Supreme Court

In a recent Judicial pronouncement the Supreme Court came up with the decision supporting the implementation of an existing framework for early detection of financial stress of enterprises, particularly in relation to Macro, Small and Micro Enterprises (MSME) sector, before the Bankers/Lenders could to take up steps for classifying their debt as Non-Performing Asset (NPA) in order to assume coercive measures under SARFAESI Act, for recovery of dues. In fact, non-adherence to such framework was held as violative on the part of Lender/Banker, with the result that any steps taken for NPA declaration or resorting to SARFAESI Act measures, to be running the risk of being declared as null and void.

The Supreme Court was called upon to decide the challenge to Bombay High Court judgment passed in exercise of its Writ Jurisdiction, wherein the action of Banker/Lender in declaring the Account of an MSME as NPA and subsequent actions of invoking the measures under SARFAESI Act, was impugned for not adhering to the framework of restructuring process contemplated in the Notification dated 29.05.2015 called, “Framework for Revival and Rehabilitation of MSMEs” (Notification), issued by Ministry of MSME, Govt. of India under MSMED Act. The Hon’ble High Court rejected the Writ holding that Bankers/Lenders are not obliged to adopt the restructuring process contemplated in the Notification on their own, when the MSME had not submitted any application for the same.

The Supreme Court however setting aside the decision of the Hon’ble High Court of Bombay, noted that Section 9 of the MSMED Act, empowers Central Government to issue Notification prescribing measures for facilitating promotion, development and enhancing competitiveness of MSMEs and in that regard specify programmes, guidelines or instructions. It was further noted that Section 10 of the MSMED Act, requires implementation Policies/Practices ensuring timely and smooth flow of credit facilities to MSMEs in consonance with Guidelines/instructions of RBI, and minimize the incidence of their sickness and enhance their competitiveness. It was further noted that in support of the Notification of 29.05.2015, the RBI, in exercise of its powers under Section 21 read with Section 35A of Banking Regulation Act, issued Master Direction, called, the “Reserve Bank of India [Lending to Micro, Small and Medium Enterprises (MSME) Sector] Directions, 2016,” (Master Directions) vide the Notification dated 21st July, 2016, thereby advising all scheduled commercial banks to follow the guidelines/instructions pertaining to MSMEs.

It was further noted from the scheme/arrangement in the Notification, that it required Bankers/Lenders to identify incipient stress in the account of the concerned enterprise registered as MSME by creating three sub categories as set out in the Notification, in order to explore various options to resolve the stress in the account, in terms of the said Notification. It was further noted, that the Bankers/Lenders stood obliged to implement the measures identified in the Notification, before proceeding to classify the account of the concerned MSME as NPA. It was also noted from the Scheme of the Notification that apart from the Bankers/Lenders adhering to the measures set out in the Notification, the borrower was also entitled to voluntarily initiate the process set out in the Notification by making an application to that effect.

Keeping in view the scheme of the Notification read with Master Directions, the Supreme Court noticed that no doubt by virtue of Section 35 the SARFAESI Act shall prevail notwithstanding anything inconsistent in any other law in force; however, the provisions of SARFAESI Act gets triggered consequent to classification of the concerned account as NPA upon default in repayment of secured debt. It was observed that the Banks/Lenders are required to take up steps under the Notification, towards identification of incipient stress in the loan account and according categorization, on the basis of authenticated and verifiable material as furnished by the concerned MSME to establish that the loan account is of a MSME. It was accordingly, held that the implementation of the scheme prescribed in the Notification becomes very crucial, before any loan account of MSME can be classified as NPA. Therefore, until the exhaustion of measures under the Notificfation, the accounts of MSME cannot be classified as NPA, without which the measures under SARFAESI Act cannot be triggered.

Taking note of the above position, the Supreme Court negated the findings of High Court that Bankers/Lenders of MSMEs were not obligated to follow the measures prescribed under Notification on its own, until MSME applies for initiation of said measures. While observing that it was mandatory for the Bankers/Lenders to follow the scheme prescribed in the Notification on its own, the Supreme Cour found it equally incumbent upon the concerned MSME to remain vigilant and follow the process set out in the framework of Notification. On that count, the Supreme Court cautioned that in case the MSME remains negligent and allows the process of enforcement of security under SARFAESI Act to get completed, such MSME could not be permitted to misuse process of Notification by taking a plea at belated stage.

It is significant to highlight from the aforesaid that the Judgment of Supreme Court clearly weighs in favour of revival of an enterprise, before taking up of any coercive measures against it. In this backdrop, it is relevant to highlight that exactly the same objective can be traced with the scheme of the Insolvency and Bankruptcy Code, 2016 (IBC) as well. So far, eight years down the line from enforcement of IBC, the economic thought leaders and think tanks find tremendous reason to rejoice the successful implementation of IBC, while alluding such reasons to encouraging arithmetic figures of ‘debt resolution’ running into several lakhs of crores. However, the legislative objective of IBC towards ‘resolution of enterprises’ is yet to see a positive prospect, much less an encouraging number. In fact, the infrastructure for enterprise resolution is still struggling to settle and stabilize, and is dependent largely on ad-hoc measures, including interim finance support, for pulling on the sick enterprise as a going concern. The present Judgment of Supreme Court is a manifestation of legislative mandate towards ‘enterprise resolution’ (and not merely ‘debt resolution’), which need be implemented with support from an institutionalized infrastructure. It is high time that Policy framers and stakeholders join hands to implement an institutionalized infrastructure, to support the resolution measures of financially ailing enterprises, rather than leaving them on support of ad-hoc measures.

Author: Mr. Jyoti K. Chaudhary