ministry of MSME, outlines the "Framework for Revival and Rehabilitation of Micro, Small and Medium Enterprises."
Ø Banks or creditors are required to identify incipient stress in the loan accounts of MSMEs before they turn into Non-Performing Assets (NPAs). This identification involves creating three sub-categories under the Special Mention Account (SMA) category to monitor the financial health of the MSMEs.
Ø Any MSME can voluntarily initiate proceedings under this Framework if it reasonably anticipates a failure in its business or an inability to pay debts, provided that the accumulated losses do not equal or exceed half of its entire net worth. The application for initiation must be verified by an affidavit from an authorized person.
Ø Banks are required to constitute one or more Committees to provide reasonable access to eligible MSMEs that have availed credit facilities. These Committees are responsible for deciding on corrective action plans and determining the terms thereof in accordance with the regulations prescribed in the Framework.
Ø The Framework establishes specific timelines for taking various decisions related to the revival and rehabilitation of stressed MSMEs.
Ø The provisions of the Notification are considered to have statutory force and are binding on all Scheduled Commercial Banks licensed to operate in India, as per the directions issued by the Reserve Bank of India (RBI).
Ø The Framework is designed to be compatible with existing regulatory guidelines on income recognition, asset classification, and provisioning pertaining to advances, ensuring a cohesive approach to managing MSME loans. These provisions aim to facilitate the promotion and development of MSMEs, enhance their competitiveness, and provide a structured mechanism for addressing financial stress before accounts are classified as NPAs.
DECISION OF THE SUPREME COURT
The High Court's ruling was set aside and the Appeal was allowed.
REASONS CITED:
Statutory Force of the 2015 Notification: The Court emphasized that the Instructions for the Framework for Revival and Rehabilitation of MSMEs, 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 and revised by the Reserve Bank of India (RBI) Notification dated 17th March, 2016 in exercise of the powers conferred by Section 21 and 35(A) of the Banking Regulation Act, possess statutory force. This means that banks and Non-Banking Financial Companies (NBFCs) are legally obligated to follow the procedures outlined in the Notification before classifying MSME loan accounts as Non-Performing Assets (NPAs).
Mandatory Identification of Incipient Stress: The Court ruled that banks must identify incipient stress in MSME accounts by creating sub-categories under the Special Mention Account (SMA) category. This proactive identification is crucial to prevent accounts from deteriorating into NPAs, thereby facilitating timely intervention and support for struggling MSMEs.
Balance Between Regulatory Frameworks: While the SARFAESI Act allows banks to enforce security interests, this enforcement can only occur after proper adherence to the MSME Framework. The provisions of the SARFAESI Act do not override the mandatory requirements of the MSMED Act.
Balance of Responsibilities: While imposing obligations on banks, MSMEs have to provide authenticated documentation to substantiate their claims for benefits under the said Framework. This dual responsibility ensures that both banks and MSMEs are proactive in addressing financial distress. 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 bank concerned that it is an MSME and if the enterprise allows the entire process of classification to get over, 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.
Decided On: 01.08.2024
Hon'ble Judges/Coram: Bela M. Trivedi and R. Mahadevan, JJ.
(This is a case summary and not an opinion piece.)
This case summary was drafted by our associate advocate, Ms. V. Mega.
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