CLASSIFICATION OF MSME ACCOUNTS AS ‘NON-PERFORMING ASSET’

[DR.MARIAPPAN GOVINDARAJAN]

MSMEs

The object of Micro, Small and Medium Enterprises Development Act, 2006 (‘Act’ for short) is to provide for facilitating the promotion and development and enhancing competitiveness of Micro, Small and Medium Enterprises (‘MSMEs’ for short) and for matters connected therewith and incidental thereto.  Section 9 of the Act provides that the Central Government may take measures for facilitating such promotion, development and enhancement of competitiveness of MSMEs by specifying programs, guidelines and instructions as it may deem fit, by issuing Notifications. 

RBI powers

Section 21 of the Banking Regulations Act,1949 empowers the Reserve Bank of India (‘RBI’ for short) to control advances by Banking companies.  The said section provides that where the RBI is satisfied that it is necessary or expedient in the public interest or in the interest of the depositors or banking policy so to do, it may decide the policy in relation to advances to be followed by banking companies generally or by any company, in particulars and when the policy has been so determined all the banking companies shall be found by the policy as determined. 

Section 35A of the Banking Regulations Act gives power to the RBI to give directions to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company or to secure the proper management of any banking companies generally or to any banking company, in particular, it may, from time to time issue such directions as it deems fit and the banking companies or the banking company shall be bound to comply with such directions. 

Framework

The Central Government issued Notification in terms of Section 9 of the Act.  It notified the instructions for the framework of Revival and Rehabilitation of MSMEs.

• Identification of incipient stress – Before a loan account of a MSME turns into a Non-Performing Asset (‘NPA’ for short), banks and creditors are required to identify incipient stress in the account by creating 3 sub categories under the Special Mention Account (‘SMA’ for short) category as detailed below-

• SMA – 0 – Principal or interest payment not overdue for more than 30 days but account showing signs of incipient stress;
• SMA – 1 – Principal or interest payment overdue between 31 – 60 days;
• SMA – 2 – Principal or interest payment overdue between 61 – 90 days.

• Any MSME borrower may also voluntarily initiate proceedings under the framework.
• Committee approach to be adopted for deciding corrective action plan.
• Timelines have been fixed for taking various decisions under the framework.

Mandatorily to be followed

The instructions and directions as contained in the said Framework is to be mandatorily to be followed along with the directions of RBI by banks and there is also an obligation on the MSMEs to submit documents/materials to avail the benefits of the Framework.  This is upheld by the Supreme Court in M/S. PRO KNITS VERSUS THE BOARD OF DIRECTORS OF CANARA BANK & ORS., MR. ZUHAIR MOHAMEDALI MERCHANT VERSUS IDFC BANK & ORS., NILESH SHAH VERSUS BANK OF BARODA & ORS., SADHANA BHARAT RAI VERSUS THE BOARD OF DIRECTORS OF KOTAK MAHINDRA BANK & ORS., M/S. A. NAVINCHANDRA STEELS PVT. LTD. & ANR. VERSUS UNION OF INDIA & ORS. AND M/S. SHREE SHANTINATH STEELS & ANR. VERSUS UNION OF INDIA & ORS. - 2024 (8) TMI 196 - SUPREME COURT the appellants in the present appeal are MSMEs registered under the Act.  The appellants challenged the actions of the banks and Non-Banking Financial Corporations (‘NBFCs’ for short) against them under the provisions of Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (‘SARFAESI’ for short).  The appellants challenged the impugned order of High Court which dismissed the writ petitions filed by the appellants holding that the respondent banks/ NBFCs ad not obliged to adopt the restructuring process by the MSMEs on its own without there being any application by the MSMEs. 

The contention of the appellants is that the banks could not have classified the loan accounts of the appellants who were MSMEs as Non-Performing Asset (‘NPA’ for short) without following the procedure laid down in the Instructions for Framework for Revival and Rehabilitation of MSMEs.  It was incumbent on the part of the respondents to identify incipient stress in the account by creating 3 sub categories and explore various options to resolve the stress.  The was mandatory for the respondents to follow the same.  Non-observance of the above said requirements has rendered all subsequent actions taken by the respondent under the SARFAESI Act is illegal, and void ab initio.

The respondents contended that the provisions contained in the SARFAESI Act override the provisions of other Acts including MSME Act.  The appellants did not apply to the respondents to avail the benefit of the above said Notification.  The respondents initiated and concluded the proceedings under SARFAESI Act after following the due process of law.  Unless the procedure under the said Notification for restructuring is opted, the appellants could not have been classified as NPA.  The instructions under the Notification are mere directory and not mandatory.  They do not have any statutory force.

The Supreme Court analysed the provisions of the Act and the framework for Revival and Rehabilitation of Micro, Small and Medium Enterprises and also the provisions of Section 21 and 35A of the Banking Regulations Act.  The instructions given in the Framework is required to be followed prior to the classification of the borrower’s account as NPAs.  The above said measures are for facilitating the promotion and development of MSME.

The Supreme Court further observed that under the ‘Framework for Revival and Rehabilitation of MSMEs, the banks and creditors are required to identify the incipient stress in the account of MSMEs before their accounts turn into NPA by creating three sub categories under the SMA.  The banks must have some authenticated and verifiable material with them as produced by the concerned MSME to show that loan account is of a MSME registered under the Act.  The MSME also to produce authenticated and verifiable documents/materials for substantiating its claim before the account is classified as NPA.  If that is not done and once the account is classified as NPA the secured creditors would be entitled to take recourse to Chapter III of the SARFAESI for the enforcement of security interest.

The Supreme Court held that it is mandatory on the part of the banks to follow the instructions/directions issued by the Central Government and RBI with regard to the Framework for Revival and Rehabilitation of MSMEs, it would be equally incumbent on the part of the MSMEs to be vigilant enough to follow the process laid down under the said Framework and to bring to the notice of the concerned banks, by producing authenticated and verifiable documents or materials to who its eligibility to get the benefit of the said framework.

The Supreme Court held 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, as revised from time to time could not be said to be mandatory in nature are erroneous and cannot be countenanced.  The Supreme Court held that the instructions/directions issued by the Central Government under Section 9 of the Act and by RBI under Section 21 and 35A of the Banking Regulations Act have statutory force and binding to all the banking companies.