Bombay High Court States Banks/NBFCs to Initiate Restructuring Process Before Classifying MSME Account as NFA sans application

Bombay High Court States Banks/NBFCs to Initiate Restructuring Process Before Classifying MSME Account as NFA sans application

Dismisses a group of writ petitions challenging the classification of accounts

The Bombay High Court has held that banks and Non-Banking Financial Companies (NBFCs) are not obligated to initiate a restructuring process before classifying accounts of Micro, Small, and Medium Enterprises (MSME) as Non-Performing Assets (NPA) in the absence of any application seeking restructuring.

A Division Bench of Justice BP Collabawalla and Justice MM Sathaye stated that the 2015 notification under Section 9 of the Micro, Small and Medium Enterprises Development Act, 2006 allowing restructuring, applied only if MSMEs approached the banks/NBFCs.

The Court dismissed a group of writ petitions challenging the classification of accounts of the petitioner MSMEs, who took financial assistance from banks and NBFCs as NPAs under Section 13(2) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act).

The challenge was on the ground that the respondents did not adhere to the procedure for restructuring outlined in the notification before classifying the MSMEs as NPAs.

However, the Court held, “Since we have found that the banks/NBFCs are not obliged to adopt the restructuring process on its own without any application by the petitioners/MSMEs, it is not necessary to deal with the arguments of the respondent banks/NBFCs about the effects of the subsequent notifications and circulars. Thus, the limited argument of the petitioners fails. There is no merit in these petitions and the same are dismissed.”

On behalf of the petitioners, Advocate Mathews Nedumpara contended that the notification mandated the constitution of a committee comprising bank officers and independent experts on MSMEs.

He added that the banks/NBFCs were obligated to make an application for a corrective action plan, and only if unsuccessful, recovery steps could be adopted. The decision of the committee was binding, and it could review the decision for initiating recovery. But none of the respondents constituted the committee, therefore, no recovery could be initiated in violation of the notification.

Appearing for the Union of India, Advocate Advait Sethna submitted that the notification was issued under Section 9 of the MSMED Act, providing measures for MSME promotion and development. It served as instructions or guidelines and did not have the force of law. The MSME had the option to initiate proceedings under the framework, but no such initiation was made by the petitioners.

Speaking on the issue, the respondent banks contended that the notification provided 90-days before an MSME was classified as an NPA. During that time, the MSME had to recognize financial stress and apply for the constitution of a committee for restructuring efforts. Once the period ended and an account was classified as NPA, action under the SARFAESI Act was to be followed. However, for restructuring, the MSMEs never invoked the notification.

The Court noted that the restructuring process was initiated based on the identification of 'incipient stress' in MSME accounts and subsequent classification into three sub-categories. The Court interpreted the term ‘incipient stress’ as the beginning of financial difficulties for MSMEs. It stated that banks and NBFCs could not identify the stress independently and needed the MSME's application, as those managing the MSMEs were likely to be aware of their financial conditions.

The bench cited Clause 1(3) of the notification, stating that the application for initiating proceedings under the framework required an affidavit from an authorized person in charge of the MSME. It asserted that the notification came into play only when the MSME approached the banks/NBFCs with an application and supporting affidavit. Following that, the MSMEs were categorized into sub-categories.

Thus, while dismissing the petitions, the judges explained that banks and NBFCs were not obligated to independently adopt the restructuring process without an MSME application. However, they allowed the petitioners to address other issues in the petitions through alternate remedies.

The bench directed that any stay granted by the Court in the writ petitions would continue for two weeks from the date of the judgment before getting vacated automatically.