The Supreme Court mandated strict compliance with the MSME revival framework by banks before classifying loan accounts as NPAs.
The Supreme Court Bench of Justice Bela M. Trivedi and Justice R. Mahadevan delivered a landmark judgment where it was held that banks and Non-Banking Financial Companies cannot classify loan accounts of Micro, Small and Medium Enterprises (MSMEs) as Non-Performing Assets without following the due procedure prescribed by the 2015 Notification issued by the Ministry of Micro, Small and Medium Enterprises.
The Supreme Court underscored that banks and Non-Banking Financial Companies (NBFCs) must adhere strictly to the procedural safeguards outlined in the Centre's 2015 notification before classifying the loan accounts of Micro, Small, and Medium Enterprises (MSMEs) as Non-Performing Assets (NPAs). The ruling, delivered by a bench of Justices Bela M. Trivedi and R. Mahadevan, clarified that the "Framework for Revival and Rehabilitation of MSMEs" established by the Centre's Notification in 2015 and reinforced by the Reserve Bank of India (RBI) in 2016, holds statutory authority, making compliance binding on all licensed commercial banks in India.
The bench emphasized that, as part of this framework, banks must first identify "incipient stress" in MSME accounts. This requires categorizing the accounts under "Special Mention Account" (SMA) with three specific sub-categories, aimed at addressing early signs of financial distress before an account is classified as an NPA. For this process, banks must rely on authenticated documentation provided by the MSME to confirm its classification under the Micro, Small and Medium Enterprises Development (MSMED) Act.
The Supreme Court also overruled a previous decision by the Bombay High Court, which had suggested that banks were not obligated to follow the restructuring guidelines. The Court found this interpretation "highly erroneous," asserting that the framework is mandatory for banking companies, including secured creditors under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002.
Furthermore, the bench clarified that MSMEs themselves have a responsibility to initiate the stress identification process by submitting verifiable documentation affirming their MSME status. Failure to do so, and allowing their accounts to be classified as NPAs without asserting MSME status, could disqualify them from later challenging the bank’s recovery actions under SARFAESI. The ruling reinforces that the 2015 framework is not only legally binding but critical for the protection and support of MSME borrowers in India, requiring proactive compliance from both financial institutions and MSMEs themselves.
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