MSMEs Must Claim Status Before NPA Classification to Stall SARFAESI Action, Can't Raise Plea Belatedly: Kerala High Court - 2025-07-18

MSME s Cannot Belatedly Invoke Revival F\ramework to Stall SARFAESI Action, Rules Kerala High Court

Ernakulam, Kerala – In a significant ruling clarifying the rights of Micro , Small, and Medium Enterprises ( MSME s) facing loan recovery, the Kerala High Court has held that a borrower cannot invoke the benefits of the MSME D Act's revival framework at a belated stage to challenge proceedings under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002.

A Division Bench of Justice Anil K. Narendran and Justice Muralee Krishna S. dismissed two writ appeals filed by M/s. M.D. Esthappan and its sister concern, M/s. M.D. Esthappan Infrastructure Pvt. Ltd., against Dhanlaxmi Bank . The court affirmed that if an MSME fails to inform the bank of its status and seek relief under the prescribed framework before its loan account is classified as a Non-Performing Asset (NPA), it is precluded from doing so later to stall recovery actions.

Background of the Case

The case involved two entities, a proprietorship and a private limited company, both run by M.D. Esthappan . After they defaulted on loan repayments, Dhanlaxmi Bank classified their accounts as NPA on July 31, 2023, and initiated recovery proceedings under the SARFAESI Act.

The borrowers challenged this action in the High Court, primarily arguing that the bank had violated the mandatory "Framework for Revival and Rehabilitation of Micro , Small and Medium Enterprises" notified by the Central Government on May 29, 2015, and adopted by the Reserve Bank of India (RBI) on March 17, 2016.

Arguments Presented

Appellants' Contentions (The Borrowers): - The bank was statutorily obligated to identify incipient stress in their accounts and refer the matter to a committee for a Corrective Action Plan (CAP) before classifying the accounts as NPA. - They argued that this framework, established under the MSME D Act, has statutory force and overrides the bank's power to initiate SARFAESI proceedings directly. - The entire recovery action was void ab initio due to the bank's failure to follow this mandatory pre-NPA procedure. - They also challenged the constitutionality of several provisions of the SARFAESI Act, RDB Act, and IBC, claiming they were one-sided.

Respondents' Contentions ( Dhanlaxmi Bank ): - The borrowers never claimed their MSME status or sought relief under the revival framework before their accounts were declared NPA. - The bank had sent communications about the stress in the accounts (Special Mention Account status), but the borrowers failed to respond with an action plan. - The borrowers had engaged in "piecemeal litigations," having previously filed other writ petitions and approached the Debt Recovery Tribunal (DRT) without raising the MSME issue, which amounted to an abuse of the legal process. - Relying on established legal precedent, the bank argued that the MSME claim was an afterthought to stall legitimate recovery proceedings.

Legal Principles and Court's Reasoning

The Division Bench heavily relied on the Supreme Court's decision in Pro Knits v. Canara Bank (2024) and a prior Division Bench ruling of the Kerala High Court in P.K. Krishnakumar v. IndusInd Bank (2024) .

The court highlighted the key principles from these judgments:

"...the stage of identification of incipient stress in the loan account of MSME s and categorisation under the Special Mention Account category, before the loan account of MSME turns into NPA is a very crucial stage, and therefore it would be incumbent on the part of the concerned MSME also 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 a NPA, the banks, i.e., secured creditors would be entitled to take the recourse to Chapter III of the SARFAESI Act..."

The bench emphasized that while the revival framework is mandatory for banks, it casts a corresponding duty on the MSME to be vigilant and assert its status in a timely manner. The judgment noted:

"If at the stage of classification of the loan account of the borrower as Non-Performing Asset, the borrower does not bring to the notice of the bank/creditor concerned that it is a Micro , Small or Medium Enterprise... such an Enterprise could not be permitted to misuse the process of law for thwarting the actions taken under the SARFAESI Act by raising the plea of being an MSME at a belated stage."

The court observed that the borrowers had only raised the MSME claim in their objections after the SARFAESI notice under Section 13(2) was issued, by which time the accounts were already classified as NPA. This, the court concluded, was too late.

Final Decision

Upholding the single judge's decision to dismiss the writ petitions, the Division Bench found no error in the reasoning. It concluded that the appellants' conduct of filing multiple proceedings and raising the MSME plea belatedly disqualified them from invoking the High Court's extraordinary writ jurisdiction.

The court declined the appellants' oral request for a stay on the judgment, thus allowing Dhanlaxmi Bank to proceed with its recovery actions under the SARFAESI Act.