Introduction

The Supreme Court of India, in the landmark case of M/S. PRO KNITS v. The Board of Directors of Canara Bank (2024 INSC 565), has reinforced the mandatory adherence of banks and Non-Banking Financial Companies (NBFCs) to the Framework for Revival and Rehabilitation of Micro, Small and Medium Enterprises (MSMEs). This case pivots on the conflict between the provisions of the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act) and the actions undertaken by financial institutions under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act).

The appellants, registered MSMEs under the MSMED Act, challenged the classification of their loan accounts as Non-Performing Assets (NPAs) by Canara Bank and other respondents without the mandatory restructuring process. The High Court had previously dismissed these writ petitions, asserting that banks were not obliged to adopt the restructuring framework unless explicitly requested by the MSMEs. However, the Supreme Court overturned this decision, establishing a new precedent.

Summary of the Judgment

The Supreme Court granted leave to the appellants to challenge the High Court's decision. The core issue revolved around whether the common order issued by the High Court was correct in stating that banks are not mandated to follow the restructuring framework unless MSMEs apply for it.

The apex court meticulously analyzed the interplay between the MSMED Act, RBI directives, and the SARFAESI Act. It concluded that the Instructions for the Framework for Revival and Rehabilitation, as notified by the Central Government and subsequently revised by the Reserve Bank of India (RBI), hold statutory force and are binding on all Scheduled Commercial Banks and NBFCs. Consequently, banks are obligated to identify incipient stress in MSME loan accounts and follow the prescribed restructuring process before classifying loans as NPAs and initiating enforcement proceedings under the SARFAESI Act.

As a result, the Supreme Court set aside the High Court's impugned order, thereby reinforcing the mandatory nature of the MSME Revival Framework.

Analysis

Precedents Cited

The judgment primarily draws upon the Banking Regulation Act, 1949, particularly Sections 21 and 35A, which empower the RBI to issue binding directions to banks regarding their advance policies. Although specific case precedents are not extensively cited, the judgment underscores the hierarchical supremacy of statutory directives over other legislative provisions. This aligns with the principle that sector-specific regulations, when framed under empowering statutes like the Banking Regulation Act and the MSMED Act, hold authoritative weight.

Legal Reasoning

The Supreme Court's legal reasoning is anchored in the statutory mandates provided by the MSMED Act and the Banking Regulation Act. Section 9 of the MSMED Act grants the Central Government the authority to issue guidelines for the promotion and development of MSMEs. The subsequent Framework for Revival and Rehabilitation, along with RBI's Master Directions, are construed as exercises of this authority.

Furthermore, Sections 21 and 35A of the Banking Regulation Act empower the RBI to dictate banking policies, including those related to credit advanced to specific sectors like MSMEs. The Court reasoned that these directives are not merely advisory but carry mandatory weight, superseding other legislative provisions in their ambit. Therefore, banks are legally bound to adhere to the Framework before taking punitive actions under the SARFAESI Act.

Impact

This judgment has far-reaching implications for the banking sector and the MSME landscape in India:

• For Banks/NBFCs: A clear mandate to implement the MSME Revival Framework diligently. Non-compliance could render their actions under the SARFAESI Act illegitimate.
• For MSMEs: Enhanced protection against arbitrary classification of loans as NPAs, ensuring they receive due opportunities for revival before facing enforcement actions.
• Legal Framework: Reinforces the precedence of sector-specific regulatory frameworks over general statutory provisions, emphasizing the need for banks to integrate such directives into their operational protocols.
• Future Litigation: Sets a precedent for MSMEs to challenge unauthorized actions by financial institutions, potentially leading to increased judicial scrutiny of bank-borrower relationships.

Complex Concepts Simplified

SARFAESI Act

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 empowers banks and financial institutions to enforce security interests without court intervention, following the classification of a loan account as an NPA. It aims to expedite the recovery process and reduce the burden on judicial systems.

MSMED Act

The Micro, Small and Medium Enterprises Development Act, 2006 provides a framework for the development and competitiveness of MSMEs in India. It grants the Central Government the authority to issue guidelines and frameworks to support MSMEs, including measures for their revival and rehabilitation.

Non-Performing Assets (NPA)

NPAs refer to loans or advances for which the principal or interest payment remains overdue for a specified period, typically 90 days. Classification as an NPA allows banks to initiate recovery actions, including legal proceedings under the SARFAESI Act.

Framework for Revival and Rehabilitation of MSMEs

This Framework, notified by the Central Government and revised by the RBI, outlines procedures for identifying incipient stress in MSME accounts and mandates the formation of committees to decide on corrective action plans. Its primary goal is to provide MSMEs with opportunities to rectify financial distress before their accounts are classified as NPAs.

Conclusion

The Supreme Court's decision in M/S. PRO KNITS v. Canara Bank marks a significant milestone in safeguarding the interests of MSMEs in India. By declaring the Framework for Revival and Rehabilitation of MSMEs as mandatory, the Court ensures that financial institutions adhere to a structured and fair process before classifying loans as NPAs and enforcing security interests. This not only strengthens the regulatory framework governing banking operations but also fosters a more supportive environment for the growth and sustainability of MSMEs.

Financial institutions must now integrate the MSME Revival Framework into their operational protocols, ensuring compliance with both the MSMED Act and the directives of the RBI. For MSMEs, this judgment provides an added layer of protection and recourse, promoting a balanced and equitable borrower-lender relationship. The ruling underscores the judiciary's role in upholding legislative intent and ensuring that sector-specific regulations are effectively implemented to achieve their intended outcomes.