Banks, NBFCs can't classify MSME loan account as NPA without following 2015 framework: SC

The Supreme Court on Thursday ruled that banks and Non-Banking Financial Companies (NBFCs) cannot classify loan accounts of Micro, Small and Medium Enterprises (MSMEs) as Non-Performing Assets (NPA) without following the due procedure prescribed by the Centre in its 2015 notification.

A bench of Justices Bela M Trivedi and R Mahadevan said the 'Framework for Revival and Rehabilitation of MSME', as notified by the Centre by its May 29, 2015 notification and subsequent directions issued by the Reserve Bank of India in 2016, have statutory force and are binding on all scheduled commercial banks licensed to operate in India by the RBI.

"What is contemplated in the "Framework for Revival and Rehabilitation of MSMEs" contained in the instructions/ directions stated hereinabove, is required to be followed before the classification of the borrower's account (in the instant case MSMEs loan account) as Non-Performing Assets," the bench said.

It said the instructions issued by the central government under the provisions of the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act) and by the RBI under the provisions of the Banking Regulation Act have statutory force and are binding on all banking companies.

The bench said the 2015 instructions issued by the Centre as part of measures taken for facilitating the promotion and development of MSMEs followed by the directions issued by the RBI need to be followed by the banking companies though they may be 'secured creditors' as per the definition contained under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI), 2002 before classifying the loan account of MSMEs as NPA.

It said under the "Framework for Revival and Rehabilitation of MSMEs", the banks or creditors are required to identify the "incipient stress" in the account of MSMEs, before their accounts turn into non-performing assets, by creating three sub-categories under the "Special Mention Account".

"...However, while creating such sub-categories, the Banks must have some authenticated and verifiable material with them as produced by the concerned MSME to show that the loan account is of a Micro, Small and Medium Enterprise, classified and registered as such under the MSMED Act," the bench said, while allowing a batch of appeals of MSMEs challenging a Bombay High Court's January 11 order.

The bench set aside the order of the high court and its finding that banks are not obliged to adopt the restructuring process on their own or that the 2015 framework cannot be said to be mandatory in nature, terming it as "highly erroneous".

It noted that the 2015 instructions also enable an MSME to voluntarily initiate the proceedings under the said Framework by filing an application along with the affidavit of an authorised person.

"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," it said.

The top court added, that if that is not done, and once the account has been classified as NPA, the banks that are secured creditors would be entitled to take recourse to the SARFAESI Act for enforcement of the security interest.

The bench, however, said 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 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.