Empowering MSMEs: Dispute Resolution through Arbitration under the MSMED Act, 2006

The MSME sector makes a significant amount of contribution to the economy by adding up to GDP and providing employment in the country. Often referred to as the “backbone” of the economy, these businesses are essential for encouraging innovation, entrepreneurship, and inclusive growth. However, MSMEs frequently dealt with issues including late payments and disagreements over contracts, which could impede their expansion and long-term viability. Therefore, the MSME Development Act of 2006 was introduced in recognition of the need to empower and safeguard this sector. The creation of a specific dispute resolution process under Section 18, which prioritied arbitration through the Micro and Small Enterprises Facilitation Council (MSEFC), is one of its main features. 

The MSME Act guarantees the efficient conduct of arbitration processes while upholding recognised legal norms by adopting the requirements of the Arbitration and Conciliation Act, 1996. Additionally, the Act’s protective objective is further enhanced by giving MSMEs a fair chance to settle disputes on favourable terms by giving MSEFC procedures preference over conflicting contractual constraints.  

For the benefit of Micro and Small Enterprises (MSEs), the MSMED Act includes a special dispute resolution procedure. The major characteristic of this framework and the legal standpoints with precedents are as follows: 

A. Reference to Facilitation Council (MSEFC)

The Section 18 of the MSME Act requires that any disagreements involving MSEs be submitted to the Micro and Small Enterprises Facilitation Council (MSEFC) [a council established to resolve disputes between buyers and suppliers of micro and small enterprises (MSMEs)]. One of the Council’s responsibilities is to assist in reaching a mutually agreeable resolution through conciliation or, if required, arbitration in a situation in case conflict persists. 

This requires State-Level Implementation as the MSME Act requires the creation of state-level Facilitation Councils. These Councils are in charge of carrying out the dispute resolution system and making sure that it is applied properly. Localised assistance for MSMEs is made possible by the decentralised structure, which also ensures consistency in the law. 

The Facilitation Council serves dual roles i.e. one as a conciliator, aiming for mutually agreeable resolution of conflict but if conflict persists then it also can act as an arbitrator and pass a binding decision/Award resolving the dispute of the Claimant.

B. Reference to ADR/Arbitration Institution

The Council after receiving the reference can itself conduct the conciliation and arbitration or refer the same/seek assistance of any Institution providing such ADR services for conducting conciliation and then arbitration to resolve the dispute.

Reference to Arbitration: If conciliation (under Section 18(2)) fails, the Council may initiate arbitration under Section 18(3) or refer the same to any Institution providing such ADR services i.e. Institutional Arbitration. The section clears that once the dispute is referred for arbitration then the provisions of the Arbitration and Conciliation Act 1996, shall then apply to the dispute as if the arbitration was in pursuance of an arbitration agreement as referred to section 7 of the Act.  

C. Dispute Resolution Process under MSMED Act vs. Contractual Arbitration Clauses

This has been much debated topic having conflicting decisions from over a decade though MSME Act makes it clear that being a special legislation it has overriding effect and this idea has been continuously maintained by judicial interpretations, yet when it came to invoking independent arbitration clauses in Purchase Orders or maintainability of MSEFC referred arbitration where such independent arbitration clause exists, the divergent views have existed but most judgements including the Hon’ble Supreme Court has affirmed precedence of MSME mechanism over independent arbitration clauses and affirmed the maintainability of such MSEFC referred arbitration. We can analyse the two views here-

I. The first view is that the MSEFC referred arbitration is not maintainable when the parties already entered into independent Arbitration Agreement where they clearly agree to resolve the dispute in certain manner (prior to dispute even arising). In M/s Steel Authority of India Ltd. v. The Micro, Small Enterprise Facilitation Council & Ors. (WRIT PETITION NO. 2145/2010), The High Court of Judicature at Bombay, Nagpur Bench held that the procedure for arbitration and conciliation is precisely the procedure under which all arbitration agreements are dealt with. We, thus find that it cannot be said that because Section 18 provides for a forum of arbitration an independent arbitration agreement entered into between the parties will cease to have effect. There is no question of an independent arbitration agreement ceasing to have any effect because the overriding clause only overrides things inconsistent therewith and there is no inconsistency between an arbitration conducted by the Council under Section 18 and arbitration conducted under an individual clause since both are governed by the provision of the Arbitration Act, 1996. This view was upheld by Division Bench judgement by Bombay High Court in case of Namco Industries Pvt. Ltd., Indore and Anr. v. State of Maharashtra & Ors. [WRIT PETITION NO.1901 of 2015].

