Banks not bound to initiate revival efforts before declaring MSMEs as NPAs: High court

The Bombay High Court has dismissed the petitions filed by 19 micro, small, and medium enterprises (MSMEs) contesting the decision of banks and non-banking financial companies (NBFCs) to categorise them as non-performing assets (NPAs).

The division bench of the Bombay High Court, comprising Justices BP Colabawalla and MM Sathaye, rejected the argument of the MSMEs that the banks and NBFCs should have implemented revival and rehabilitation measures outlined in a 2015 notification issued under the MSMED Act, 2006 before declaring them as NPAs, according to a report by Bar and Bench, an online portal for Indian legal news.

The high court ruled that the MSMEs must file an application with the banks or NBFCs to kickstart the above-mentioned process under the notification. This implies that the banks and NBFCs are not obligated to independently initiate a rehabilitation or restructuring process without a formal application from the MSMEs, the report said.

The court added that, without any such intimation, it would be difficult for banks and NBFCs to identify the that are under stress of repayment as thousands of MSMEs receive loans.

“How a particular borrower is performing in its business and whether any such business is undergoing or beginning to feel stress on its financial capacity, is within the knowledge of the said borrower running its business. Unless such knowledge of incipient stress on the financial condition of MSME is brought to the notice of the bank, it is next to impossible, in our opinion, to be identified on its own by the banks or NBFCs”, reads the January 11 order.

The notification in focus was dated May 29, 2015 and was issued under Section 9 of the MSMED Act. It provided for the formation of a committee consisting of bank officers and independent experts on MSMEs to implement a corrective action plan for MSMEs facing financial stress.

This notification provided for the categorisation of MSMEs into various kinds of 'special mention accounts'.

In their plea before the high court, the MSMEs contended that as the prescribed procedure had not been adhered to initially in their situation, the NPA declarations made under Section 13(2) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act of 2002 (SARFAESI Act) were deemed invalid.

Representing the MSMEs, Advocate Mathews Nedumpara put forth the argument that no committee had been formed, and, as a result, no recovery proceedings should have been instigated.

In response, representing the central government, Advocate Advait Sethna asserted that the notification merely provided an option for MSMEs to commence restructuring proceedings. He emphasised that such a procedure would not impose restrictions on recovery proceedings under the SARFAESI Act.

The high court ultimately dismissed the petition on concluding that the MSMEs had to submit an application to the banks or NBFCs to initiate the process under the 2015 notification.

As the MSMEs did not submit such an application in this instance, the court rejected their opposition to the measures undertaken by the banks and NBFCs. The court permitted the banks and NBFCs to proceed with the SARFAESI proceedings.

Nevertheless, it temporarily halted the order for a duration of two weeks to provide the MSMEs with an opportunity to file an appeal, should they choose to do so.