The Bombay High Court has issued a significant interim observation affirming that co-operative banks must adhere to the RBI’s structured revival framework before initiating coercive recovery against Micro, Small and Medium Enterprises. This ruling reinforces statutory safeguards under the MSME Act and sets a critical precedent for lenders seeking to enforce dues against protected borrowers.
Background & Facts
The Dispute
The petitioner, Juliuscessor Chamban Vareed, is the proprietor of a Micro, Small and Medium Enterprise (MSME) registered under the Micro, Small and Medium Enterprises Development Act, 2006 (MSME Act). The respondent bank, TJSB Sahakari Bank Limited, initiated recovery proceedings against the petitioner’s loan account, which totaled Rs.77.50 lakhs, without first referring the account to the Committee for Revival and Rehabilitation constituted under the Reserve Bank of India’s Framework dated 17.03.2016.
Procedural History
- The petitioner filed a writ petition under Article 226 of the Constitution challenging the bank’s unilateral recovery actions.
- The bank had already initiated arbitration under the Multi-State Co-operative Societies Act, 2002, and proceeded to sell movable and immovable assets of the petitioner.
- The petitioner contended that these actions violated the mandatory pre-recovery protocol under the MSME Act and RBI’s Notification dated 29.05.2015.
Relief Sought
The petitioner sought an immediate stay on all recovery, arbitration, and asset sale proceedings until the bank complied with the RBI’s Framework for Revival and Rehabilitation of MSMEs. The petitioner also sought a declaration that non-compliance with the Framework renders any recovery action illegal.
The Legal Issue
The central question was whether Section 19 of the MSME Act and the RBI’s Framework for Revival and Rehabilitation impose a mandatory obligation on co-operative banks to refer MSME loan accounts for restructuring before initiating coercive recovery measures.
Arguments Presented
For the Petitioner
The petitioner relied on Section 19 of the MSME Act, which empowers the Central Government to issue notifications for the protection of MSMEs, and the RBI’s Notification dated 29.05.2015, which mandates that lenders identify incipient stress and refer accounts to a dedicated committee before taking coercive steps. The petitioner argued that the Framework explicitly applies to all lenders, including co-operative banks, as it defines eligibility based on loan size (up to Rs.25 crores), not bank type. The petitioner cited State of Maharashtra v. M/s. R. S. Enterprises to underscore that statutory protections for MSMEs must be interpreted liberally.
For the Respondent
The Reserve Bank of India (RBI) contended that the Framework was designed only for scheduled commercial banks and did not extend to co-operative banks, which are governed by separate regulatory regimes under the Multi-State Co-operative Societies Act. The bank argued that the Framework lacked explicit language binding co-operative institutions and that imposing such obligations would disrupt their operational autonomy.
The Court's Analysis
The Court examined the language of the RBI’s Framework and the enabling provisions of the MSME Act. It noted that the Framework defines eligible borrowers by loan amount and enterprise classification, not by lender type. The Court observed that the RBI’s intent, as reflected in the 2016 Framework, was to create a uniform mechanism for early intervention across all lending institutions serving MSMEs.
"The eligibility criteria are based on the borrower’s status as an MSME and the quantum of credit extended, not on the nature of the lender. To exclude co-operative banks would defeat the very purpose of the statutory scheme."
The Court further held that Section 19 of the MSME Act authorizes the Central Government to issue notifications that bind all entities extending credit to MSMEs, regardless of their regulatory classification. The Court rejected the RBI’s argument that co-operative banks are exempt, noting that the RBI, as the apex banking regulator, has the authority to issue guidelines applicable to all credit institutions, including co-operatives, under the Banking Regulation Act, 1949.
The Court found a strong prima facie case that the bank’s failure to refer the account to the revival committee constituted a violation of statutory duty. The Court also noted that the petitioner’s assets had already been sold, raising serious concerns about irreparable harm.
The Verdict
The petitioner succeeded on the prima facie case. The Court held that co-operative banks are bound by the RBI’s Framework for Revival and Rehabilitation of MSMEs and must refer loan accounts for restructuring before initiating coercive action. The bank was directed not to proceed with arbitration until the next hearing, and the petitioner’s request for stay was granted conditionally.
What This Means For Similar Cases
Mandatory Referral Is Non-Negotiable
- Practitioners representing MSMEs must now assert that any lender, including co-operative banks, must refer stressed accounts to the RBI’s revival committee before initiating arbitration, attachment, or sale.
- Failure to do so renders recovery proceedings legally vulnerable to challenge under Article 226.
Statutory Protection Overrides Regulatory Distinctions
- The judgment clarifies that MSME protections under Section 19 override technical distinctions between bank types.
- Co-operative banks can no longer claim exemption from RBI’s MSME-specific guidelines on grounds of separate regulation.
Evidence of Incipient Stress Must Be Documented
- Lenders must maintain written records identifying incipient stress and demonstrating compliance with the Framework.
- In litigation, the burden now shifts to the lender to prove that the referral process was initiated before any coercive step was taken.
