Last Updated on June 7, 2026 by Satish Mishra
DRT Sets Aside SARFAESI Proceedings After Declaring MSME Loan Account NPA Classification Illegal. The Tribunal quashed the entire recovery proceedings, including auction and possession actions initiated by the bank.
In a significant ruling dated 03 March 2026, the Debts Recovery Tribunal (DRT), Chandigarh held that:
SARFAESI proceedings initiated against an MSME borrower were illegal because the loan account had been wrongly classified as NPA in violation of RBI guidelines.
MSME CASES IN DRT
MSME cases in the Debt Recovery Tribunal (DRT) usually involve borrowers defending against banks or financial institutions that have initiated loan recovery or asset seizure (SARFAESI Act) proceedings. Debtors frequently challenge these actions if the creditor classifies the account as a Non-Performing Asset (NPA) without following mandatory MSME guidelines. In MSME Cases in DRT, NPA Classification should only valid when RBI guidelines/ circulars duly followed.
Key Legal Protections & Precedents for MSMEs
- Mandatory Rehabilitation Framework: The RBI’s Framework for Revival and Rehabilitation of Micro, Small and Medium Enterprises and relevant notifications under the MSMED Act require banks to refer distressed MSME accounts to a Designated Committee before declaring them as NPAs. [1, 2, 3]
- Supreme Court Precedent: In the Pro Knits v. Board of Directors of Canara Bank case, the Supreme Court clarified that a bank’s failure to adhere to the MSME Revival & Rehabilitation Framework before taking SARFAESI measures vitiates the NPA classification, which renders subsequent possession and auction proceedings illegal. [1]
- DRT Enforcement: Tribunals (such as DRT Chandigarh and DRT Ernakulam) have repeatedly quashed bank possession and sale notices when banks failed to prove they explored restructuring options under the MSME framework first. [1, 2, 3]
How the DRT Process Works for MSMEs
- Minimum Threshold: Banks and financial institutions can only approach the DRT if the outstanding debt is Rs. 20 lakh or more. Cases below this must be pursued through civil courts. [1]
- Filing an Application: If an MSME unit’s property or assets are subjected to measures like a demand notice or a possession notice under the SARFAESI Act, the borrower can file a Securitization Application (SA) under Section 17(1) of the SARFAESI Act. [1, 2]
- Proving Status: To claim these protections, borrowers must present a valid Udyam Registration Certificate obtained before the NPA classification
Resources & Case Tracking
📌 Background of the Dispute
The case involved:
- A business entity registered as an MSME
- Credit facilities and term loans granted by a bank
- Secured assets mortgaged against the loan account.
According to the borrowers:
- The loan accounts were standard as on the relevant RBI cut-off date
- RBI had issued special relief circulars for MSME borrowers
- Despite eligibility for protection, the bank classified the accounts as:
❌ Non-Performing Assets (NPA).
The borrowers challenged:
- Demand notice under Section 13(2) SARFAESI Act
- Possession notice under Section 13(4)
- Auction and sale notices.
⚖️ Key Arguments Raised Before the Tribunal
The borrowers argued that:
✔ RBI Circular dated 07.02.2018 granted relief to eligible MSMEs
✔ The account qualified for restructuring/protection
✔ The bank failed to refer the matter to the Designated Committee before NPA declaration
✔ Mandatory SARFAESI procedures were violated.
The bank, however, contended that:
- The NPA classification was lawful and proper.
🏛 DRT’s Key Findings
🔹 MSME Protection Under RBI Circular Ignored
The Tribunal examined the MSME registration documents and held that:
- The borrower was already registered as MSME prior to sanction of loan
- Therefore, RBI’s MSME relief framework was applicable.
The Tribunal observed:
Before classifying the account as NPA, the matter ought to have been referred to the Designated Committee.
Failure to do so rendered the NPA classification illegal.
🔹 Non-Filing of Reply by Bank Weighed Against It
A major factor noted by the Tribunal was that:
- The bank failed to file reply despite opportunities granted
The Tribunal observed that:
- This strengthened the borrowers’ assertions regarding procedural violations.
🔹 Objections Under Section 13(3A) Ignored
The Tribunal further found that:
- Borrowers had submitted objections/representation under Section 13(3A) SARFAESI Act
- The bank failed to properly respond to the objections.
This was held to be another procedural illegality.
🔹 Possession Notice Not Properly Served
The Tribunal noted that:
- The bank failed to establish proper service of possession notice under Section 13(4)
- No evidence was produced regarding:
✔ Personal service
✔ Publication compliance
✔ Pasting/electronic service requirements under SARFAESI Rules.
🔹 Entire SARFAESI Action Held Unsustainable
The Tribunal concluded that:
Once the NPA classification itself is illegal, all consequential SARFAESI proceedings automatically collapse.
Thus:
- Auction proceedings
- Sale actions
- Possession proceedings
were all held unsustainable.
✅ Final Order Passed by DRT
The Tribunal:
✔ Allowed the securitisation application
✔ Quashed entire SARFAESI proceedings from inception
✔ Directed bank to:
- Take back possession from auction purchasers
- Restore possession to borrowers within 30 days
✔ Directed refund of auction money with applicable interest to auction purchasers.
The Tribunal clarified that:
- Fresh proceedings could still be initiated strictly in accordance with law.
📌 Key Legal Takeaways
✔ RBI MSME circulars are binding on banks
✔ MSME accounts require special consideration before NPA declaration
✔ Non-compliance with Section 13(3A) can vitiate SARFAESI action
✔ Improper service of possession notice violates SARFAESI Rules
✔ Illegal NPA classification invalidates subsequent recovery proceedings
🧑⚖️ Why This Judgment Matters
This ruling is highly significant for:
- MSME borrowers
- SARFAESI disputes
- NPA classification challenges
- Banking recovery litigation
It reinforces the principle that:
“Banks must strictly comply with RBI guidelines and SARFAESI procedure before taking coercive recovery measures.”
🔍 Read more about these Keywords:
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