Prohibition of Foreclosure Charges on MSME Loans

Source: Orissa High Court 

Why in News? 

The bench of Dr. Justice Sanjeeb K Panigrahi in the case of Maa Tarini Poultries Pvt. Ltd. v. Indian Bank, Main Branch, Berhampur & Ors. (2025) held that the levy of foreclosure charges on MSME loans with floating interest rates is illegal, arbitrary, and contrary to binding RBI directives, and directed the immediate release of mortgaged property documents without insisting on such charges.

What was the Background of Maa Tarini Poultries Pvt. Ltd. v. Indian Bank and Ors. (2025) Case? 

• The petitioner, Maa Tarini Poultries Pvt. Ltd., was a registered MSME bearing Registration No. UDYAM-OD-11-0003310, engaged in the poultry sector. 
• In September 2020, the petitioner approached Indian Bank, Berhampur seeking financial assistance of Rs. 1.80 crores under the MSME Scheme for establishing an agro-based industrial unit. 
• In February 2022, Indian Bank sanctioned a loan of Rs. 1.80 crores comprising a Term Loan of Rs. 1.45 crore and a Cash Credit facility of Rs. 35 lakhs, subject to creation of equitable mortgage over the petitioner's immovable properties. 
• The petitioner alleged that bank officials coerced them to purchase an SBI Life Personal Insurance policy valued at Rs. 1.53 lakh per annum, and upon refusal, the bank dishonoured cheques and obstructed NEFT transactions during 2023. 
• On 22 May 2023, the petitioner's poultry farm suffered severe damage due to a Kala Baisakhi storm. Despite immediate approach to the bank for insurance claim processing, no effective steps were taken for over a year, causing grave financial strain. 
• Due to persistent difficulties, the petitioner approached HDFC Bank for loan takeover. After clearing all outstanding dues with Indian Bank through cheques dated 22 May 2024 and 26 May 2024, the loan was taken over by HDFC Bank on 26 May 2024. 
• Despite complete repayment and takeover, Indian Bank raised a demand for foreclosure charges at 4% of the outstanding amount, contrary to RBI guidelines prohibiting such charges on MSME floating-rate loans. 
• The bank refused to return the petitioner's original title deeds and property documents despite full loan repayment, including a residential property valued at approximately Rs. 2 crores and 5.9 acres of Garabari land near NH-16. 
• The petitioner approached the RBI Ombudsman on 4 July 2025 with Complaint No. N2025260030026, but the grievance remained unresolved as the mechanism did not provide for personal hearings. 
• With no efficacious remedy available through banking authorities, the petitioner filed a writ petition before the Orissa High Court.

What were the Court's Observations? 

• The Court observed that banking contracts operate within public regulatory norms, and when RBI prescribes protections for MSMEs, contractual terms inconsistent with such prescriptions cannot be enforced. 
• Relying on Central Bank of India v. Ravindra (2002), the Court held that RBI circulars are binding on commercial banks, and contractual terms cannot override RBI directives as per ICICI Bank v. Official Liquidator (2010). 
• The Court found that the substance of a charge, not its label, determines legality—disguised prepayment fees like "processing fee on prepayment" or "switchover charge" are illegal foreclosure charges. The bank's subsequent reduction from 4% to 2% cannot cure the original illegality. 
• Citing LIC of India v. Consumer Education & Research Centre (1995), the Court observed that unfair contract terms in "dotted line contracts" where weaker parties lack bargaining power can be struck down. 
• The Court held that foreclosure penalties constitute anti-competitive practices under Section 3 of the Competition Act, 2002, stifling competition and limiting consumer choice in the credit market. 
• The Court observed that even if the loan sanction contained foreclosure charge stipulations, such clauses would collide with binding RBI mandates under Sections 21 and 35A of the Banking Regulation Act, 1949, and stand ipso jure nullified. 
• The Court held that the bank's refusal to release original title deeds based on statutorily prohibited demands amounts to abuse of authority, violating Articles 14 and 300-A of the Constitution. 
• The Court directed Indian Bank to forthwith release the petitioner's property documents without insisting on foreclosure charges, and ordered filing of a compliance affidavit within one month. 

What are Foreclosure Charges? 

About: 

• Foreclosure charges, also known as prepayment penalties, are fees levied by banks when a borrower repays a loan before its scheduled maturity date. 
• These charges were historically justified as compensation to banks for loss of anticipated interest income from the remaining loan tenure. 
• Banks argued that when borrowers prepay loans, particularly to switch to competing lenders offering better rates, it disrupts their revenue projections and cash flow planning. 
• However, such charges operate as a deterrent to early repayment and loan refinancing, restricting borrower mobility and consumer choice in the credit market. 
• The levy of foreclosure charges has been progressively prohibited by RBI through various circulars to promote credit mobility and prevent anti-competitive practices. 

Statutory Framework Supporting MSME Protection: 

• Section 10 of the Micro, Small and Medium Enterprises Development Act, 2006 enjoins formulation of progressive credit policies for MSMEs in consonance with RBI guidelines to ensure timely and unhindered flow of credit. 
• Section 21 of the Banking Regulation Act, 1949 confers upon RBI the power to regulate lending and credit practices of banking companies, and Section 21(3) mandates that every banking company shall comply with all directions issued by RBI. 
• Section 35A of the Banking Regulation Act, 1949 gives RBI wider powers to intervene in banking operations in public interest. 
• The Banking Codes and Standard Board of India (BCSBI) has formulated a Code of Bank's Commitment to Micro and Small Enterprises prescribing minimum standards of fair and transparent banking practices. 

Anti-Competitive Nature of Foreclosure Charges: 

• Section 3(1) of the Competition Act, 2002 prohibits agreements which cause or are likely to cause an appreciable adverse effect on competition. 
• Under Section 3(3)(b), a presumption of anti-competitive effects arises where there is any practice resulting in limitation or control in provision of services. 
• Foreclosure penalties stifle competition by compelling borrowers to remain tied to particular institutions, imposing unwarranted restrictions on freedom of trade and consumer choice.