Arbitration under MSME Act: What’s the status? 

The Micro, Small and Medium Enterprises (“MSMEs”) are an extremely critical sector for India’s economic growth. This has been highlighted during the tough times of COVID-19, where special financial stimulus packages have been showered on this sector by the Central Government.

MSMEs are regulated under ‘the Micro, Small and Medium Enterprises Development Act, 2006’[1] (“the MSME Act”) and one of the main objectives of the MSME Act has been to protect the MSMEs from defaulting buyers, who clog up payments these enterprises. The MSME Act mandatorily requires a buyer of goods and/or services from a MSME to make payments within forty-five days[2] else be subject to a steep rate of interest[3]. In order to provide a robust and efficient statutory mechanism, resolution of disputes[4] under the MSME Act is through the ‘Micro and Small Enterprises Facilitation Council’ (“the Facilitation Council”).

The reference of disputes to a Facilitation Council under the MSME Act is a statutory tier-wise dispute resolution mechanism[5]. The dispute is firstly attempted to be resolved by the Facilitation Council through conciliation either by itself or by making a reference to an institution/centre for conducting Conciliation under the aegis of the Arbitration & Conciliation Act, 1996[6] (“the A&C Act”). If the disputes remain unsettled through Conciliation, then the Facilitation Council either takes up the dispute itself or refers it to an institution or centre for resolution of disputes by way of arbitration under the A&C Act which ought to be completed within the statutory period of ninety days from making such reference.

Interestingly, in a plethora of decisions by the Supreme Court as well the High Courts across the country, conciliation as a pre-arbitral mechanism has been held to be merely directory and not mandatory. But would such decisions be also applicable to a statutory pre-arbitral mechanism? A possible No!

To aid the sellers further, the MSME Act lays down that in case the buyer challenges (“appeal”) any order/decree/award (specifically “award”), the appeal for setting aside such an award will not be entertained unless the appellant deposits a hefty 75% of the award amount[7] 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. The constitutionality of this provision was put to test before the Kerala High Court[8] which was upheld and later in a different case was also discussed by the Supreme Court[9], thus the mandatory pre-deposit as a sine qua non for filing an appeal, ought to be followed.

Recently, a Single Judge of the Delhi High Court in ‘AVR Enterprises v. Union of India’[10](“AVR Enterprises case”) 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 A&C Act? In the case concerned, the petitioner was a registered MSME enterprise which had invoked arbitration under the A&C Act. It was categorically held that, invocation of arbitration was not under the MSME Act as there was no ‘reference’ placed before the Facilitation Council which could have led to the statutory reference of arbitration under the MSME Act. It was also held that, provisions and requirements of Section 19 of MSME Act would only be applicable if the arbitration was initiated by way of a statutory reference made by the Facilitation Council and not when initiated inter-se between the parties based on a contractual arbitration agreement.

This is not the first time that this issue of an overlap between the MSME Act and the A&C Act has come up. It has been an on-going tussle of interpretation by the High Courts across the country. 

The Division Bench of the Gujarat High Court while dealing with the same proposition in ‘Saryu Plastics Pvt. Ltd. v. Gujarat Water Supply and Sewerage Board^’[11] (“Saryu Plastics case”) held that, upon a reading of Section 18 of MSME Act, the Facilitation Council is authorised to conduct conciliation either itself or refer the same to any center providing alternate dispute resolution services. The council is also authorised to arbitrate and render an award. Further it was held that, Section 19 of the MSME Act cannot be understood in a restrictive manner to be applicable only in a situation where an award is passed under Section 18 of MSME Act. Thus, it was held that, there cannot be a legally tenable situation that Section 19 of MSME Act would apply only in case of an award being passed by the Facilitation Council or any institute or center to which reference is made by the Council. 

It was also held that if such an interpretation was to be accepted, then the term ‘decree’ as provided in Section 19 of MSME Act would be rendered as redundant, as, neither the Facilitation Council nor any institution or center is empowered to pass a decree. Importantly, this judgment of the Gujarat High Court was appealed before the Supreme Court and was disposed of[12] with a slight modification with extension of timeline to make the pre-deposit before the court concerned for filing the appeal.

In our considered opinion, after a careful reading of Section 19 of MSME Act, it appears that the usage of the term ‘decree’ is a case of poor drafting by the Legislature. The Facilitaion Council itself, or any other institution or centre cannot be equated to a civil court which has the authority under law to pass a ‘decree’. Hence, the Gujarat High Court as well as the Supreme Court should have delved into this aspect.

