Best MSME Loan in Trouble? Restructuring, NPA and SARFAESI Help Lawyer

For small manufacturers, traders and service businesses, a bank loan is often what keeps the unit running. When orders fall, a big customer delays payment, or raw material prices jump, EMIs and interest fall behind, the account is classified as a non-performing asset (NPA), and the bank starts recovery: a SARFAESI notice, possession of the factory, a DRT case against the promoters as guarantors. Many MSME owners believe they have no choice but to wait for the auction. In fact, the law gives MSMEs specific protections before enforcement, and practical options at every stage.

This page is for MSME borrowers and their promoters and guarantors. In short: banks must follow the framework for revival and rehabilitation of MSMEs, which requires early identification of stress and consideration of corrective action, including restructuring, before recovery, as the Supreme Court confirmed in Pro Knits v Canara Bank (2024); the borrower must invoke the framework promptly, with proof of its MSME status; restructuring and one-time settlements remain possible even after NPA classification; and SARFAESI and DRT proceedings have their own deadlines and defences.

The earlier an MSME acts, the more options it has. Write to the bank at the first sign of stress, not after the possession notice.

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MSME borrower's options

The MSME revival framework and Pro Knits

In 2015, the MSME Ministry notified a framework for revival and rehabilitation of micro, small and medium enterprises under the MSMED Act, and the RBI issued directions to banks in 2016 to implement it. The framework requires banks to identify incipient stress in MSME accounts early, by classifying them in special mention account categories, and to refer stressed accounts to committees for stressed MSMEs, which consider corrective action plans: rectification, restructuring or recovery.

In Pro Knits v Canara Bank (August 2024), the Supreme Court held that the framework is binding on banks, and that banks must follow it before taking recovery action against MSMEs. But the Court also held that the MSME borrower must bring its status to the bank's notice and invoke the framework at the earliest, with evidence such as its Udyam registration, and cannot sit back and raise it only after enforcement has progressed. So the first step for any stressed MSME is a written request to the bank, attaching its registration, asking for its account to be considered under the framework.

How we help stressed MSMEs

Time and typical cost range

Our fees are agreed in writing at the start, stage by stage, and are not linked to the outcome.

Documents needed

Stages of stress and what to do

Restructuring options

Under the RBI's directions on resolution of stressed assets and the MSME-specific frameworks, banks can restructure MSME loans by extending the repayment period, granting a moratorium, reducing interest, converting part of the debt into a funded interest term loan, or providing additional finance where the unit is viable. Restructuring usually requires a viability study showing that the unit can repay on the revised terms, and the promoters may be asked to bring in additional funds.

Restructuring is not a right; it is a decision for the bank's committee, applying the framework and its policies. But a well-prepared proposal, with realistic projections, evidence of orders, and the promoters' commitment, has a much better chance than a general request for relief. Even where restructuring is refused, a reasoned refusal is needed, and the process itself may give the MSME time to recover.

One-time settlements

Where the unit cannot be revived on its current debt, a one-time settlement (OTS) may be the best outcome. Banks have board-approved policies for compromise settlements, and the RBI's 2023 framework for compromise settlements and technical write-offs allows settlements across categories of borrowers, subject to board policies. An OTS usually involves payment of a negotiated amount, often from the sale of non-core assets, new investment or family funds, within a fixed period.

Negotiate from a position of information: the realisable value of the security, the cost and time of recovery for the bank, and the borrower's realistic capacity to pay. Insist on a written sanction, a no-dues certificate on completion, release of all security and guarantees, withdrawal of SARFAESI and DRT proceedings, and correction of credit bureau records.

Laws and rules that apply

How we work

We are a litigation and advisory practice led by Advocate BK Singh, with offices in Dwarka (New Delhi) and Vaishali (Ghaziabad), with a dedicated DRT practice at drtadvocates.com. This is what you can expect:

• Early action: the framework invoked before enforcement starts.
• Viability planning: with your chartered accountant, for a credible proposal.
• Deadline control: SARFAESI and DRT limits managed closely.
• Settlement experience: OTS terms that close the matter fully.
• Written fee terms: agreed stage by stage, never linked to the outcome.

Mistakes stressed MSMEs make

Checking the NPA classification

Before negotiating, check whether the account was correctly classified as an NPA. Under the RBI's prudential norms, a term loan becomes an NPA when interest or instalments remain overdue for more than 90 days, and a cash credit account when it remains out of order for more than 90 days. Errors happen: payments not credited on time, drawing power not updated, interest debited wrongly, or classification made by reference to the wrong date.

