The Supreme Court has ruled that banks and Non-Banking Financial Companies (NBFCs) cannot classify loans given to Micro, Small, and Medium Enterprises (MSMEs) as Non-Performing Assets (NPAs) without following the proper procedures set forth by the government. The ruling came from a bench of Justices Bela M. Trivedi and R. Mahadevan, who emphasized the significance of the 'Framework for Revival and Rehabilitation of MSMEs' established by the Centre on May 29, 2015, and the subsequent guidelines issued by the Reserve Bank of India (RBI) in 2016.

These guidelines have statutory force under the provisions of the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act) and the Banking Regulation Act. They are binding on all scheduled commercial banks licensed by the RBI. The Court stated that banks must follow the specific instructions outlined in the framework before classifying MSME loan accounts as NPAs. This framework aims to facilitate the promotion and development of MSMEs by identifying financial stress early on and preventing the premature classification of loan accounts as NPAs.

The 2015 framework requires banks to identify "incipient stress" in MSME accounts by creating three sub-categories under the "Special Mention Account" before the accounts turn into NPAs. To do this, banks must have authenticated and verifiable material proving that the loan account belongs to an MSME registered under the MSMED Act. This step is crucial in ensuring that MSMEs are not unfairly classified as NPAs without due process.

The Supreme Court overturned a Bombay High Court decision from January 11, which had stated that banks were not obligated to adopt the restructuring process independently and that the 2015 framework was not mandatory. The Supreme Court found this decision to be "highly erroneous" and affirmed the mandatory nature of the 2015 instructions.

Additionally, the framework allows MSMEs to voluntarily initiate the restructuring process by applying along with an affidavit from an authorized person. The identification of financial stress and categorization under the Special Mention Account is a critical stage. Therefore, MSMEs must provide authenticated and verifiable documents to substantiate their status before their accounts are classified as NPAs.

If an MSME fails to notify the bank of its status before the loan account is classified as an NPA and allows the classification process to conclude, the bank, as a secured creditor, can take action under the SARFAESI Act to enforce the security interest. However, MSMEs cannot misuse the law to avoid actions under the SARFAESI Act by claiming their status belatedly.

In conclusion, the Supreme Court's ruling ensures that banks and NBFCs must follow a clear and fair process before classifying MSME loans as NPAs. This decision supports the growth and stability of small businesses in India by protecting them from premature NPA classification and providing a structured approach to managing financial stress.

(Src: Input from PTI)