A Single Judge of the Punjab & Haryana High Court, in what appears to be a similar view to that of the Delhi High Court, disagreed with the Division Bench of the Gujarat High Court, and held[13] that Section 19 of MSME Act is not applicable to an ‘award of the arbitrator’ unless the procedure as laid down in Section 18 of MSME Act is followed.

Coming back to AVR Enterprises case[14], it appears that the Single Judge placed reliance on a similar decision of an earlier coordinate Bench, to reach its conclusion and ultimately differed with the views of the Division Bench of the Gujarat High Court. In the earlier decision[15] of the Delhi High Court, it was held that the Facilitation Council is not bound by the terms of the arbitration agreement while making a reference. Further, the Delhi High Court in another case held[16] that the reference under Section 18 of MSME Act is a statutory reference and is dehors any arbitration agreement between the parties.

The incumbent Chief Justice of India, while presiding over a Division Bench at the Bombay High Court in a decision[17] dealt with the question of law that “what would be the next step after such a reference is made, when an arbitration agreement exists between the parties or not?” It was held that, there is no provision under the MSME Act, which negates or renders an arbitration agreement between the parties as ineffective. Referring to Section 24 of the MSME Act, it was pointed out that, it is enacted to give an overriding effect to Sections 15 to 23 of the MSME Act over any other prevailing inconsistent laws. It was further held that Section 18 of the MSME Act provides for the forum for resolution of the disputes which cannot have the effect of negating an arbitration agreement. It was also held that there is no question of an independent arbitration agreement ceasing to have any effect because, the overriding clause only overrides things/instances which are inconsistent therewith and per se there is no inconsistency between an arbitration conducted by the Facilitation Council under Section 18 of the MSME Act and an arbitration conducted under a contractual clause, since both situations would ultimately be governed by the provisions of the A&C Act. However, when both the laws are stacked up against each other, it might be interesting to note that the timeline to complete arbitral proceedings under the MSME Act is a strict 90 days with no provision of extension whereas the A&C Act comparatively has a larger time period for completion, with the option of extension of timelines.

The Calcutta High Court on this issue held[18] that, even when there exists an arbitration agreement between two parties and one of such parties is an MSME enterprise, only the Facilitation Council or any institution/centre identified by it, has the jurisdiction to arbitrate such disputes. The reasoning provided by the Calcutta High Court for reaching this conclusion was by relying on Section 2(4) of A&C Act which stipulates that, provisions of the first part of the A&C Act apply to a statutory arbitration impliedly, as if there was an arbitration agreement between the parties. However, the first part of the A&C Act would not apply in the event there is a conflict between it and the provisions of the Act concerned which enforces statutory arbitration, in this case being the MSME Act. 

Thus, the Calcutta High Court went on to hold that, upon a harmonious construction of the provisions of the MSME Act when read with the A&C Act, the arbitration clause contained in the agreement between the parties, which is governed under the A&C Act, stands superseded by the statutory rights granted under the MSME Act.

Hence, it can be seen that there is a situation of conflicting decisions on this issue of there being an overlap between the MSME Act and the A&C Act. In our understanding, the Delhi, Bombay and Punjab & Haryana High Court(s) have time and again held that in the event an arbitration proceeding is commenced under the A&C Act, it would be separate and dehors the statutory arbitration under the MSME Act. The reasoning of the three High Courts also appears to be similar. On the other hand, the Gujarat and Calcutta High Courts have taken a separate approach though on different principles. 

In our opinion, the Calcutta High Court’s decision appears to suffer from infirmities as it did not consider the settled principles of law. Undoubtedly, the MSME Act is a special Act, however, a three-Judge Bench[19] of the Supreme Court has held that the A&C Act is also a special Act, since it consolidates the law relating to arbitration. Interestingly, there is a conflicting opinion amongst the Supreme Court over the status of the A&C Act itself, where earlier a Division Bench held[20] that the A&C Act is a general law. Keeping the debate aside for the moment, in either of the two circumstances the MSME Act would prevail over the A&C Act, as it is a special Act which came in force later than the A&C Act.

However, what appears to be a more pragmatic and correct view, in our opinion, is that of the Delhi, Bombay and Punjab & Haryana High Court(s). Just by merely being an MSME enterprise does not bind such an enterprise to be taking all its decisions within the ambit of the MSME Act. Further, every such enterprise will have the option to either invoke arbitration if provided contractually, under the A&C Act and if not, then exercise its statutory option under the MSME Act. 

