Permissibility of Arbitration Proceedings by Empanelled Arbitrators under the MSMED Act, 2006

Introduction

Section 18¹ of the Micro, Small and Medium Enterprises Development Act, 2006 (the MSME Act)² provides for a statutory mechanism for recovery of delayed payments along with interest in terms of Section 16³. The mechanism is carried out in two steps — (i) conciliation proceedings; and (ii) arbitration proceedings, where the conciliation proceedings are unsuccessful.

Section 18(2) of the MSME Act states that the Micro and Small Enterprises Facilitation Council (Council/MSEFC) “shall either itself conduct conciliation in the matter or seek the assistance of any institution or centre providing alternate dispute resolution services by making a reference to such an institution or centre”. Section 18(3) of the MSME Act similarly provides that the MSEFC “shall either itself take up the dispute for arbitration or refer to it any institution or centre providing alternate dispute resolution services for such arbitration”.

It is important to note that the provision uses the mandatory “shall” when prescribing that the MSEFC has only two options — either take up the dispute itself for conciliation and/or arbitration, or refer the same to an institution or centre providing alternate dispute resolution services. The MSME Act does not define or describe any qualifications or requirements of an “institution or centre providing alternate dispute resolution services” in terms of Section 18. Accordingly, one of the important questions that arises is whether the dispute can be referred for ad hoc conciliation or arbitration, in place of reference to an institution. This question becomes particularly relevant where the agreement entered into between the parties also contains an arbitration clause.

The Supreme Court in Gujarat State Civil Supplies Corpn. Ltd. v. Mahakali Foods (P) Ltd.⁴, has decisively held that the MSME Act has an overriding effect over the provisions of the Arbitration and Conciliation Act, 1996 (the A&C Act, 1996)⁵. The Court made reference to the non obstante clause contained in Sections 18(1) and (4) of the MSME Act, which specifies that they shall take effect “notwithstanding anything contained in any other law for the time being in force”. It was further noted that once the statutory mechanism provided under Section 18(1) of the MSME Act is triggered by any party, the same would override and supersede any arbitration agreement between the parties.

The issue as to whether ad hoc arbitration is permitted under Section 18(3) of the MSME Act was considered by the High Court of Allahabad in Paper and Board Converters v. U.P. State Micro and Small Enterprises⁶. The Division Bench considered this issue in the context of a fact situation where after the failure of conciliation proceedings, the MSEFC had referred the dispute for ad hoc arbitration by an arbitrator appointed in terms of the arbitration agreement between the parties. The Court examined the text of Section 18 of the MSME Act and noted the non obstante clauses present in sub-sections (1) and (4). In view of the non obstante clauses, the Court noted that the MSEFC alone had jurisdiction to act as a conciliator or arbitrator, and the MSEFC has only two courses of action open to it — either to conduct an arbitration itself or to refer the parties to a centre or institution providing alternate dispute resolution services stipulated in Section 18(3) of the MSME Act. Accordingly, the Court held that reference of the dispute to an external sole arbitrator appointed by one of the parties was manifestly illegal and set aside the arbitral award.

The High Court of Delhi also reached a similar conclusion in BHEL v. Micro and Small Enterprises Facilitations Centre⁷, wherein it was held that Section 18(3) of the MSME Act does not leave any scope for non-institutional arbitration.

Thus, it is now settled that regardless of the existence of an arbitration agreement between the parties, ad hoc arbitration is not permitted under Section 18(3) of the MSME Act. In this background, let us now examine the mechanism for the arbitration process provided in the Haryana MSEFC Rules, 2021⁸ (the 2021 Rules). The 2021 Rules replaced the previously applicable Haryana MSEFC Rules, 2007 (the 2007 Rules)⁹.

Rule 6 of the 2021 Rules governs the procedure of the Council in respect of reference. Sub-rules (6) and (7) provide that the Council may take up the conciliation on its own or refer it to an institution. Sub-rules (8) to (11) provide that in case conciliation is not successful, the MSEFC shall take up the dispute for arbitration in terms of Section 18(3) of the MSME Act and may refer the matter to an institution. The institution is required to act in terms of the A&C Act, 1996 and refer the award to the Council. It is noteworthy that even where the dispute is referred to an institution, the institution is only required to furnish its findings/reports to the MSEFC, which then considers the arbitral findings/reports and recommendations and passes an appropriate final award in the matter. Rule 6(12) makes reference to Section 26 of the MSME Act and provides that the Council may appoint or engage the services of one or more experts for taking assistance while conducting the arbitration proceedings.

