Challenging Wrongful NPA Classification: RBI Norms, Grounds and Forums

An account becomes a non-performing asset because of its record of recovery, not because of the lender's view of the borrower. The Reserve Bank of India draws the line at ninety days of overdue interest or principal for a term loan, and at "out of order" status for a cash credit or overdraft. A classification made otherwise than in accordance with those directions can be challenged — first by representation to the secured creditor, and then before the Debt Recovery Tribunal — and the challenge matters because the NPA tag is the statutory gateway to SARFAESI enforcement and the trigger for adverse credit-bureau reporting.

As an Advocate practising at the Delhi High Court and Senior Partner at Unified Chambers And Associates, I see the classification date argued from both sides — by lenders establishing that enforcement was validly founded, and by borrowers demonstrating that the account was tagged earlier or on a different basis than the prudential norms permit. This note sets out the framework, the fault lines, and the forums.

What exactly makes a loan account a non-performing asset?

The governing framework is the RBI Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances, usually called the IRACP norms. The underlying idea is simple: an asset is non-performing when it has ceased to generate income for the lender. Everything else is measurement.

"Overdue" carries a defined meaning. Any amount due to the bank under any credit facility is overdue if it is not paid on the due date fixed by the bank. The ninety-day standard is not arbitrary either — it replaced the earlier one-hundred-and-eighty-day standard with effect from 31 March 2004, aligning Indian classification with international practice.

Two principles do a great deal of work in practice and are routinely overlooked on the borrower side.

Classification follows the record of recovery, not the security. The availability of collateral, the net worth of the borrower, or the personal worth of a guarantor is irrelevant to whether an advance is treated as non-performing. A fully secured account with a solvent promoter is still an NPA if the instalments have not come in.

Classification is borrower-wise, not facility-wise. Where a borrower holds more than one facility with the same lender, all facilities are treated as non-performing once one of them crosses the line. A single irregular working-capital account therefore taints an otherwise regular term loan with the same bank.

Does the ninety-day rule apply the same way to every facility?

It does not. The ninety-day period is the headline, but the trigger event differs by asset class.

For agricultural advances, the crop season is determined by the State Level Bankers' Committee for the area concerned, and a long-duration crop is one with a crop season longer than one year. Getting the wrong test applied to an agricultural account is a straightforward classification error and one that is easy to demonstrate on paper.

What does "out of order" mean for a cash credit account?

This is where most operating-account disputes live. RBI's clarificatory circular of 12 November 2021 restated the definition. An account is out of order if the outstanding balance remains continuously in excess of the sanctioned limit or drawing power for ninety days, or, where the outstanding balance is within the sanctioned limit or drawing power, if there have been no credits continuously for ninety days or the credits during the preceding ninety-day period are not enough to cover the interest debited during that period.

The second limb is the one that surprises borrowers. An account that has never exceeded its limit can still be classified as non-performing purely because routed turnover has fallen below the interest burden.

When does drawing power turn an operating account into an NPA?

Drawing power is meant to be computed on the value of current assets actually available. The IRACP norms treat outstandings based on drawing power calculated from stock statements older than three months as irregular, and a working-capital account becomes non-performing if such irregular drawings are permitted for a continuous period of ninety days — even where the unit is working and the borrower's financial position is otherwise satisfactory. Separately, where regular or ad hoc limits are not reviewed or renewed within one hundred and eighty days from the due date or the date of ad hoc sanction, the account is treated as non-performing.

But the same norms caution against treating an advance as non-performing merely because of deficiencies that are temporary in nature, such as the non-availability of adequate drawing power on the latest stock statement, a temporary excess over the limit, non-submission of stock statements, or non-renewal of limits on the due date. The distinction between a temporary deficiency and a continuous ninety-day irregularity is frequently the entire dispute.

When exactly does the classification clock run?

Before the 2021 clarification, the date on which an account "became" an NPA was often a matter of when the lender's recovery department got to the file. That discretion has been removed.

