A) Abstract / Headnote

This case examines whether the Notification dated 29 May 2015 issued under Section 9 of the Micro, Small and Medium Enterprises Development Act, 2006 (“MSMED Act”), as revised by RBI in 2016, mandating a “Framework for Revival and Rehabilitation of MSMEs,” holds a mandatory or directory nature. The appellants contested the classification of their loan accounts as NPAs without compliance with this Framework. The Supreme Court concluded that the Notification and related RBI Directions are mandatory, reversing the High Court’s decision. It emphasized that banks must implement the prescribed identification and categorization of stress in MSME accounts before declaring them NPAs. The MSMEs, however, bear the burden of substantiating their eligibility for the Framework’s benefits.

Keywords: MSME Act, NPA Classification, RBI Directions, Mandatory Compliance, Revival Framework

B) Case Details

• Judgment Cause Title: M/s Pro Knits v. The Board of Directors of Canara Bank & Ors.
• Case Number: Civil Appeal No. 8332 of 2024
• Judgment Date: 1 August 2024
• Court: Supreme Court of India
• Quorum: Hon’ble Ms. Justice Bela M. Trivedi and Hon’ble Mr. Justice R. Mahadevan
• Author: Justice Bela M. Trivedi
• Citation: [2024] 8 S.C.R. 140; 2024 INSC 565
• Legal Provisions Involved:
  • Micro, Small and Medium Enterprises Development Act, 2006: Sections 9, 10
  • The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act): Sections 13(2), 35
  • Banking Regulation Act, 1949: Sections 21, 35A
• Judgments Overruled: High Court judgment in WPL No. 20100 of 2023
• Case Related To: Banking Law, MSME Development, Corporate Finance, SARFAESI Law

C) Introduction and Background of Judgment

The case arose after appellants, registered as MSMEs under the MSMED Act, 2006, challenged actions by banks classifying their loan accounts as Non-Performing Assets (NPAs). The appellants alleged that the banks failed to adhere to the Framework for Revival and Rehabilitation of MSMEs, as notified by the Government of India and revised by the Reserve Bank of India (RBI). The Bombay High Court rejected their claim, ruling that the Framework was directory, not mandatory. This appeal before the Supreme Court focused on the statutory nature of the Framework.

D) Facts of the Case

1. The appellants were registered MSMEs engaged in manufacturing and business activities under the MSMED Act, 2006.
2. Their loan accounts were classified as NPAs by their creditor banks and NBFCs.
3. The appellants argued that the banks failed to comply with the Framework for Revival and Rehabilitation of MSMEs under the Notification dated 29 May 2015, issued under Section 9 of the MSMED Act and further detailed by the RBI’s 2016 Guidelines.
4. The appellants sought relief, arguing that the Framework’s provisions, such as early stress identification and categorization of accounts, were mandatory.
5. The Bombay High Court dismissed their writ petitions, stating the Framework was not binding without MSMEs’ proactive applications.

E) Legal Issues Raised

1. Is the Notification dated 29 May 2015, issued under the MSMED Act, 2006, mandatory for banks?
2. Do the directions issued by the RBI under Sections 21 and 35A of the Banking Regulation Act hold statutory force?
3. Did the banks violate procedural safeguards by classifying the appellants’ accounts as NPAs without complying with the Framework?

F) Petitioner/Appellant’s Arguments

1. The Framework for Revival and Rehabilitation of MSMEs under the MSMED Act was issued to promote and develop MSMEs. Non-compliance with its procedures renders subsequent NPA classifications invalid.
2. The RBI Guidelines of 2016, issued under Sections 21 and 35A of the Banking Regulation Act, 1949, supplemented the MSMED Act. These guidelines have statutory force and are binding on all banks.
3. The Framework necessitates early identification of stress in MSME accounts and categorization under the Special Mention Account (SMA) scheme before turning them into NPAs.
4. Non-compliance with the Framework violates principles of natural justice, as MSMEs are deprived of restructuring opportunities.
5. The SARFAESI Act cannot override the MSMED Act and related RBI guidelines unless explicitly stated.

G) Respondent’s Arguments

1. The SARFAESI Act grants banks the authority to classify accounts as NPAs and enforce security interests independently of the MSMED Act.
2. The Framework and RBI Directions are directory rather than mandatory, allowing banks discretion based on circumstances.
3. The appellants failed to proactively apply for the benefits under the Framework, absolving banks of compliance obligations.
4. The banks followed due process under the SARFAESI Act, including issuing notices and providing time for debt repayment.

H) Related Legal Provisions

1. Section 9, MSMED Act, 2006: Authorizes the government to issue guidelines to promote and develop MSMEs.
2. Section 21, Banking Regulation Act, 1949: Empowers RBI to regulate advances by banks.
3. Section 35A, Banking Regulation Act, 1949: Permits RBI to issue binding directions in the public interest.
4. Section 13, SARFAESI Act, 2002: Governs the enforcement of security interest by secured creditors.
5. Section 35, SARFAESI Act, 2002: States the Act’s provisions override other laws.

I) Judgment

a. Ratio Decidendi

1. Framework’s Mandatory Nature: The Court held that the Notification dated 29 May 2015 and subsequent RBI Directions of 2016 possess statutory force and are mandatory.
2. RBI’s Statutory Powers: Directions issued under Sections 21 and 35A of the Banking Regulation Act are binding on banks.
3. Pre-NPA Obligations: Banks must identify stress in MSME accounts and take corrective action before declaring them NPAs.

b. Obiter Dicta

The Court emphasized the shared responsibility of MSMEs to substantiate their eligibility and actively seek the Framework’s benefits.

c. Guidelines

1. Banks must establish mechanisms to detect and address stress in MSME accounts at the SMA stage.
2. MSMEs must proactively furnish documentation proving their eligibility for relief under the Framework.

J) Conclusion and Comments

The judgment strengthens protections for MSMEs while holding them accountable for proactive compliance. It reinforces the binding nature of government and RBI-issued guidelines on banks, promoting equitable finance practices.

References

1. Micro, Small and Medium Enterprises Development Act, 2006
2. Banking Regulation Act, 1949
3. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002