Institute of Legal and Management Studies

The Supreme Court recently held that secured creditors and banks are not obligated to identify "incipient stress" in the accounts of MSMEs prior to classifying them as Non-Performing Assets (NPAs), unless the MSME borrower has explicitly invoked the 2015 RBI Framework for revival and rehabilitation.

The Court clarified that MSMEs cannot belatedly rely on the Framework during the course of SARFAESI proceedings initiated by lenders following a default. Instead, it is incumbent upon the MSME to proactively initiate rehabilitation measures if it anticipates business distress.

Further, the Court stated that only when an MSME, upon receiving a notice under the SARFAESI Act, affirmatively seeks the benefit of the Framework, does an obligation arise for the lender to consider such a request and temporarily suspend recovery action under SARFAESI.

The bench comprising Justices Dipankar Datta and Augustine George Masih was hearing the Writ Petition filed by an MSME, who was aggrieved by the Respondent-bank's action to classify its loan account as NPAs, without identifying 'incipient stress' in its accounts. The Petitioner-MSME contended that under the RBI's Framework for MSME Rehabilitation, the Respondent-bank should have undertaken the exercise to identify its 'incipient stress', failing which the SARFAESI proceedings cannot continue. Further, the petitioner argued that the Framework does not mandatorily require an MSME to notify the lending bank/secured creditor first about its incipient stress to seek benefit under Framework.

Rejecting MSME's contention, the judgment authored by Justice Datta observed:

“In our reading, the terms of the FRAMEWORK do not prohibit the lending bank/secured creditor (assuming that it has no conscious knowledge that the defaulting borrower is an MSME) to classify the account of the defaulting MSME as NPA and to even issue the demand notice under Section 13(2) of the SARFAESI Act without such identification of incipient stress in the account of the defaulting borrower (MSME); however, upon receipt of the demand notice, if such borrower in its response under Section 13(3-A) of the SARFAESI Act asserts that it an MSME and claims the benefit of the FRAMEWORK citing reasons supported by an affidavit, the lending bank/secured creditor would then be mandatorily bound to look into such claim keeping further action under the SARFAESI Act in abeyance; and, should the claim be found to be worthy of acceptance within the framework of the FRAMEWORK, to act in terms thereof for securing revival and rehabilitation of the defaulting borrower.”, the court said.

The Court doubted the bonafides of the Petitioner-MSME as it didn't seek the benefit even after the demand notice was issued under the SARFAESI proceedings, and it is only after an order was passed by the magistrate, it approaches the Court seeking benefits under Framework.

“the petitioning enterprise does not seem to have ever claimed the benefit of the terms of the FRAMEWORK after the demand notice under Section 13(2) of the SARFAESI Act was issued. It is at the stage of compliance with an order passed by the relevant Magistrate under Section 14 of the SARFAESI Act that this writ petition has been presented before this Court claiming benefits of the FRAMEWORK to restrain the respondent no.2 and its officers from proceeding further under the SARFAESI Act and other enactments except in the manner contemplated under the said Notification. We find the bona fides of the petitioning enterprise to be suspect.”

Also, the Court found the petitioner's reliance on Pro Knits v. Canara Bank to be misplaced as in that case, the Court nowhere supported the Petitioner's argument that the MSMEs should not be vigilant in bringing their case to the secured creditors/banks for claiming benefits under the Framework. The Court said that even Pro Knits case discourages the MSMEs to claim benefits only at the belated stage just to thwart the interest of the secured creditors/banks.

“Pro-Knits (supra) is a decision of a coordinate Bench of this Court holding, inter alia, that the Notification is binding on the lending banks/secured creditors. Finding to the contrary by the High Court of Bombay in the judgment and order under challenge in the appeal was, thus, quashed. Though while stressing that the terms of the FRAMEWORK need to be followed by the lending banks/secured creditors before the account of an MSME is classified as NPA, this decision also lays stress on the obligation of the MSMEs by holding that “it would be equally incumbent on the part of the MSMEs concerned to be vigilant enough to follow the process laid down under the said Framework, and bring to the notice of the Banks concerned, by producing authenticated and verifiable documents/material to show its eligibility to get the benefit of the said Framework”. It was cautioned that “if such an Enterprise allows the entire process for enforcement of security interest under the SARFAESI Act to be over, or it having challenged such action of the bank/creditor concerned in the court of law/tribunal and having failed, 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”. This decision, however, left unsaid something which we have explained hereinabove while construing the terms consistently to prevent undermining of rights that one central enactment confers by another.”, the court observed.

Accordingly, finding no case for interference under Article 32, and the petition being devoid of merit, the Court dismissed the petition, keeping an option for them to seek remedy under Section 17 of SARFAESI Act.

Cause Title: SHRI SHRI SWAMI SAMARTH CONSTRUCTION & FINANCE SOLUTION & ANR. VS. THE BOARD OF DIRECTORS OF NKGSB CO-OP. BANK LTD. & ORS.

Citation : 2025 LiveLaw (SC) 760

Click here to read/download the judgment

Appearance:

For Petitioner(s) : Mr. Mathews J Nedumpara, Adv. Ms. Maria Nedumpara, Adv. Ms. Hemali Suresh Kurne, Adv. Mr. Shameem Fayiz, Adv. Mr. Chand Qureshi, AOR Mr. Dewashish Vishwakarma, Adv.

For Respondent(s) : None

Related: Banks Can't Classify MSMEs Loan Accounts As NPAs Without Following Procedure In Centre's 2015 Notification : Supreme Court