In a landmark judgment that significantly impacts the banking sector's approach to Micro, Small, and Medium Enterprises (MSMEs), the Supreme Court has established comprehensive guidelines regarding the classification of MSME loan accounts as Non-Performing Assets (NPAs). The judgment emphasizes the mandatory nature of the Framework for Revival and Rehabilitation of MSMEs which have been prioritised by the government for a long time.
The Court examined the legislative framework, particularly focusing on the intersection of three crucial statutes: the MSMED Act, 2006, the Banking Regulation Act, 1949, and the SARFAESI Act, of 2002. Section 9 of the MSMED Act empowers the Central Government to take measures for facilitating promotion and development and enhance the competitiveness of MSMEs by specifying programs, guidelines, or instructions as it may deem fit.
The Framework, initially notified by the MSME Ministry on May 29, 2015, was designed to provide a simpler and faster mechanism to address stress in MSME accounts. Under this Framework, as the Court emphasized, the Banks had to identify incipient stress in the account by creating three sub-categories under the Special Mention Account (SMA) category: SMA-0 for accounts showing signs of incipient stress but not overdue for more than 30 days, SMA-1 for accounts overdue between 31-60 days, and SMA-2 for accounts overdue between 61-90 days.
The Court explicitly stated that the Instructions/Directions issued by the Central Government under Section 9 of the MSMED Act and by the RBI under Section 21 and Section 35A have statutory force and are binding to all the Banking companies. This interpretation significantly strengthens the Framework's implementation requirements.
The Court's ruling creates a balanced approach to responsibilities between banks and MSMEs. While the court mandated that the entire exercise as contained in the Framework for Revival and Rehabilitation of MSMEs is required to be carried out by the banking companies before the accounts of MSMEs turn into Non-Performing Assets, it simultaneously emphasizes that it would be equally incumbent on the part of the concerned MSMEs to be vigilant enough to follow the process laid down under the said Framework.
As far as the SARFAESI Act is concerned, the judgment clarifies that while the SARFAESI Act provisions have an overriding effect, they can only be initiated after the proper classification of an account as NPA, which must follow the Framework's requirements for MSME accounts. However, the Court also established a crucial limitation which states that 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 a Micro, Small or Medium Enterprise under the MSMED Act then 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.
The Supreme Court's verdict explicitly overturned the High Court's interpretation that banks were not obliged to adopt the restructuring process without an application from MSMEs. The Court termed this interpretation as "highly erroneous," establishing unequivocally that the Framework's requirements are mandatory, not directory and banks can initiate the restructuring process independently.
This judgment has far-reaching implications for both banking institutions and MSMEs. Banks must now ensure comprehensive compliance with the Framework before NPA classification, including the creation and maintenance of Special Mention Account categories and a proactive approach to stress identification. MSMEs, in turn, must maintain timely documentation of their status and actively participate in the stress identification process.
The Supreme Court's ruling thus establishes a clear precedent for handling MSME loan accounts, emphasizing both the rights and responsibilities of financial institutions and MSMEs. While maintaining existing SARFAESI proceedings and preserving alternative remedies for appellants, the judgment creates a comprehensive framework that demands proactive engagement from both financial institutions and MSMEs while ensuring procedural fairness and systematic stress resolution. This balanced approach serves to protect MSME interests while maintaining banking sector stability, marking a significant development in banking jurisprudence.