MSME Loan Restructuring and SARFAESI Act: Supreme Court Rules on Bank Obligations

The case of M/S. Pro Knits & Others v. The Board of Directors of Canara Bank & Others addresses a critical dispute concerning the restructuring of loans for Micro, Small, and Medium Enterprises (MSMEs) and the application of the SARFAESI Act by banks. The Supreme Court was tasked with deciding whether banks were obligated to follow the restructuring process under the 2015 MSME Notification before classifying an MSME loan as a Non-Performing Asset (NPA).

Several MSMEs challenged the classification of their loans as NPAs by various banks, arguing that banks should have followed the statutory framework for revival and rehabilitation before taking recovery actions under the SARFAESI Act. The Supreme Court ruled in favor of the MSMEs, stating that banks are bound to follow the MSME framework before initiating recovery proceedings.

Arguments Presented

Appellants’ Arguments

The MSMEs contended that:

• Banks cannot classify an MSME loan as an NPA without following the steps outlined in the 2015 Notification issued under the MSMED Act.
• The notification requires banks to identify stress in MSME accounts early and take corrective action before marking them as NPAs.
• By failing to follow this mandatory framework, banks violated statutory provisions and acted arbitrarily.

Respondents’ Arguments

The banks argued that:

• The SARFAESI Act overrides other laws, including the MSMED Act, when it comes to loan recovery.
• The MSME restructuring framework is not mandatory but only provides guidance.
• Since the MSMEs did not voluntarily apply for restructuring, the banks were not obligated to initiate the process.

Supreme Court’s Observations

The Supreme Court examined the MSMED Act, SARFAESI Act, and the Banking Regulation Act, concluding:

• Directions issued by the Reserve Bank of India (RBI) and the Central Government under the MSMED Act have statutory force.
• Banks are obligated to follow the MSME revival and rehabilitation framework before classifying an MSME loan as an NPA.
• The restructuring process must be initiated proactively by banks, and MSMEs should not have to apply separately.

Final Judgment

The Supreme Court:

• Set aside the High Court’s ruling that banks had no obligation to follow the MSME restructuring process.
• Declared that banks must implement the MSME framework before classifying an account as an NPA.
• Allowed MSMEs to pursue alternative legal remedies to recover damages where SARFAESI proceedings were already concluded.

This ruling reinforces the protection of MSMEs under statutory frameworks, ensuring that banks comply with due process before initiating harsh recovery measures.

Petitioner Name: M/S. Pro Knits & Others.
Respondent Name: The Board of Directors of Canara Bank & Others.
Judgment By: Justice Bela M. Trivedi, Justice R. Mahadevan.
Place Of Incident: India.
Judgment Date: 31-07-2024.

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