RBI now requires lending institutions to flag borrower accounts as overdue as part of their day-end processes for the due date, irrespective of when those processes are run. Classification as a Special Mention Account (SMA) and as an NPA must likewise be carried out as part of the day-end process for the relevant date, and the SMA or NPA classification date is the calendar date for which that day-end process was run. The classification therefore reflects the position at the end of that calendar day and cannot be back-dated or advanced to suit the lender's file.

Note that the SMA sub-classification for a revolving facility is keyed to the outstanding remaining continuously in excess of the sanctioned limit or drawing power, whereas non-performing status for the same facility turns on the wider "out of order" test set out above. The two tests are not interchangeable, and conflating them is itself a source of error.

The regulator's own worked illustration is the cleanest way to see the mechanics. Take an instalment due on 31 March. If the full dues are not received before the day-end process is run on 31 March, the date of overdue is 31 March, and the account enters the SMA-0 band. If the default continues, the account is tagged SMA-1 at the day-end process on 30 April, SMA-2 at the day-end process on 30 May, and is classified as an NPA at the day-end process on 29 June.

That sequence is worth reconciling against the lender's own statement of account in every matter. If the bank asserts an NPA date that does not sit on the ninetieth day from a demonstrable overdue date, either there is an earlier overdue event the borrower has not accounted for, or the classification is wrong.

How are NPAs sub-classified into substandard, doubtful and loss?

Sub-classification determines the lender's provisioning cost and, in turn, its appetite for settlement.

• Substandard: an asset that has remained non-performing for a period of twelve months or less.
• Doubtful: an asset that has remained in the substandard category for twelve months. It is graded D1 for up to one year in the doubtful category, D2 for one to three years, and D3 beyond three years.
• Loss asset: an asset where loss has been identified by the bank, by its internal or external auditors, or by RBI inspection, but the amount has not been written off wholly.

Provisioning tracks the grade. A substandard advance attracts a general provision of fifteen per cent of the total outstanding, computed without allowance for the security available; an unsecured exposure identified as substandard attracts a further ten per cent, taking it to twenty-five per cent. For doubtful assets, the unsecured portion attracts a hundred per cent provision, while the secured portion attracts twenty-five per cent in D1, forty per cent in D2 and a hundred per cent in D3. Loss assets are provided for in full.

Two shortcuts also exist. Where the realisable value of the security is less than fifty per cent of the value assessed at the time of the last inspection, the account may be classified straight to doubtful; where the realisable value is less than ten per cent of the outstanding, it may go directly to loss. A borrower disputing a sub-classification jump should ask which valuation the lender relied on and when it was carried out.

What makes a classification wrongful?

A classification is wrongful when it does not follow from the record of recovery applied through the correct test. In practice, the recurring categories are these.

Funds in transit and value-dating. A payment made before the cut-off but credited with a later value date can push an account across the ninety-day line on paper while the borrower has in fact paid on time. Cheque realisation dates, NEFT and RTGS timestamps, and the lender's own value-dating convention need to be reconciled against the day-end position on the critical date.

Wrongful appropriation of payments. Where a credit is appropriated towards charges, penal amounts or a different facility instead of the overdue instalment, the instalment stays overdue and the clock keeps running. Appropriation is governed by Sections 59 to 61 of the Indian Contract Act 1872: where the debtor expressly intimates that a payment is to be applied to a particular debt, the creditor must apply it accordingly. A borrower who has recorded the intended appropriation in writing has a materially stronger case than one who has not.

Disputed debits and penal charges. Unilateral charges, wrongly compounded interest, or inspection and processing debits that were never contractually agreed can be the sole reason an account shows arrears. RBI's directions on penal charges in loan accounts require that a breach of material terms be recovered as a penal charge and not as penal interest added to the rate of interest, and that penal charges not be capitalised — no further interest is to be computed on them. Interest computed on capitalised penal charges is an identifiable, quantifiable error.