But, by virtue of there being a Facilitation Council, Conciliation and/or arbitration proceedings under the MSME Act cannot automatically exclude the invocation of arbitral proceedings under the A&C Act. Such an interpretation would also be in violation of the constitutional right of a person, for the freedom to choose its own avenue of legal proceedings. Though it is the be kept in mind that, in the event a party chooses to take the route under the MSME Act, then it cannot return to the provisions under the A&C Act. For example, strict timelines under MSME Act would have to be adhered to for completion of proceedings and then the enlarged timelines under the A&C Act cannot come to the aid of such an enterprise, which would stand excluded.

In our understanding, most of the decisions under the MSME Act have been challenged before the High Courts concerned on the issue of the mandatory pre-deposit to file an appeal. Thus, even if the Delhi, Bombay and the Punjab & Haryana High Courts were to hold that Section 34 of the A&C Act does not entail pre-deposit for being dehors the MSME Act, in our opinion, the requirement of 100% pre-deposit of the award as per the prevailing judicial legislation would kick in. Hence, the Delhi High Court in AVR Enterprise case ought to have considered the judgment of the Supreme Court in Hindustan Construction Company Limited v. Union of India[21] wherein, as a measure of protection and as a step in aid of the enforcement of arbitral awards, it was held that, in every case the Court concerned must insist on a 100% deposit, before hearing a petition under Section 34 of the A&C Act or before staying the enforcement of the award, however, the amount of deposit may depend on the facts of the case and would be as per the discretion of the  Court concerned hearing such petition.

When compared prudently, mandatory pre-deposit of 75% under the MSME Act would in fact be lesser than the 100% pre-deposit for a challenge under Section 34 of the A&C Act, as per the Supreme Court’s judicial legislation. Thus, it becomes crucial for the MSME enterprise to make a conscious choice keeping all factors in mind, whether to invoke the arbitral proceedings under the MSME Act or the Arbitration Act?

Hence, in view of the fractured verdict amongst the High Courts and there being divergent views, the stage is now ripe for the tussle amongst the High Courts to be played out before the final decisive authority, the Supreme Court, to finally settle the dust and put this debate to rest and pave a clear path ahead.

*Partner, L&L Partners Law Offices, New Delhi, India who specialise in commercial matters.

 **Managing Associate in Litigation and Dispute Resolution Group at L&L Partners Law Offices, New Delhi Authors can be reached out at sanjeevk@luthra.com and asehgal@luthra.com. The views expressed are personal.

[1] Micro, Small and Medium Enterprises Development Act, 2006

[2] Section 15 of MSME Act.

[3]. Section 16 of MSME Act.

[4] Section 17 of MSME Act.

[5] Section 18 of MSME Act.

[6] Arbitration and Conciliation Act, 1996 

[7] Section 19 of MSME Act.

[8] Kerala S.R.T.C. v. Union of India,  2009 SCC OnLine Ker 6621 

[9] Goodyear India Limited v. Norton Intech Rubbers (P) Ltd., (2012) 6 SCC 345

[10] AVR Enterprises v. Union of India, CM(M) No. 769/2018, judgment dated 08.05.2020

[11] Special Civil Appl. No. 12769 of 2017, judgment dated 11-9-2017.

[12] Gujarat Water Supply and Sewerage Board v. Saryu Plastics Pvt.  Ltd., SLP (C) No. 31022/2017, order dated 24-11-2017 

[13] State of Punjab v. Oasis Contractors and Consultant Pvt. Ltd. 

[14] AVR Enterprises v. Union of India, CM(M) 769/2018, judgment dated 08.05.2020

[15] Bharat Heavy Electricals Limited v. The Micro and Small Enterprises Facilitations Centre, 2017 SCC OnLine Del 10604

[16] Ramky Infrastructure Private Ltd. v. Micro and Small Enterprises Facilitation Council, 2018 SCC OnLine Del 9671

[17] Steel Authority of India Ltd. v. Micro, Small Enterprise Facilitation Council, 2010 SCC OnLine Bom 2208 

[18] NPCC Limited  v. West Bengal State MSEFC, 2017 SCC OnLine Cal 263  

[19] Consolidated Engg. Enterprises v. Irrigation Deptt., (2008) 7 SCC 169

[20] Gujarat Urja Vikas Nigam Ltd. v. Essar Power Ltd., (2008) 4 SCC 755 

[21] 2019 SCC OnLine SC 1520