Recent Supreme Court Judgment Strengthens Position of MSMEs in Financial Distress: Analysis by Ayushi Parnami and Mohit Goyal

Supreme Court Judgment Strengthens Position of MSMEs in Financial Distress

In a recent landmark judgment, the Supreme Court ruled in favor of micro, small, and medium enterprises (MSME) facing financial distress, significantly enhancing their protection. The case, M/s Pro Knits v The Board of Directors of Canara Bank and Ors, has brought attention to the interaction between the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI act), and the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED act).

The Ministry of MSMEs issued a notification in 2015 under the MSMED act, requiring banks and creditors to identify accounts of MSMEs showing incipient stress and adopt rectification, restructuring, or recovery action plans before classifying them as non-performing assets (NPAs). However, in the case at hand, banks classified MSME accounts as NPAs without following the restructuring process outlined in the notification.

The Supreme Court’s decision overturned a previous ruling and emphasized the mandatory nature of the notification, ensuring fair asset classification and supporting MSME growth. However, the judgment also highlighted unresolved issues, particularly the conflict in hierarchy between the SARFAESI and MSMED acts.

The conflicting provisions of the two acts have created ambiguity regarding the precedence of the notification under the MSMED act over the SARFAESI act. The Supreme Court’s judgment in Kotak Mahindra Bank Limited v Girnar Corrugators Private Limited and Ors further complicates the matter by according precedence to the SARFAESI act.

The court’s allocation of roles in the mandatory restructuring process has caused uncertainty, as it places shared obligations on both banks and MSMEs. While banks are required to adhere to the framework, MSMEs must actively engage in the process and inform banks of their eligibility.

Overall, the judgment is seen as a positive step towards safeguarding the interests of MSMEs by early identification of financial distress. However, the lack of clarity in reconciling the interplay between the SARFAESI and MSMED acts calls for a more robust and consistent legal framework to effectively protect MSMEs without compromising the banking system’s efficacy.