II. Though the second view which proves precedence of MSME contends that MSMED Act 2006 is a special legislation and by virtue of section 18(4) of the Act, Notwithstanding anything contained in any other law for the time being in force, the Facilitation Council or MSEF Council under the Act has the jurisdiction to entertain complaints made by the supplier/service provider situated within its jurisdiction against the buyer located anywhere in the country. In M/s. Bharat Heavy Electricals Limited v. State of U.P. & Ors., [W.P.(C) No. 11535 of 2014], the Division Bench of the Hon’ble High Court of Judicature at Allahabad observed that though there may be an arbitration agreement between the parties, the provisions of Section 18 (4) specifically contain a non-obstante clause empowering the Facilitation Council to act as an Arbitrator. Moreover, section 24 of the Act states that sections 15 to 23 shall have effect notwithstanding anything inconsistent therewith contained in any other law for the time being in force. Furthermore, the Division Bench of Hon’ble High Court of Gujarat in Principal Chief Engineer v. Manibhai & Brothers [FA No.637/2016], after considering the sub-section (1) of Section 18 of the Act, 2006 held that the Facilitation Council has jurisdiction to act as Arbitrator and /or conciliator any dispute between the parties and that Council had only one of two courses of action open to it, either to conduct an arbitration itself or refer the parties to a centre or institution providing alternate dispute resolution services stipulated in Section 18(3) of the Act, 2006.

However, the entire controversy of this issue has been set to rest and the validity of section 18 of the MSMED Act,2006 was upheld by Hon’ble Supreme Court in SLP No. 017434/2017 in Re Manibhai case where the Hon’ble Apex Court held that the interpretation placed by the High Court on Section 18 of the Micro, Small and Medium Enterprises Development Act, 2006, in the impugned order, with reference to arbitration proceeding is fully justified and in consonance with the provisions thereof. Considering the verdict by Hon’ble Supreme Court, there is no doubt left as to the question of maintainability of arbitration proceedings referred by MSEFC even if there is separate arbitration agreement between the parties.

D. Time-Bound Resolution

The MSME Act places a strong emphasis on a time-bound resolution process in order to reduce the financial burden brought on by lengthy disputes. Therefore, the reference made to MSEFC, must be decided within ninety days of the dispute being reported to the MSEFC, according to Section 18(5) of the Act. Whereas this clause is often misunderstood as the time limit for even deciding the whole dispute/claim when such claim is referred to Institutional Arbitration which is not the case. Once the claim is referred to Institutional Arbitration under section 18(3) of the Act, it has to be decided in a speedy manner as provided in the Arbitration and Conciliation Act 1996 i.e. twelve months. In case of Driplex Water Engineering Pvt. Ltd v. Micro and Small Enterprises Facilitation Council & Ors. [W.P. (C) No. 9060/2015], the Hon’ble Delhi High Court clarified this position of section 18(5) of the act holding that Section 18(5) of the Act mandates the Council to decide the references made to it by Micro and Small Enterprises within a period of 90 days only.

D. Liability of Buyer for Delayed Payments

The section 15 of MSMED Act clearly states that the liability of the buyer to make payment to the supplier starts on the date agreed for such payment in case there is no written agreement for the same. But even if there is written agreement then in such agreement, the payment period agreed upon between the supplier and the buyer in writing shall not exceed forty-five days from the date of acceptance or the day of deemed acceptance of such goods or services.

E. Interest on such delayed payments

The section 16 of the MSMED Act provides for Interest on such delayed payments as provided for in section 15. It is clear from Section 16 of the Act, in case the buyer does not make payment within the period specified under Section 15, the buyer is liable to pay compound interest with monthly rests to the supplier on that amount from the appointed day or, as the case may be, from the date immediately following the date agreed upon, at three times of the bank rate notified by the Reserve Bank. 

