Arbitration In IndiaCommercial Agreements & Contracts In IndiaMSMED ActOverlap between MSMED Act and Arbitration Act

August 24, 20200
The Micro, Small and Medium Enterprises (“MSME”) sector has arisen as an extremely vibrant and dynamic sector of the Indian economy over the eras. It not contributes towards the economy through the supply of goods, but also generate massive employment opportunities.
The Micro, Small and Medium Enterprises Development (MSMED) Act was notified in 2006 to address policy issues affecting MSMEs. The prime objective of the Act is advancement and development of MSMEs and boost competitiveness of MSMEs.
MSMEs have constantly been coping with challenges faced due to delayed realisation of their bills and receivables, mainly from large corporate buyers and government organisations, leading to financial hardships and liquidity constraints. Delayed payments is one of the main reason for many of them turning into Non-Performing Assets (“NPA”), thus affecting their sustainability.
With the introduction of the Insolvency and Bankruptcy Code, 2016 and strict measures by the Reserve Bank of India (RBI) for taking stringent action against NPA accounts, MSMEs have been facing two-fold pressure:
i. Delayed payments; and
ii. Threat of turning into an NPA.
The MSMED Act has made provisions to mitigate the problem of delayed payment.
The issue of delayed payments can be attributed to the conduct of the buyers who tend to drag supplier from pillar to post for recovery of amounts towards goods supplied and services rendered. In order to do away with the growing uncertainties and delay in recovery process, Chapter V of Micro, Small and Medium Enterprises Development Act, 2006 was incorporated which contains the provisions regarding recovery of dues from buyer in case of services availed or goods brought by him.
Section 15 of the MSMED Act addresses the liability of the buyer and provides that the period agreed between the parties shall not exceed 45 days from the day of acceptance or deemed acceptance of goods or services.
It stipulates that every buyer is obligated to make payment towards goods supplied or services rendered on or before the date agreed in writing in view of the agreement, before the appointed day.
Appointed date here means as per Section 2 (a), the day following immediately after the expiry of the period of 15 days from the day of acceptance or the day of deemed acceptance of any goods or any services by a buyer from a supplier.
Section 16 says that upon failure to pay, the buyer must pay a compound interest, at three times the rate notified by the RBI, at a monthly rate, to the supplier on that amount from the appointed day or from the date immediately following the date agreed upon.
Section 18 of the act provides for the redressal mechanism in case of the delayed payments to Micro and Small Enterprises. It states that if the supplier is aggrieved due to the failure of the buyer to make payment within stipulated time, then it may refer the dispute to Micro and Small Enterprises Facilitation Council.
The Council shall either itself conduct conciliation or seek assistance of any institution under Section 65-81 of Arbitration and Conciliation Act, 1996 (“Arbitration Act”).
If the conciliation is not successful and stands terminated without any settlement between the parties, the Council shall either itself take up the dispute for arbitration and act as the arbitral tribunal or refer to it any arbitration institution or any centre providing alternate dispute resolution system, regardless of the fact that there is no arbitration agreement between the parties to that effect. The Council shall be decide the dispute within 90 days of reference.
Section 19 comes to the aid of the suppliers by providing that in case the buyer challenges the order or award passed by the Council or the arbitral institution or the centre, the appeal for setting aside such an award shall not be entertained unless the appellant deposits 75% of the award amount and a portion of that amount, as deemed fit by the Court concerned, pending the appeal would be disbursed to the seller subject to necessary directions. 
Currently, arbitration is amongst the most preferred method of dispute resolution. Majority of the commercial contracts encompasses an arbitration clause to resolve the disputes arising therein.
Arbitration law is premised on the fundamental principle of party autonomy which grants the parties the prerogative to decide the method of dispute resolution including the details of the procedure to be undertaken. Indian Courts have also construed this principle in its strict form as an effort towards building India as the arbitration hub of the world.
Nonetheless, MSMED Act is a special statute that provides for a fix mechanism to resolve the dispute.
A question which strikes here is when there is an arbitration agreement between the parties for resolution of any dispute which may arise, will the arbitration agreement override the statutory arbitration provision under the MSMED Act or vice-versa?
It is an undisputed principle of statutory interpretation that incase of inconsistency and ambiguity, a special statute pertaining to a specific subject will have an overriding effect over the general statute. 
