Bank vs MSME: Who gets paid first when a borrower defaults?

A bank had a mortgage. A small supplier had an award. Both wanted the same land. The local officer said: MSME first. The Supreme Court just said — no.

Two plots of land in Dhar, Madhya Pradesh. Two laws. One borrower who defaulted on both a bank loan and a payment to a small supplier. The question that landed before the Supreme Court was deceptively simple: when a company owes money to both a bank and a small business, and there is only one piece of land to sell, who gets paid first?

When the bank moved first

Kotak Mahindra Bank had lent money to a company called Mission Vivacare. As security, the borrower mortgaged two plots of land in Dhar. When Mission Vivacare stopped paying, the bank did what any secured creditor does — it sent a demand notice under Section 13(2) of the SARFAESI Act (the law that lets banks seize and sell assets of defaulting borrowers without going to court). When the borrower did not pay, the bank approached the District Magistrate under Section 14 of the same Act, asking for help to take physical possession of the mortgaged land. The District Magistrate allowed the application on September 24, 2014. The local Sub-Divisional Magistrate was directed to hand over possession to the bank.

That should have been the end of it. But the land had another claimant.

The small supplier with a different law

Girnar Corrugators, a small enterprise registered under the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act), had supplied goods to Mission Vivacare and had not been paid. It approached a Facilitation Council — a body set up under the MSMED Act to resolve payment disputes involving small businesses — and won an award on September 11, 2014. The Council directed Mission Vivacare to pay. When the company did not, Girnar Corrugators obtained recovery certificates against the same two plots of land.

Now the Naib Tehsildar — the local revenue officer who was supposed to execute the bank's possession order — had a problem. Two different laws were pointing at the same land. On March 21, 2016, he sat at his desk, looked at the bank's possession order and the MSMED recovery certificate, and wrote his refusal. The paper felt thin in his hands — two legal worlds, each claiming the same patch of earth. He refused to hand over possession to the bank, saying the MSMED Act recovery had priority because it was a later law.

Why the local officer said MSME first

The Naib Tehsildar's reasoning was not random. The MSMED Act contains Section 24, a non-obstante clause (a provision that says "this law overrides other laws"). It states that Sections 15 to 23 of the MSMED Act — the sections dealing with delayed payments, the Facilitation Council, and recovery — shall have effect notwithstanding anything inconsistent in any other law. The officer read this to mean that once a Facilitation Council award was issued, the MSMED Act recovery trumped everything else, including a bank's mortgage.

The bank disagreed. It went to the High Court of Madhya Pradesh at Indore.

The High Court's back-and-forth

A Single Judge of the High Court ruled for the bank. The Naib Tehsildar's order was set aside. The courtroom had the quiet hum of a working afternoon — the judge's voice clear as he read out the order restoring the bank's possession claim. But the bank's victory was short-lived. The Division Bench — a larger panel of two judges — reversed the Single Judge on August 11, 2017. It held that the MSMED Act, being a later enactment, prevailed over the SARFAESI Act. The bank's mortgage, the Division Bench said, had to wait until the small supplier was paid.

Kotak Mahindra Bank appealed to the Supreme Court.

The missing word: priority

At the Supreme Court, the argument turned on a single concept that the MSMED Act did not contain. The MSMED Act gives small businesses a mechanism to recover unpaid dues through a Facilitation Council. It has a non-obstante clause that overrides inconsistent laws. But it does not have a provision that says: "MSME dues shall be paid in priority over all other debts."

The SARFAESI Act, on the other hand, had gained such a provision in 2016. Section 26E was inserted by an amendment, and it states explicitly that debts due to secured creditors — banks and financial institutions holding a mortgage or charge on assets — shall be paid in priority over all other debts. This section also carries a non-obstante clause: it overrides anything inconsistent in any other law.

The question, then, was which non-obstante clause wins.

What the Supreme Court decided

The bench of Justice M.R. Shah and Justice Krishna Murari delivered the answer on January 5, 2023. The courtroom fell silent as the judgment was read — the rustle of pages, the weight of the file on the dais, the quiet breath of the lawyers waiting for the final word. The SARFAESI Act's Section 26E, they held, prevails over the MSMED Act's recovery mechanism. The reason was straightforward: Section 26E was inserted in 2016, while the MSMED Act's non-obstante clause in Section 24 dates back to 2006. When two laws have overriding clauses, the later one in time prevails — provided it is specific about priority.

The court noted that Section 26E of the SARFAESI Act is an express priority provision. It does not merely say "this law overrides other laws." It says secured creditors get paid first. The MSMED Act, by contrast, gives small businesses a recovery mechanism but does not give them priority over secured creditors. A Facilitation Council award does not automatically rank above a bank's mortgage.

The court also clarified the role of the District Magistrate under Section 14 of the SARFAESI Act. The District Magistrate, the court said, has no jurisdiction to adjudicate disputes between the secured creditor and the debtor. Their job is limited to assisting the bank in taking possession. If anyone is aggrieved by the bank's action, they must approach the Debts Recovery Tribunal under Section 17 of the SARFAESI Act — not resist the possession order through the revenue officer.

The court observed: "The priority conferred under Section 26E of the SARFAESI Act, which contains a non-obstante clause expressly providing that debts due to secured creditors shall be paid in priority over all other debts, prevails over the recovery mechanism under Sections 15-23 of the MSMED Act, which does not contain any express provision for priority of MSME dues over secured creditor dues." The words hung in the air — a clear, legal hierarchy drawn on the page.

What this means for banks and small businesses

For banks, the judgment is a reassurance that their mortgage priority, introduced through the 2016 amendment to the SARFAESI Act, will be enforced even against statutory recovery claims under the MSMED Act. The security interest they hold is not easily displaced by a later award from a Facilitation Council.

For small businesses, the judgment is a limitation. The MSMED Act gives them a fast-track mechanism to recover dues — but it does not give them a priority claim over secured creditors. If the borrower's assets are already mortgaged to a bank, the small supplier stands behind the bank in the queue.

The practical takeaway for MSMEs is this: a Facilitation Council award is useful, but it does not leapfrog over a registered mortgage. If the borrower has pledged assets to a bank, the small business must look for unencumbered assets or other recovery routes.

THE PLAY: A Facilitation Council award under the MSMED Act does not override a bank's mortgage priority under Section 26E of the SARFAESI Act — secured creditors get paid first, regardless of which recovery proceeding started earlier.

The bank got the land. The small supplier got a lesson in priority.

[Civil Appeal No. 6662 of 2022, Kotak Mahindra Bank Limited v. Girnar Corrugators Pvt. Ltd. & Ors., decided on January 5, 2023 by Justice M.R. Shah and Justice Krishna Murari]