Karnataka High Court dismisses challenge to 2025 Ordinance against coercive loan recoveries

The Karnataka High Court on Monday dismissed a petition questioning the constitutional validity of the Karnataka Micro Loan and Small Loan (Prevention of Coercive Actions) Ordinance, 2025 [Karnataka Hire Purchase Association v. State of Karnataka and ors]..The ordinance, which took effect last month, is aimed at protecting economically vulnerable or poor people from coercive loan recovery practices.Justice M Nagaprasanna had earlier noted that the prime concern raised by the petitioner appeared to be whether the ordinance would apply to lenders other than micro-finance institutions (MFI).The judge clarified in the judgment pronounced today that the ordinance only applies to transactions involving unsecured microfinance loans. It would not apply to transactions with non-MFI lenders, the Court has ruled. "The Ordinance does not traverse into the realm of secured transactions undertaken by the regulated entities like the petitioner, on the contrary, it carves out a protective shield specifically for those trapped in the labyrinth or unsecured micro loans extended without collateral, targeting an annual income of Rs.3 lakhs or less, which is clearly defined by the Reserve Bank of India, as quoted supra. Therefore, the Ordinance has taken birth from the womb of social justice, it nowhere depicts arbitrariness. The grievance of the petitioner is, on the face of it, imaginary and unacceptable. The issue is thus answered against the petitioner," its judgment reads. .The Court concluded that the ordinance did not suffer from any manifest arbitrariness that required it to be struck down as unconstitutional. "Courts must always be loathe to strike down a measure of this kind, unless compelled by an egregious violation of constitutional mandates, I find none. The petition wanting in merit should necessarily meet its dismissal. It accordingly meets. The petition stands dismissed," the Court ruled. .The ordinance in focus prohibits collateral-based microfinance loans and requires lenders engaged in such transactions to release securities already taken from borrowers. Among other provisions, it also discharges 'vulnerable' borrowers from loans taken before the ordinance came into force if the loans were given by unregistered or unlicensed micro-finance institutions/lenders.However, the Karnataka Hire Purchase Association - an association representing motor vehicle/asset financiers - had argued that the ordinance failed to properly distinguish between predatory creditors and law-abiding lenders. They highlighted that their business of motor vehicle or asset financing differs from conventional money lending as it helps in asset creation for borrowers and contributes to economic growth and financial inclusion.The association, therefore, filed a writ petition challenging the constitutionality of the 2025 ordinance on apprehensions that hire-purchase lenders too were hit by this ordinance. Representing the association, Senior Advocate Udaya Holla argued that terms such as "borrower" or "lender" to whom the ordinance is applicable have been defined without any application of mind.."Vulnerable" borrowers have been defined without any income criteria, which could lead to the misuse of the ordinance, the petition added.The ordinance would undermine existing contractual obligations and set a bad precedent, as borrowers may default on obligations anticipating similar relief measures in future, the plea further stated.It would affect the financiers' freedom of trade and rights to property, the plea added.The petitioner, therefore, urged the High Court to either strike down the ordinance as arbitrary and unconstitutional or to clarify that motor vehicle or asset financing businesses are outside its purview..Advocate General (AG) for Karnataka Shashi Kiran Shetty, however, countered that the ordinance is only meant to protect vulnerable borrowers who borrow microfinance loans. He contended that the petitioner-association is not affected by it at all..The Court today agreed with the AG's stance. It acknowledged that the term "microfinance loan" has not been expressly defined in the ordinance, nor has any income criteria been fixed for "borrowers" to whom the ordinance would apply. However, it pointed out that the Reserve Bank of India (RBI) has issued circulars to define a microfinance loan as a "collateral free loan given to a household having annual household income up to ₹3,00,000/- or less."The RBI's circular, which has the force of law, is sufficient to take care of the petitioner's concerns over whether it is covered by the ordinance, the Court said. "The petitioner does not come within the ambit of the Ordinance. It is still permitted to run its business in terms of other legislations. There is no impediment, in the subject Ordinance, for the petitioner to make a hue and cry that all securities would stand released in favour of the borrower. The borrower is defined; microfinance is defined and vulnerable sections are defined. Therefore, it is unequivocal that it is applicable only to microfinance lending institutions for protection of borrowers who are from the vulnerable sections of the society," the Court added. .The Karnataka Hire Purchase Association was also represented by Advocate Sanjay Sethiya, Founder and Managing Partner of Law Square and Advocate Akshatha Prasad MD, Senior Associate at Law Square..[Read Judgment].Follow Bar and Bench channel on WhatsAppDownload the Bar and Bench Mobile app for instant access to the latest legal news.