The issue then arises is regarding the applicability of this principle in arbitration laws, whether it would apply automatically or subject to certain exceptions.
Prima facie if we look at it, the reference of disputes to a Facilitation Council under the MSMED Act is a statutory tier-wise dispute resolution mechanism and any statutory provision will have supremacy over any agreement or a contract.
An argument can be presented by citing Section 24 of the MSMED Act which provides that if there is anything inconsistent with Sections 15 to 23, the latter will have an overriding effect.
But mere presence of an arbitration agreement in itself does not imply that it is inconsistent with the Section 18.
Section 18 of the MSME Act became combative when multiple cases surfaced where a party involved in a dispute with a supplier filed proceedings in Court challenging its applicability to their dispute in light of the arbitration agreement entered between the parties. This issue of an overlap between the MSMED Act and the Arbitration Act has created an on-going tussle of interpretation by the High Courts across the country.
The High Court of Bombay in the case of Steel Authority of India v. The Micro, Small Enterprise Facilitation Council, Writ Petition No. 2145/2010, decided on 27 August 2010, had reasoned that Section 24 of the MSMED Act, which was enacted to give an overriding effect to provisions of Section 15 to 23 of the MSMED Act would override only such provisions which were inconsistent with Section 15 to 23.
The Court was of the view that there was no inconsistency between the provisions of Section 18(3) of the MSMED Act and the agreement between the parties to refer the disputes to arbitration under the Arbitration Act and held that the arbitration agreement between the parties could not be rendered ineffective.
No inconsistency between the scope of the MSMED Act and the Arbitration Agreement.
The High Court of Punjab and Haryana in the case of Welspun Corp. Ltd. v. The Micro and Small Enterprises Facilitation Council, Punjab and others, CWP No.23016 of 2011, decided on 13 December 2011, held that that there is an express provision under Section 24 of the MSMED Act, which spells out an overriding effect of the Act. The Court held that Section 18 provided a particular procedure for an arbitration and the same Act also provides a particular method of setting aside an award passed by an Arbitrator, the said provisions shall prevail over Arbitration Act.
The Court categorically held that since the enactment specifically did not save the sanctity of specific terms of contracts by making express provision that the Act shall be subject to any contract to the contrary, the legislation must prevail over the choice of the parties.
Dispute resolution mechanism provided in the MSME Act over rides the arbitration agreement.
The High Court of Bombay in the case of Bharat Sanchar Nigam Limited v. Maharashtra Micro and Small Enterprises, Arbitration Petition No. 990 OF 2014, decided on 31 March 2015, held that there is no provision in the MSMED Act, which negates or renders an arbitration agreement entered into between the parties as ineffective. It cannot be said that because Section 18 provides for a forum of arbitration to the extent that 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 provisions of law that are 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.
Herein the Court held that since one of the party had already invoked Section 18 (1) of the MSMED Act, it was mandatory to undergo conciliation in accordance to Section 18 (2). After exhausting the conciliation mechanism, parties were free to invoke the arbitration clause in their agreement.
If dispute resolution mechanism under MSMED Act is invoked before the Arbitration Agreement, then the former to prevail.
The High Court of Gujarat through its decision which was later affirmed by the Supreme Court, in the case of Principal Chief Engineer v Manibhai and Brothers, Diary No(s).16845/2017, order dated 5 July 2017, categorically dissented with the view taken by the High Court of Bombay in the case of Steel Authority. It held that the Council is de jure empowered to conduct arbitration proceedings either by itself or the institution or the centre as prescribed. An application under Section 8 of the Arbitration cannot be construed to be maintainable before the Council.
The Court held that the Section 18 of the MSMED Act had an overriding nature, thereby, independent arbitration proceedings cannot be permitted when there is explicit provision of arbitration to be conducted by the Council.
Dispute resolution mechanism provided in the MSME Act over rides the arbitration agreement.