Drawing power computed on stale or incorrect figures. As set out above, drawing power built on outdated stock statements, unreconciled book debts, or margins other than those sanctioned can create an artificial excess. The remedy is a facility-level reconstruction of drawing power for each month in issue.

A restructuring or moratorium that was never given effect. Where a sanctioned restructuring, a revised repayment schedule, or a resolution plan has been approved but the core banking system continues to run the original schedule, arrears accumulate against a schedule that no longer governs.

Pure technical and system error. Wrong due date fields, holiday adjustments, a mis-keyed instalment amount, or a mapping error between facilities are more common than borrowers assume, and are usually visible on a careful reading of the statement of account rather than in correspondence.

Facilities that ought not to have been classified at all. Advances against term deposits, National Savings Certificates eligible for surrender, Kisan Vikas Patras, Indira Vikas Patras and life policies need not be treated as non-performing where adequate margin is available in the account. A credit facility backed by a guarantee of the Central Government, though overdue, is treated as non-performing only when the Government repudiates its guarantee on invocation — and that relaxation operates for asset classification and provisioning, while income recognition norms continue to apply. A State Government guaranteed advance, by contrast, follows the ordinary overdue test. Misclassification of an exempt facility is a clean point.

What follows from the classification, and why the date matters

The NPA tag is not merely an accounting entry. Four consequences flow from it.

SARFAESI eligibility. Section 13(2) of the SARFAESI Act permits a secured creditor to issue a demand notice only where the borrower has defaulted and the account has been classified as a non-performing asset. Section 2(1)(o) defines a non-performing asset by reference to the classification directions issued by the authority regulating the lender, or, in other cases, by the RBI. The Supreme Court in Keshavlal Khemchand and Sons Private Limited v. Union of India upheld that definition and confirmed that the lender must classify in accordance with the guidelines applicable to it. An account not validly classified is an account against which the Section 13 machinery has not been lawfully engaged. For the wider enforcement sequence, see the SARFAESI Act guide.

Credit-bureau reporting. Credit institutions report account status to credit information companies under the Credit Information Companies (Regulation) Act 2005. A substandard or doubtful tag on a credit information report follows the borrower and its promoters into every subsequent credit assessment. Reporting has moved to a fortnightly cycle, so an erroneous tag propagates quickly and a correction has to be pursued with equal speed.

Wilful defaulter and large defaulter processes. RBI's directions on the treatment of wilful defaulters and large defaulters build on the classification: the examination of an account for wilful default is tied to its non-performing status, and a large defaulter is identified by reference to a doubtful or loss classification above a monetary threshold. A wrong classification can therefore seed a reputational consequence far heavier than the arrears themselves.

Income recognition and provisioning. For the lender, classification stops accrual-based interest recognition, requires reversal of unrealised interest already credited, and imposes the provisioning cost set out above. This is why lenders resist re-dating: the correction has a balance-sheet effect.

By contrast, an application under Section 7 of the Insolvency and Bankruptcy Code turns on default above the prescribed threshold and does not require an NPA classification at all — a distinction worth keeping in view when assessing which route a lender is likely to take. The IBC guide sets out that framework.

Where can a borrower challenge a wrongful classification?

The representation under Section 13(3A)

Once a demand notice under Section 13(2) is received, the borrower may make a representation or raise objections within the sixty-day notice period. Section 13(3A) requires the secured creditor to consider that representation and, where it concludes that the representation or objection is not acceptable or tenable, to communicate the reasons for non-acceptance within fifteen days of receipt. The sub-section also provides that such communication of reasons does not by itself confer a right to approach the Tribunal under Section 17. The provision was inserted following the Supreme Court's decision in Mardia Chemicals Limited v. Union of India, and it is the correct place to put the classification challenge on record with the supporting reconciliation. A challenge first articulated at the Tribunal, months later, invites the question of why it was not raised when the statute provided the opportunity.