If the classification was premature or wrong, raise it in writing with the bank, with the account statement and payment records. A wrong classification can affect the validity of SARFAESI action that followed, and can support an application under Section 17 in the DRT. See DRT and debt recovery.

Penal charges and interest

The RBI's directions on fair lending practice and penal charges, effective from 2024, require that penal charges for default be levied as charges, not as penal interest added to the rate, and that they not be compounded. Many older loan accounts carry compounding penal interest. Review the account statement for penal interest and charges, and challenge those that do not comply. Reducing these amounts strengthens the borrower's position in restructuring and settlement.

Also check whether interest rate resets, processing fees and other charges were applied as the sanction letter allowed. A careful reconciliation of the account often reduces the claimed dues.

Delayed receivables and the MSME council

Many MSMEs are stressed not because their business is weak but because their buyers do not pay on time. An MSME with receivables from larger buyers can file claims before the MSME Facilitation Council, with interest at three times the bank rate, compounded monthly. Recoveries from buyers can then be used to regularise the loan or fund a settlement.

Present the pending council claims to the bank as part of the restructuring proposal, as evidence of expected inflows. Some banks will accept a plan that ties repayment to recoveries from specific buyers. See MSME delayed payment.

Guarantors and promoters

Promoters of MSMEs usually give personal guarantees and often mortgage their homes as collateral. When the business fails, the bank may pursue both the business assets and the personal assets. Personal guarantors to corporate debtors can also face insolvency proceedings under Part III of the IBC before the NCLT.

Guarantors should review the guarantee terms, check whether any variation of the loan without their consent may discharge them, and ensure that any settlement expressly releases them. Where the family home is mortgaged, negotiate for its release in return for a payment, or for a structured sale that maximises value.

Wilful defaulter risk

Banks may classify a borrower and its promoters as wilful defaulters where the default is deliberate: for example, where funds were diverted, the borrower has the capacity to pay but does not, or assets securing the loan were disposed of without the bank's knowledge. The label restricts access to fresh credit and can affect directorships. The RBI's directions require a show-cause notice, a written representation and, generally, a personal hearing before an identification committee, with review by a higher committee.

Stressed MSMEs should avoid any step that looks like diversion: moving funds to related entities, selling hypothecated stock without depositing the proceeds, or concealing receivables. Keep the bank informed, and respond to any show-cause notice promptly with documents.

When the unit cannot be saved

Sometimes the best outcome is an orderly exit: a sale of the unit as a going concern to a buyer who can run it, a sale of assets in coordination with the bank to maximise value, or, for corporate MSMEs, a pre-packaged insolvency under Section 54A of the IBC, which allows the promoters to propose a resolution plan while remaining in control during the process. An orderly exit usually recovers more for the bank and leaves the promoters in a better position than an auction under SARFAESI.

Discuss the exit options with the bank early. Banks often prefer a negotiated sale to a forced auction, if the process is transparent and the proceeds come to them. See MSME pre-pack insolvency.

Credit guarantee cover

Many MSME loans are covered by the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), which guarantees part of the loan to the bank without collateral. When such a loan becomes an NPA, the bank may claim on the guarantee after taking certain recovery steps. The guarantee does not reduce the borrower's liability; the bank and the trust can still recover the full amount from the borrower.

For borrowers, the existence of CGTMSE cover can make a settlement easier, because the bank's loss is partly covered. Ask whether the loan is covered, and factor it into the settlement negotiation.

Communicating with the bank

Throughout the process, communicate with the bank in writing, through letters or e-mails to the branch and the regional office, and keep copies. Oral assurances from bank officers are not binding and are hard to prove. Record the reasons for stress, the steps taken to address it, the requests made under the framework, and the bank's responses. If the bank later takes enforcement action, this record shows that the borrower acted in good faith and invoked the framework in time, which Pro Knits (2024) makes important.

Recovery agents and harassment

Banks and NBFCs often use recovery agents for overdue accounts. The RBI's directions require recovery agents to carry authorisation, to call only at reasonable hours, and not to use threats, abuse or intimidation. Borrowers can complain to the bank's grievance officer, then to the RBI Ombudsman under the Integrated Ombudsman Scheme, and, where an offence is involved, to the police.