Bank beats MSME in priority fight: Supreme Court settles SARFAESI vs MSMED clash

The Naib Tehsildar looked at two recovery orders and said: "I can't give you the property. The small company's claim comes first." The bank disagreed.

On a January morning in 2023, the Supreme Court of India settled a clash that had paralysed a single piece of land in Dhar district, Madhya Pradesh. A bank held a mortgage. A small enterprise held an award. Each carried a piece of paper that said "pay me first." Only one could win.

The question was simple: when a bank and a small company both try to recover their dues from the same property, who gets paid first? The answer would decide not just this case, but thousands of similar disputes across the country.

The bank that came calling

Kotak Mahindra Bank lent money to a company called Mission Vivacare. As security, the borrower mortgaged two plots of land in Dhar district. The loan went bad. Mission Vivacare defaulted.

The bank did what any secured creditor does — it started recovery proceedings under the SARFAESI Act (the law that lets banks seize and sell assets of defaulting borrowers without going to court). It issued a demand notice under Section 13(2) of the SARFAESI Act, asking the debtor to pay up. When that failed, the bank approached the District Magistrate under Section 14 of the same Act — a provision that allows a bank to get government assistance to take physical possession of the mortgaged property. The District Magistrate allowed the application. The Sub-Divisional Magistrate was directed to hand over possession.

That should have been the end of it.

It was not.

The small company that got there first

Before the bank could take possession, another claimant appeared. Girnar Corrugators Pvt. Ltd., a micro, small or medium enterprise (MSME), had supplied goods to Mission Vivacare. The debtor hadn't paid. Girnar took its dispute to the MSME Facilitation Council under the MSMED Act (the law that protects small businesses from delayed payments by larger buyers).

The Facilitation Council passed an award in Girnar's favour in September 2014. Girnar then obtained recovery certificates against the same two plots of land that the bank had already mortgaged. Now two competing claims sat on the same property — one from a bank with a registered mortgage, one from a small company with a government award.

When the bank's officials arrived at the Naib Tehsildar's office in Dhar to execute the District Magistrate's possession order, the Tehsildar refused. The room smelled of old paper and ink. A dusty file lay open on the desk, its edges frayed. The Naib Tehsildar picked up a stamp pad, pressed it firmly onto the refusal order, and said: the MSMED Act overrides the SARFAESI Act. The small company's claim, he said, comes first.

Two laws, one question

The bank went to the High Court of Madhya Pradesh at Indore. A Single Judge sided with the bank, setting aside the Tehsildar's order. But the bank's victory was short-lived. The Division Bench reversed the Single Judge, holding that the MSMED Act — passed in 2006 — is a later enactment than the SARFAESI Act of 2002, and therefore prevails.

The bank appealed to the Supreme Court. The core legal question: which law's non-obstante clause (a clause that says "this law overrides other laws") wins?

The MSMED Act has Section 24, which gives an overriding effect to Sections 15 to 23 of that Act — the provisions dealing with delayed payments and recovery for MSMEs. The bank's counsel argued that this overriding effect covers the recovery mechanism, but does not create a priority for MSME debts over secured creditors. The SARFAESI Act, on the other hand, has Section 26E — inserted by a 2016 amendment — which expressly says that secured creditors get priority over all other debts.

The small company argued that the MSMED Act, being a special law for small enterprises, should prevail. The bank countered that Section 26E of the SARFAESI Act was enacted later than the MSMED Act, and its language was unambiguous: secured creditors come first.

Why the Supreme Court chose the bank

The Supreme Court bench — Justice M.R. Shah and Justice Krishna Murari — delivered its judgment on January 5, 2023. The courtroom fell silent as the judgment was read out. The red velvet of the bench seemed to absorb every sound. The court held that Section 26E of the SARFAESI Act, inserted by the 2016 amendment, expressly provides priority to secured creditors over all other debts. This provision has its own non-obstante clause — meaning it overrides other laws.

The court stated: "Section 26E of the SARFAESI Act, inserted by the 2016 amendment, expressly provides priority to secured creditors over all other debts." The court noted that the MSMED Act, while providing a recovery mechanism for small enterprises, does not contain any express provision giving MSME debts priority over secured creditors. Sections 15 to 23 of the MSMED Act deal with delayed payments and the procedure for recovery, but they do not say "this debt comes before a bank's mortgage." Section 24 gives those sections an overriding effect, but the court said this override does not extend to creating a priority that the law does not explicitly grant.

Since Section 26E of the SARFAESI Act was enacted in 2016 — ten years after the MSMED Act — and since it expressly legislates on the subject of priority, the later law prevails. The court also clarified that there is no real conflict between the two laws: the MSMED Act provides a recovery mechanism, while the SARFAESI Act provides a priority rule. They operate on different planes.

The court also addressed a procedural point: under Section 14 of the SARFAESI Act, the District Magistrate's role is limited to assisting the bank in taking possession. The DM cannot adjudicate disputes between the bank and third parties like the MSME. If the small company was aggrieved, its remedy lay under Section 17 of the SARFAESI Act — an appeal to the Debt Recovery Tribunal (DRT).

The dusty file in Dhar

Back in the Naib Tehsildar's office, the file had grown thicker. The bank's mortgage deed — a yellowing document with a faded seal — sat on one side. The MSME's recovery certificate, crisp and new, lay on the other. For three years, the file had gathered dust as the case wound its way through the courts. The Naib Tehsildar's initial refusal, stamped in blue ink, remained the first page. Now the Supreme Court had written the last.

What this means for lenders and small businesses

The judgment restores the Single Judge's order: the bank's recovery under the SARFAESI Act prevails over the MSME's recovery under the MSMED Act. The Naib Tehsildar's refusal was wrong. But the court did not leave the small company without a remedy — it said Girnar could still approach the DRT under Section 17 of the SARFAESI Act to challenge the bank's possession or claim its share of the sale proceeds.

THE PLAY: An MSME holding a recovery certificate against a debtor should check whether the debtor's assets are already mortgaged to a secured creditor — if they are, the MSME must approach the Debt Recovery Tribunal under Section 17 of the SARFAESI Act to assert its claim, because the bank's mortgage will otherwise get paid first.

The court ended where it began: with two pieces of paper and a single piece of land. The bank's mortgage won. The small company's award did not. For thousands of small businesses across India, the message is clear: winning an award from the Facilitation Council is not enough. If the debtor's assets are already mortgaged to a bank, the MSME must either challenge the bank's claim before the DRT or find other assets to attach.