The application to the DRT under Section 17

The adjudicatory remedy is an application to the Debt Recovery Tribunal under Section 17 of the SARFAESI Act, which must be filed within forty-five days from the date on which the measure under Section 13(4) was taken. If the Tribunal finds that the measures taken are not in accordance with the Act and the Rules, it may declare the recourse invalid and restore possession or management to the borrower. Whether the account was validly classified in accordance with RBI's directions is squarely within that enquiry. The jurisdictions page sets out the tribunals in which these applications are filed.

The appeal to the DRAT under Section 18

An appeal from the Tribunal's order under Section 17 lies to the Debt Recovery Appellate Tribunal under Section 18, within thirty days from the date of receipt of the Tribunal's order. The appeal is not entertained unless the borrower deposits fifty per cent of the amount of debt due as claimed by the secured creditor or determined by the Tribunal, whichever is less, which the Appellate Tribunal may reduce for reasons recorded in writing to not less than twenty-five per cent. The pre-deposit is the single largest practical constraint on a borrower's appellate strategy, and it is a reason to build the classification record fully at first instance.

Writ jurisdiction under Article 226

High Courts have consistently declined to entertain writ petitions where the statutory remedy under the SARFAESI framework is available. United Bank of India v. Satyawati Tondon and Authorised Officer, State Bank of Travancore v. Mathew K.C. are the authorities usually cited for that position. Writ relief remains available in narrow situations — a manifest jurisdictional defect, or a gross breach of natural justice — but a classification dispute that turns on figures in a statement of account is, by its nature, a matter for the Tribunal.

Credit-reporting grievances

A challenge to the classification and a challenge to what has been reported are separate exercises. Correction of a credit information report is pursued with the credit institution and the credit information company under the dispute mechanism prescribed by RBI, with escalation to the RBI Ombudsman where the grievance is not resolved within the prescribed period. A compensation framework applies to delayed resolution. Where a Tribunal sets aside the classification, the consequential correction of the report should be sought expressly rather than assumed.

The civil court is barred

Section 34 of the SARFAESI Act bars civil courts from entertaining any suit or proceeding in respect of a matter which a Debt Recovery Tribunal or the Appellate Tribunal is empowered to determine. Filing a declaratory suit challenging the classification is, in most fact patterns, a wasted step.

A checklist for building the record before you challenge

The classification argument is won on documents, assembled in this order.

• The sanction letter and every subsequent amendment, restructuring sanction, or revised repayment schedule.
• A complete, machine-readable statement of account for the full period, not merely the disputed months.
• A month-wise reconstruction of drawing power against the stock and book-debt statements actually submitted, with submission dates.
• Proof of every payment with instrument date, value date and the borrower's written appropriation instruction, if any.
• A line-by-line schedule of disputed debits, separating contractual interest, penal charges, and any interest computed on penal charges.
• The lender's asserted NPA date, and the day-end sequence that would have to be true for that date to be correct.
• The Section 13(2) notice, the Section 13(3A) representation, and the lender's reasoned reply.
• The current credit information report, to record what has been reported and from when.

Can an account be upgraded back to standard?

Only on full payment. RBI's clarification of 12 November 2021 provides that a loan account classified as a non-performing asset may be upgraded as a standard asset only if the entire arrears of interest and principal are paid by the borrower. Clearing the specific instalments that triggered the classification, or servicing interest alone, does not restore standard status. Accounts upgraded following a restructuring are subject to their own conditions under the applicable resolution framework.

For borrowers, that rule has a strategic consequence: a settled classification is expensive to unwind by payment, which increases the value of getting the classification right at the outset. For lenders, it reinforces why the day-end discipline and the audit trail behind the classification date have to be sound. Institutional lenders reviewing their own enforcement readiness may find the institutional counsel page and the NPA resolution and debt recovery practice notes useful. Defined terms used above are collected in the legal glossary.

This article is general information on the law as it stands and is not legal advice; the position in any particular account depends on its own documents and figures. Queries can be directed through the contact page.