Directions issued by Govt and RBI under S. 9, MSMED Act and Ss. 21 & 35-A, Banking Regulation Act respectively, have statutory force: SC

Supreme Court: While considering the instant appeals revolving around whether the Notification dated 29-05-2015 containing instructions for the “Framework for Revival and Rehabilitation of MSMEs”, issued by the Central Government in exercise of the powers conferred under Section 9 of the MSMED Act, as revised from time to time, is mandatory or directory; the Division Bench of Bela M. Trivedi* and R. Mahadevan, JJ., held that Instructions/Directions issued by the Central Government under Section 9 of the MSMED Act and by the RBI under Section 21 and Section 35-A of the Banking Regulation Act, 1949, have statutory force and are binding to all the Banking companies.

The Court further added that along with the banks, the concerned MSMEs also have a mandatory obligation to be vigilant enough to follow the process laid down under the Framework.

Background and Contentions: The appellants had challenged the challenged the actions of the Respondents against them under the provisions of Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) before the Bombay High Court. Appellants claim themselves to be Micro, Small and Medium Enterprises (MSMEs) registered under the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act).

In the impugned order, Bombay High Court dismissed the writ petitions filed by the appellants holding that Banks/ Non-Banking Financial Companies are not obliged to adopt the restructuring process as contemplated in the Notification dated 29-5-2015 issued by the Ministry of Micro, Small and Medium Enterprises, on its own without there being any application by the appellants/ MSMEs.

Counsels for the appellants argued that the Respondents could not have classified the loan accounts of the appellants as Non-Performing Assets (NPA), without following the procedure laid down in the Instructions for Framework for Revival and Rehabilitation of MSMEs issued vide the Notification dated 29-5-2015 by the Ministry of MSME. It was further submitted that it was mandatory on the part of the Respondents to identify incipient stress in the account by creating three sub-categories as mentioned in the said Notification and to explore various options to resolve the stress in the account as contemplated in the said Notification.

Per contra, counsels for Respondents argued that the High Court rightly did not consider the process or procedure laid down in the Notification dated 29-5-2015 as mandatory, as the provisions contained in the SARFAESI Act override the provisions of the other Acts including the MSME Act.

Court’s Assessment: The Court had to consider whether the Notification dt. 29-5-2015 issued by the Central Government in exercise of the powers conferred under Section 9 of the MSMED Act, as revised sometimes, is mandatory or directory.

To resolve the issue, the Court delved into the relevant provisions of MSMED Act, namely Sections 9 and 10. The Court pointed out that Section 9 empowers the Central Government to take measures for the purpose of facilitating such promotion and development and enhancing competitiveness of MSMEs by specifying the programmes, guidelines or instructions as it may deem fit, by issuing Notifications. While Section 10 states that the policies and practices in respect of the credit to the Micro, Small and Medium Enterprises shall be progressive and such as may be specified in the guidelines or instructions issued by the Reserve Bank, from time to time, to ensure timely and smooth flow of credit to such enterprises, minimize the incidence of sickness among and enhance the competitiveness of such enterprises.

The Court also perused Section 21 of Banking Regulation Act, 1949, which empowers RBI to control advances by Banking companies. It was noted that S. 21(3) states that every banking company shall be bound to comply with any directions given to it under the said Section. The Court also examined Section 35-A which lays down similar obligations for banking companies. Therefore, the Court found that Section 21 read with Section 35-A of the Banking Regulation Act, makes it clear that the directions issued by the RBI to the banking companies are binding on them.

The Court further examined the Government Notification dt. 29-5-2015, specifically the part vis-a-vis the identification of the incipient stress and the Committees for stressed MSMEs. The Court noted that to make the Framework under Notification dt. 29-5-2015 compatible with the existing regulatory guidelines on “Income Recognition, Asset Classification and provisioning pertaining to Advances”, the RBI made certain changes in the Notified Framework, in consultation with the Central Government and issued a revised Framework along with the operating Instructions vide the Communication dated 17-3-2016, addressed to all the Scheduled Commercial Banks.

Furthermore, RBI in exercise of its powers u/Ss. 21 and 35-A of Banking Regulation Act, issued a Master Direction, called the Reserve Bank of India [Lending to Micro, Small and Medium Enterprises (MSME) Sector] Directions, 2016, vide Notification dated 21-7-2016. Taking note of Direction 4.8 in the 2016 Master Direction, advising all the Scheduled Commercial Banks to follow the guidelines/ instructions pertaining to MSMEs, the Court said that the notified Framework dt. 29-5-2015, the revised Framework by RBI dt. 17-3-2016 and the Master Direction, 2016 have statutory force, and are binding to all Scheduled Commercial Banks, licensed to operate in India by the Reserve Bank of India. “(…) the Banking Regulation Act, 1949 basically seeks to regulate banking business and mandates a statutory comprehensive and formal structure of banking regulation and supervision in India”.

The Court emphasised that Section 21 and Section 35A of Banking Regulation Act empower the Reserve Bank of India to frame the policy and give directions to the banking companies in relation to the advances to be followed by the banking companies. “Such directions have got to be read as supplement to the provisions of the Banking Regulation Act and accordingly are required to be construed as having statutory force and mandatory”. Therefore, Instructions/Directions, and the exercise contained in the “Framework for Revival and Rehabilitation of MSMEs” dt. 29-5-2015 must be carried out by the banking companies before the accounts of MSMEs turn into NPA.

The Court pointed out that the Notified Framework dt. 29-5-2015 is a part of measures taken to facilitate the promotion and development of MSMEs issued by the Central Government in exercise of powers conferred under Section 9 of the MSMED Act, followed by the Directions issued by the RBI in exercise of the powers conferred under Section 21 and 35-A of the Banking Regulation Act. Banking companies though may be ‘secured creditors’ as per the definition contained in Section 2 (zd) of the SARFAESI Act, but they are bound to follow the instructions, before classifying the loan account of MSME as NPA.

The Court further added that under the Notified Framework, banks or creditors are required to identify the incipient stress in the account of the MSMEs, before their accounts turn into NPA, by creating 3 sub-categories under the “Special Mention Account” Category, however, while creating such sub-categories, the Banks must have some authenticated material with them as produced by the concerned MSME to show that loan account is of a MSME, classified and registered as such under the MSMED Act.

Hence, the stage of identification of incipient stress in the loan account of MSMEs and categorization under the Special Mention Account category, before the loan account of MSME turns into NPA is a very crucial stage. Therefore, it would be mandatory on the part of the concerned MSME to produce authenticated and verifiable documents/material for substantiating its claim of being MSME, before its account is classified as NPA. If that is not done, and once the account is classified as NPA, the banks i.e. secured creditors would be entitled to take recourse to Chapter III of the SARFAESI Act for enforcement of the security interest.

With the afore-stated assessment, the Court allowed the instant appeal, and the impugned order of the Bombay High Court was set aside.