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SC decrees banks must follow procedure before classifying MSME loans as NPAs
Industry News- Aug 08,24
The ruling was based on the 2015 notification by the Ministry of MSME, which established a framework for the revival and rehabilitation of MSMEs.
In a landmark decision on the revival of entities under the Micro, Small, and Medium Enterprises Development Act, 2006 (MSMED Act), the Supreme Court ruled that banks cannot classify loan accounts of MSMEs as Non-Performing Assets (NPAs) without adhering to the prescribed procedures.
The court's ruling was based on the 2015 notification by the Ministry of MSME, which established a framework for the revival and rehabilitation of MSMEs. This framework, which aims to provide a streamlined process for addressing financial stress in MSME accounts, mandates that banks identify incipient stress by categorising accounts into sub-categories under the “Special Mention Account” before classifying them as NPAs.
The Reserve Bank of India (RBI) reinforced this framework through its Master Circular dated July 21, 2016, which requires banks to comply with these guidelines. The Supreme Court confirmed that these regulations, issued under Section 9 of the MSMED Act and revised by RBI notifications, have statutory force and are binding on all Scheduled Commercial Banks in India.
In the case at hand, banks and Non-Banking Financial Companies (NBFCs) had begun enforcing security interests under the SARFAESI Act without following the mandatory requirements set out by the MSME Ministry. The court found that banks and NBFCs must first identify and address incipient stress by using the “Special Mention Account” sub-categories before they can classify loans as NPAs.
The court also addressed the responsibility of MSMEs to prove their status to qualify for benefits under the framework. It noted that if an MSME fails to inform the bank of its status as a Micro, Small, or Medium Enterprise at the time of NPA classification and allows the enforcement process to proceed without objection, it cannot later use its MSME status as a defence.
Additionally, the Supreme Court overruled the High Court's decision that banks and NBFCs are not obligated to initiate the restructuring process on their own. The Supreme Court held that the High Court's view was erroneous, emphasising that the framework set forth in the 2015 notification is indeed mandatory.
Case Details: M/S. Pro Knits v. The Board of Directors of Canara Bank & Ors., Special Leave Petition (C) No. 7898 of 2024 & Other Connected Matters.
(Source: 2024 LiveLaw (SC) 548)
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