The High Court of Delhi in the case of Bharat Heavy Electrical Enterprises v. The Micro and Small Enterprises Facilitation Council and others, W.P.(C) 10886/2016 and CM No. 42638/2016, decided on 18 September 2017, held that: 
“If one examines the scheme of the provision of Section 15 to 23 of the Act, it is apparent that the scheme is to provide a statutory framework for Micro and Small Enterprises to expeditiously recover the amounts due for supplies made by them. This is in conformity with the object of the Act to minimise the incidence of sickness in Small and Medium Enterprises and to enhance their competitiveness. It is understood that the Small and Medium Enterprises do not command a significant bargaining power and-as indicated in the statement of object and reasons of the Act-the object of the Act is, inter alia, to extend the policy support and provide appropriate legal framework for the sector to facilitate its growth and development. It is, apparently, for this reason that Section 18(3) does not contemplate an arbitration to be conducted by an arbitrator which is to be appointed by either party, but expressly provides that the same would be conducted by MSEFC or by any institution or a centre providing alternate disputeresolution services.”
Dispute resolution mechanism provided in the MSME Act over rides the arbitration agreement.
Similar view was taken by the High Court of Delhi in the case of GET & D India Limited v. Reliable Engineering, W.P.(C) 10886/2016 and CM No. 42638/2016, decided on 18 September 2017, the petition was filed challenging the award passed by the Council and also Section 18 of the Act on the ground that there was a pre-existing arbitration agreement between the parties.
The Court’s decision was contrary to the decision of the High of Court of Bombay in Bharat Sanchar case. The Court held that no arbitration agreement nor any contractual provisions can override the statutory mandate, especially when the statutory mandate emanates from a special statute providing special dispute resolution mechanism for the benefit of MSMEs.
Dispute resolution mechanism provided in the MSME Act over rides the arbitration agreement.
The decision of the High Court of Bombay in M/s. Porwal Sales Vs. M/s. Flame Control Industries, Arbitration Petition No. 77 OF 2017, decided on 14 August 2019, has highlighted an incongruity in the MSME Act and held that in case of a dispute between parties, if the Supplier invokes the jurisdiction of the Council first, then the provisions of the MSMED Act would be applicable to the dispute. But if the Buyer invokes arbitration first under the contract between the parties, the provisions of the MSME Act may not be
applicable to such arbitration proceedings.
This essentially implies that if the Buyer wants to avoid arbitrating under the MSME Act, it merely has to pull the trigger first and invoke arbitration under the contract before the Supplier invokes the jurisdiction of the Council.
Though the Court also noted that the dispute in the said case did not involve delayed payments within the meaning of section 17 of the MSME Act and hence reference of the said dispute need not be made to the Council, the fact that Section 18(1) of the MSMED Act does not use mandatory language, as noted in the said decision, allows Buyers to invoke the arbitration agreement even in cases involving payment disputes, as long as a reference has not already been made to the Council.
First Mover Advantage: The Dispute Resolution mechanism invoked first shall prevail over the other.
Recently, a Single Judge of the High Court of Delhi in AVR Enterprises v. Union of India, CM(M) 769/2018, decided on 08 May 2020, reignited the on-going debate over the status of arbitration proceedings concerning an MSME enterprise, that, whether such arbitrations originate under the MSME Act or are distinctly originated under the Arbitration Act?
In the case concerned, the petitioner was a registered MSME enterprise which had invoked arbitration under the Arbitration Act. It was categorically held that, invocation of arbitration was not under the MSMED Act as there was no ‘reference’ placed before the Council which could have led to the statutory reference of arbitration under the MSMED Act.
Thus, MSMED Act will not be applicable if parties first invoke the arbitration proceedings under the arbitration agreement.
First Mover Advantage: The Dispute Resolution mechanism invoked first shall prevail over the other.
The Government has taken various initiatives to strengthen the MSME sector which aim to provide security against unwarranted delays. The means stipulated under the MSMED Act for statutory arbitration are for addressing the issues of delayed payments
that have afflicted the MSME Sector since ages.
The Act aims to provide advantages to suppliers for conciliation process before referring the dispute to arbitration, and mandatory deposit of 75 % of the award amount in Court as a pre-condition for challenging an award passed by the Council. The rationale behind this is that MSME may not have the required bargaining power to undertake extensive and expensive legal proceedings against other entities.
Though the Supreme Court of has still not settled the dispute but as per the majority of High Courts of India, Section 18(3) will have supremacy over any arbitration agreement. Nonetheless, the recent liberal interpretation taken by the High Court of Bombay and Delhi have tilted the MSMED Act towards the buyers as against the intent of the Act that was to provide protection to the suppliers.
One also needs to keep in mind that the arbitration under Section 18 is only confined to unpaid dues. For other disputes, arbitration agreement will prevail. 
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