M/s. Pro Knits vs. The Board of Directors of Canara Bank [August 01, 2024]
Background
This Supreme Court case centered on the obligations of banks and Non-Banking Financial Companies (NBFCs) when dealing with loan accounts of Micro, Small, and Medium Enterprises (MSMEs) showing signs of financial stress. The dispute arose after Canara Bank classified M/s. Pro Knits’ loan account as a Non-Performing Asset (NPA) and initiated recovery proceedings under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) without first following the Framework for Revival and Rehabilitation of MSMEs, as mandated by a Central Government Notification dated May 29, 2015.
Key Legal Issues
Whether banks are mandated to follow the MSME Revival and Rehabilitation Framework before classifying MSME accounts as NPAs and taking coercive recovery measures.
Whether the directions under the MSMED Act and RBI circulars have statutory force, binding all banks and NBFCs.
Whether the obligation to initiate the MSME restructuring process is triggered only upon application by the MSME, or if banks must act proactively.
Supreme Court’s Ruling
Mandatory Compliance: The Supreme Court held that the Framework for Revival and Rehabilitation of MSMEs, as notified by the Central Government and reinforced by RBI directions, is mandatory and has statutory force. Banks and NBFCs must adhere to these procedures before classifying MSME accounts as NPAs or initiating action under the SARFAESI Act.
Proactive Duty of Banks: The Court clarified that banks cannot wait for MSMEs to apply for restructuring. Instead, banks are obligated to proactively identify financial stress in MSME accounts and initiate the prescribed revival and rehabilitation process on their own.
Setting Aside High Court Ruling: The Supreme Court overruled the High Court’s decision, which had previously held that banks were not required to follow the framework unless the MSME applied for it.
Mutual Responsibility: While banks have a mandatory duty to follow the framework, MSMEs must also be vigilant and cooperate by providing necessary documentation and participating in the process. If an MSME is negligent and allows enforcement to proceed to completion, it cannot later claim the benefit of the framework.
Conflict Between Acts: The judgment highlighted potential ambiguities and conflicts between the SARFAESI Act and the MSMED Act, noting the need for legislative clarity to harmonize the two frameworks for the benefit of both MSMEs and financial institutions.
Implications
The decision strengthens legal protections for MSMEs, ensuring that banks must follow a structured process for early identification and resolution of financial distress before resorting to harsh recovery measures.
It may impact the speed and approach of banks in handling stressed MSME accounts, requiring greater diligence and compliance with regulatory frameworks.
The judgment calls for further legislative action to resolve overlaps and ambiguities between the SARFAESI and MSMED Acts.
Conclusion
The Supreme Court’s ruling in M/s. Pro Knits v. The Board of Directors of Canara Bank marks a significant advance in MSME rights protection, mandating strict adherence by banks to revival and rehabilitation protocols before classifying accounts as NPAs or initiating recovery under SARFAESI. This ensures a fairer, more transparent process for MSMEs facing financial distress, while also emphasizing the need for both parties to act responsibly within the legal framework.
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