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Is SARFAESI applicable to MSMEs?

The Division Bench of Bombay High Court held that the Banks/NBFCs are not obliged to adopt the restructuring process on their own if there is no application to do so by the Petitioners/MSMEs.

The Bombay High Court clubbed all common matters involving challenge to a Notification dated 29th May 2015 issued under Section 9 of the Micro, Small and Medium Enterprises Development Act, 2006 (for short “MSMED Act”) to the action of Respondent Banks or Non-Banking Financial Companies.

The Petitioners, who are all registered under the MSMED Act, are Borrowers who have taken loans or other financial assistance from the Respondent Banks/NBFCs and have been classified as Non-Performing Assets [NPAs] under Section 13 (2) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (for short “SARFAESI Act, 2002”). The Petitioners have challenged the classification and its implications, by preferring a Writ Petition under Art. 226 and have averred that the Respondents have not followed due process as contemplated under the Notification 29th May 2015 [hereinafter referred to as the said Notification], which outlines the Framework for Revival and Rehabilitation of Micro, Small and Medium Enterprises.

In the present judgement, the arguments were limited to the grounds of challenge to the said Notification, without going into facts and merits of individual cases, as agreed between all the parties, including the Petitioner. 

The Petitioners contentions:

The Petitioners made several submissions to challenge the said Notification. It was their case that the Respondent Banks/NBFCs had failed and neglected to follow the procedure provided under the said Notification for identifying the ‘incipient stress’ undergone by the Petitioners and its consequent due classification in the Special Mention Account categories SMA-0, SMA-1 and SMA-2 before classifying them as Non-Performing Assets [NPA]. Consequently, according to the Petitioners, the classification of the Petitioners accounts as NPA was illegal and the notices under Section 13(2) of the SARFAESI Act, 2002, did not survive and all actions taken under the SARFAESI Act, 2002, were void ab initio, as their foundation itself was illegal. 

The Petitioners inter alia prayed for a declaration that the SARFAESI Act, 2002, is not applicable since the (MSMED Act) is a special Act and has exhaustively provided the mechanism to deal with ‘stressed incipient account’ of MSME borrower with the objective to provide nurture and care to MSME before initiating recovery. 

The Petitioners argued that the said Notification casts a duty upon the banks and NBFCs to constitute a committee, primarily consisting of Bank officers and independent experts on MSME, whose decision is binding on all concerned. 

The petitioners argued that as the Respondent Banks/NBFCs have not constituted any such committee, no recovery could have been initiated in violation of the said Notification and the Banks/NBFCs are duty bound to make an effective  corrective action plan for the MSME and if such corrective action plan is not successful, only then it can adopt the recovery steps.

As regards jurisdiction of the High court to hear the present petition, the Petitioners averred that as the MSMED Act does not provide for any specific forum, the High Court has the jurisdiction to hear and decide the present petition.

The Unions’ submissions: 

The Union of India, who was party Respondent, stressed on the word “Instructions” appearing in the opening paragraph of the said Notification and submitted that the Notification is in the nature of either instructions or guidelines and cannot be interpreted to have force of Law. 

It was the Unions’ case that under the said Notification, an option was provided to the MSME to initiate proceedings under the framework. It was the responsibility of the MSME to apply to the Bank/NBFC, supported by an affidavit of an authorized person and only after that, the Banks or NBFCs are required to categorize them as in the Special Mention Account categories like SMA-0, SMA-1 and SMA-2. As the Petitioners have neglected to follow due process as laid down, the Petitioners are not entitled to any relief under the present petition. 

The Union placed reliance upon, Supertech Limited Vs. Emerald Court Owner Resident Welfare Association and Ors, [2021] 10 SCR 569 which specifically states that:  

“It is that where a power is given to do a certain thing in a certain way, the thing must be done in that way or not at all and that other methods of performance are necessarily forbidden.”

The Union also challenged the jurisdiction of the High Court and placed reliance upon Himachal Pradesh High Court in the matter of M/S Neelkanth Yarn vs. Punjab National Bank and Ors. (Civil Writ Petition No. 4538 of 2023, decided on 02.08.2023). It was the Unions’ case that as the Petitioners have an alternate remedy under the SARFAESI Act, 2002, Writ under Constitutional jurisdiction should not be entertained and that it is not a fit case for exercise of extra ordinary Writ Jurisdiction.

The Banks submissions:

The Bank argued that the process of restructuring and classification of an account as NPA are two independent subjects and therefore it cannot be interpreted to mean that unless the procedure under the said Notification for restructuring is adopted, the Petitioners accounts cannot be classified as NPAs and SARFAESI Act, 2002 cannot be applied. It was reiterated again by the Banks that there is no mandate in the said Notification on the Banks or NBFCs to constitute a committee, until the borrower approaches the Bank first. As the Petitioners had not applied to the Bank for appointment of a Committee, as provided in the said Notification, the Petitioners cannot be heard to find fault with the Banks in adopting legal process under the SARFAESI Act, 2002.

The Bank relied upon Oriental Bank of Commerce Vs. Sunder Lal Jain and Anr. (2008) 2 SCC 280, regarding guidelines issued by the RBI (about settlement), in which the Hon’ble Apex Court had already held that such guidelines are merely internal guidelines for the Banks and have no statutory force and the guidelines do not create any rights in favour of the borrowers. 

The Bank also pointed out that as the Petitioner/MSME has addressed letters to the Bank admitting liability and requesting for more time to pay, it was evident that the MSME had apprehensions of its inability to repay its debts, and it could have voluntarily initiated the process for the appointment of a Committee as contemplated by the said Notification. 

The NBFCs contentions: 

The NBFCs argued that as the provisions of the Insolvency and Bankruptcy Code, 2016 [IBC], overrides all other laws, there was no requirement of classification of an account of borrower as NPA and under section 7 of the IBC, an NBFC can file an application for initiating Corporate Insolvency Resolution Process [CIRP] against corporate debtor when a default has occurred and the whole argument of the Petitioners, that without following process under the said Notification, an account of MSME cannot be classified as NPA, will not apply in the case of NBFC as its action was under the IBC, 2016.

Orders of the Court:

The Court, on a conjoint reading of Clause 1(1) and Clause 1(3) of the said Notification, came to an indisputable interpretation that the said Notification can be pressed into service only and only after the MSME [such as the Petitioners] approaches the Banks/NBFCs with an appropriate application supported by an affidavit of the authorized person placing on record the bundle of facts which lead to the conclusion and the Banks/NBFCs are not obliged to adopt the restructuring process on its own without there being any application by the Petitioners/MSMEs. 

The Court found no merits in the averments of the Petitioner and dismissed the petitions and granted leave to the Petitioners to agitate the other issues in their petitions, which may vary on facts, on a case-to case basis by adopting alternate remedies, as available under law.

However, the Petitioners were of the opinion that the issues involved in the present Writ Petitions are important issues and they would like to test the same before the Hon’ble Supreme Court.

If the Petitioners indeed approach the Supreme Court, the arguments will continue there. Meanwhile, MSMEs will have to approach the Bank/NBFC first and apply with an affidavit in support and only then the Bank/NBFC can appoint a Committee, to take benefit as contemplated under the said Notification,




W. P. NO. 4620 OF 2022

M/s. A. Navinchandra Steels Pvt. Ltd and Others…Petitioners


1. Union of India and Others                                  ...Respondents

Order dated : 11th January 2024

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