The Supreme Court of India, in a landmark judgment, ruled that the directions issued by the Central Government and the Reserve Bank of India (RBI) under the Micro, Small, and Medium Enterprises Development (MSMED) Act, 2006 and the Banking Regulation Act, 1949 have statutory force. This ruling has significant implications for banks, financial institutions, and MSMEs, reaffirming the mandatory nature of these directions and strengthening the legal framework for MSMEs.
The case concerned the enforceability of a notification dated May 29, 2015, issued by the Central Government. This notification introduced the "Framework for Revival and Rehabilitation of MSMEs" under Section 9 of the MSMED Act, which mandates procedures for the revival of stressed MSMEs. The appellants, identifying themselves as MSMEs, challenged the actions of banks and non-banking financial companies (NBFCs) that had declared their loan accounts as non-performing assets (NPAs) without adhering to the framework provided in the 2015 notification.
The appellants contended that the banks failed to identify stress at an early stage and did not pursue the prescribed resolution plans, as mandated by the notification. They argued that the banks were required to implement restructuring measures before declaring the loan accounts as NPAs. The respondents (banks and NBFCs), on the other hand, argued that provisions of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 would prevail over the MSMED Act in case of a conflict, and that the restructuring framework did not apply unless initiated by the MSMEs themselves.
The appellants claimed that the banks were obligated to follow the restructuring scheme under the 2015 notification, identifying stress early and implementing resolution plans before declaring the MSME loan accounts as NPAs. According to the appellants, this process was critical for the revival of MSMEs and the protection of their statutory rights under the MSMED Act.
The respondents countered that the SARFAESI Act, which deals with the recovery of secured assets, overrides the MSMED Act in such cases. They contended that the Bombay High Court had correctly ruled that the 2015 notification was not applicable to MSMEs unless the MSMEs themselves initiated the revival process.
The Supreme Court was tasked with determining whether the 2015 notification issued under Section 9 of the MSMED Act was mandatory or merely advisory. The Court analyzed provisions from both the MSMED Act and the Banking Regulation Act to assess the obligations imposed on banks.
Section 9(a) of the MSMED Act empowers the Central Government to issue guidelines for the promotion and development of specific industries, including MSMEs. The Court concluded that these guidelines are binding and must be followed by banks to ensure that MSMEs are identified early in the process of financial stress, and appropriate measures are taken for their revival.
Section 21 and Section 35-A of the Banking Regulation Act authorize the RBI to issue directions related to credit management and advances. The Court noted that these directions, including those related to MSMEs, are binding on all banks and financial institutions.
The Court held that the 2015 notification, as supplemented by subsequent RBI directions, constitutes a complete statutory framework for MSME revival. Banks are mandated to follow this framework by identifying stressed MSMEs and classifying them accordingly, preventing them from becoming NPAs.
Statutory Force of Directions: The Supreme Court held that directions issued by the Government under the MSMED Act and the RBI under the Banking Regulation Act carry statutory force, meaning they are legally binding, not merely advisory. Banks and financial institutions are now required to follow these directions when dealing with MSMEs.
Obligations of Banks and MSMEs: The judgment imposes mandatory obligations on banks to classify MSMEs as "stressed" at an early stage of financial distress. Banks are required to implement restructuring plans and provide timely credit relief to MSMEs, adhering to the 2015 notification and subsequent RBI guidelines. MSMEs, in turn, must comply with the processes outlined in these frameworks to ensure their financial recovery.
SARFAESI Act vs MSMED Act: While the SARFAESI Act provides mechanisms for banks to recover secured assets from defaulters, the Court ruled that it does not override the statutory rights of MSMEs under the MSMED Act and the Banking Regulation Act. This means that the revival and rehabilitation framework for MSMEs must be followed even when the SARFAESI Act is invoked by banks.
Banking Regulation and RBI's Role: The Court reiterated that the RBI’s power to issue binding directions under the Banking Regulation Act, especially concerning MSME credit management, is crucial for maintaining financial stability. The RBI’s role in regulating and supervising banks ensures that MSMEs receive the necessary financial support and that banks adhere to proper credit discipline.
The Supreme Court’s ruling affirms the statutory force of government and RBI directions issued under the MSMED Act and the Banking Regulation Act. This judgment is a critical development for MSMEs, ensuring that banks provide early intervention and restructuring opportunities, safeguarding the rights of small businesses. It also strengthens the regulatory framework, emphasizing that MSMEs are entitled to timely financial support and that banks must adhere to mandatory guidelines for their revival and rehabilitation