F. MSMED Act being Special legislation and Overriding effect vis a vis the Arbitration & Conciliation Act:

The section 24 of the MSME Act makes it clear that these provisions of MSMED Act would have overriding effect. Section 24 of the MSME Act reads as “Overriding effect -The provisions of sections 15 to 23 shall have effect notwithstanding anything inconsistent therewith contained in any other law for the time being in force.”

This clears that the requirements of the MSME Act, especially those found in section 15 to Section 23, will take precedence even if a case is sent to arbitration. This guarantees that existing arbitration agreements or other regulations cannot circumvent or weaken the legislative protections and expedited resolution procedures for MSMEs, thereby fully protecting their rights and interests. In Gujarat State Civil Supplies Corporation Ltd. v. Mahakali Foods Pvt. Ltd. (2023) 6 SCC 401, the Hon’ble Supreme Court held that the Arbitration Act, 1996 in general governs the law of Arbitration and Conciliation, whereas the MSMED Act, 2006 governs specific nature of disputes arising between specific categories of persons, to be resolved by following a specific process through a specific forum. The MSMED Act, 2006 being a special law and Arbitration Act, 1996 being a general law, the provisions of MSMED Act would have precedence over or prevail over the Arbitration Act, 1996. 

Similar was held in the case of Silpi Industries v. Kerala SRTC (2021) 18 SCC 790, where the Court had observed while considering the issue with regard to the maintainability and counter claim in arbitration proceedings initiated as per Section 18(3) of the MSMED Act, 2006 that the MSMED Act, 2006 being a special legislation to protect MSME’s by setting out a statutory mechanism for the payment of interest on delayed payments, the said Act would override the provisions of the Arbitration Act, 1996 which is a general legislation. Hence, it is clear from the judicial pronouncements as well that MSME act being a special legislation to protect the interest of small businesses will have an overriding effect over any other provision including Arbitration and Conciliation Act, 1996. 

G. Interest u/s 16 MSMED Act vs. Interest u/s 31 of the Arbitration and Conciliation Act 1996

This is a significant legal issue since the interest under both the acts are quite different and the rate of interest in MSMED Act being compound interest at monthly rests make a huge difference in calculation of amount to be awarded. This has been a complex issue for a while since section 18(3) itself mandates arbitration proceedings to be governed as per the Arbitration and Conciliation Act 1996 whereas since the MSMED is a special legislation and has an overriding effect, therefore the interest under section 16 shall prevail. This position is cleared by Hon’ble Delhi High Court in IHMCL vs. Sowil Limited 2022 SCC OnLine Del 4078 wherein the Court held that as held by the Supreme Court in Snehdeep Structures Pvt. Ltd., the provisions of the special Act framed to protect the interest of Small Scale and Ancillary Industrial Undertakings override the provisions of the Arbitration & Conciliation Act. By the same analogy, the provisions of the MSMED Act – which provide for a higher rate of interest under Section 16 thereof, would prevail over Section 31 of the Arbitration & Conciliation Act, since the MSMED Act is a special legislation as far as liability to pay interest to Micro and Small Enterprises – which fall within the definition of supplier, is concerned. Therefore, it is clear that the provisions of MSMED Act being special legislation shall override the provisions of Arbitration and Conciliation Act 1996 and the provisions of the MSMED Act – which provide for a higher rate of interest under Section 16 thereof, would prevail over Section 31 of the Arbitration & Conciliation Act. But it is a point to be noted that the MSMED Act is silent on the date till which such compound interest shall be paid i.e. either it governs pendente lite interest only or also future interest.

Conclusion 

The MSME Act 2006’s arbitration mechanism is a big step in creating a more welcoming and business-friendly atmosphere for micro and small businesses. It addresses the particular difficulties faced by MSMEs and is definitely a beneficial legislation providing higher interest rates, speedy conflict resolution etc. Its protective attitude toward smaller businesses is further demonstrated by the precedence it gives over conflicting contractual conditions.  

Though there are certain questions open if dispute is between two MSME registered companies, then should this beneficial legislations provide some leniency to them? Though it has not been specifically decided over yet by the courts but this remains a topic for consideration.

Authored By-

Megha Chaturvedi, Senior Associate

Anchal Sharma, Intern, 3rd year Student HPNLU