Banks must follow MSME Development Act procedures before classifying accounts as Special Mention Accounts or issuing SARFAESI notices

The Bombay HC disposed of a petition challenging respondent banks/NBFCs' actions under the MSME Development Act, 2006 notification dated 29th May, 2015. The court held that banks/NBFCs failed to follow prescribed procedures for identifying incipient stress in MSME accounts before classification as Special Mention Accounts and issuing SARFAESI notices. The court interpreted that the notification requires MSMEs to first approach banks with applications supported by affidavits demonstrating incipient stress facts, after which banks must categorize accounts as SMA-0, SMA-1, or SMA-2. The petition was disposed of with leave granted to petitioners to pursue other case-specific issues through alternate legal remedies.

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Issues Involved:

1. Legality of actions by banks and NBFCs under the SARFAESI Act, 2002, without following the procedure outlined in a notification under the MSMED Act, 2006.
2. Interpretation and application of the notification dated 29th May 2015 issued under Section 9 of the MSMED Act.
3. Whether the notification has a binding effect on banks and NBFCs to adopt restructuring procedures for MSMEs.
4. The jurisdiction of civil courts in the context of the MSMED Act and SARFAESI Act.
5. The applicability of SARFAESI Act, 2002, to MSMEs in light of the MSMED Act, 2006.
6. The status and enforceability of interim reliefs sought by the petitioners.

Issue-wise Detailed Analysis:

1. Legality of Actions under SARFAESI Act, 2002:
The petitioners challenged the actions of banks and NBFCs declaring them as Non-Performing Assets (NPA) under Section 13(2) of the SARFAESI Act, 2002, arguing that the procedure for restructuring as per the notification under the MSMED Act was not followed. The court found that the banks and NBFCs were not obliged to initiate restructuring without an application from the MSMEs, thus rendering the actions under SARFAESI Act, 2002, valid.

2. Interpretation of the Notification under MSMED Act:
The court examined whether the notification issued on 29th May 2015 under Section 9 of the MSMED Act had a mandatory character. It concluded that the notification required MSMEs to initiate the process by applying for restructuring, supported by an affidavit, before banks or NBFCs were obliged to act. The notification was deemed to be more of a guideline rather than having the force of law.

3. Binding Effect on Banks and NBFCs:
The petitioners argued that the notification imposed a duty on banks and NBFCs to adopt restructuring procedures. However, the court held that such procedures were not mandatory unless initiated by the MSMEs themselves. The notification was interpreted as providing a framework rather than a binding obligation on financial institutions.

4. Jurisdiction of Civil Courts:
The petitioners sought a declaration that the jurisdiction of civil courts was not ousted by the MSMED Act. The court did not find it necessary to delve into this issue in detail, as the primary argument regarding the notification's binding nature was resolved against the petitioners.

5. Applicability of SARFAESI Act to MSMEs:
The petitioners contended that the SARFAESI Act, 2002, was not applicable to MSMEs due to the special provisions of the MSMED Act, 2006. The court dismissed this argument, affirming that the SARFAESI Act, 2002, applies unless specific procedures under the MSMED notification are initiated by the MSMEs.

6. Interim Reliefs and Further Directions:
The court dismissed the petitions, indicating that the interim reliefs sought by the petitioners were not warranted. It allowed the petitioners to pursue other issues on a case-by-case basis through alternate legal remedies. The court also provided a temporary extension of any interim orders for two weeks to allow the petitioners to approach the Supreme Court if desired.

In conclusion, the court dismissed the petitions, holding that the notification under the MSMED Act did not impose a mandatory obligation on banks and NBFCs to initiate restructuring without an application from MSMEs. The actions under the SARFAESI Act, 2002, were deemed lawful, and the petitioners were advised to pursue other remedies as available under law.

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