The State of Haryana, taking support of Section 26 of the MSME Act read with Rule 6(12) of the 2021 Rules [similar to Rule 4(16) of the 2007 Rules], has adopted a modus operandi whereby the process of arbitration is referred to sole arbitrators empanelled by the MSEFC. Prima facie, this would appear to be a reference of the dispute for non-institutional arbitration. As stated by the Delhi High Court, such a course of action would be barred by Section 18(3) of the MSME Act. The question as to whether reference of the disputes to empanelled sole arbitrators was legally permissible came up for consideration before the High Court of Punjab and Haryana in a batch of writ petitions titled Indian Oil Corpn. Ltd. v. Haryana Micro and Small Enterprise Facilitation Council¹⁰.

The petitioners in the writ petitions argued that as per the MSME Act, the Council is to conduct the arbitration either by itself or through any institution or centre providing alternative dispute resolution services. Therefore, the appointment of a sole arbitrator empanelled by the Government (who are generally retired judicial officers of the rank of District Judge) by the Council is a violation of the provisions of the statute as the same is not a reference of arbitration to an institute or any centre providing alternative disputes resolution services. Further, the proceedings conducted by such an arbitrator are non est and without jurisdiction, as they do not fall within the definition of “institute” or “centre providing alternative dispute resolution services”. Relying on the judgment in BHEL¹¹ the petitioners argued that Section 18(3) of the MSME Act only contemplates institutional arbitration and not ad hoc arbitration. Reliance was also placed on the Allahabad High Court judgment in Paper and Board Convertors¹².

The State of Haryana, however, presented an interesting justification as to why the reference of this dispute to a sole arbitrator is in fact not in violation of Section 18(3) of the MSME Act. It argued that considering the timelines laid down in the MSME Act, the Council seeks the assistance of arbitrators/experts/facilitators. The State further submitted that the arbitration proceedings were in fact conducted by the Council and the dispute was not being referred to the empanelled sole arbitrators for the decision at all. The use of nomenclature like “arbitrator/sole arbitrator” cannot be interpreted to mean that the said person has passed the final award or is competent to do so. These “arbitrators” are retired judicial officers who had been appointed/empanelled by the Council as experts in terms of Section 26 of the MSME Act in order to facilitate the arbitration process and the said experts only submitted a report before the Council. Thereafter, the Council examines the report, provides opportunities of being heard to both the parties, and finally, based upon the report and the submissions from both the parties, the Council decides the dispute and passes the award. Hence, as per the procedure, the Council is “itself” deciding the dispute through arbitration. It was further argued that the MSME Act has an overriding effect, and that the Council has exclusive jurisdiction in the matter.¹³

The Court while rejecting the contentions of the petitioners held that the arbitration being conducted by the arbitrators/experts/facilitators would still be under the aegis of the Facilitation Council and hence in compliance with the MSME Act. Further considering that the arbitrators/experts/facilitators do not have the authority to pass the final award and the substantive power to do the same has been retained by the Facilitation Council, the proceedings carried out by them are in accordance with the MSME Act. It was also observed that the petitioners have failed to point out how the statutory objective of the MSME Act would be defeated or any right prejudiced in seeking the assistance and report of an independent party. Further, the Court recorded that the appointment/engagement of the judicial officers has been done under Section 18(3) of the Act read with Rule 4(16) of the 2007 Rules. The High Court accepted the State’s argument that the engagement of the empanelled arbitrators in the role of facilitators was permitted in terms of Section 26 of the MSME Act read with the 2007 Rules.

The High Court also noted that no institutions providing alternate dispute resolution services had been recognised or graded within the States of Punjab and Haryana. As such, the arbitration process in terms of the MSME Act is required to be conducted by the Council itself, even though the MSME Act also contemplates the option of reference of the dispute to an institute.

Conclusion

The innovative manner in which the State of Haryana has tackled the statutory bar on ad hoc arbitrations under Section 18(3) of the MSME Act certainly makes for an interesting case study. No doubt, it is not a perfect system and there are various questions which still remain unaddressed, such as whether the arbitrators/experts/facilitators are required to meet the criteria of independence and impartiality, given that technically they are not arbitrators at all. Another related question arises as to the level of deference that the report submitted by the arbitrators/experts/facilitators would enjoy during final consideration by the Council.

The High Court seems to have adopted a practical approach for justifying the jurisdiction of empanelled arbitrators, especially in light of the fact that no recognised arbitration institutions exist in the State of Punjab and Haryana. Since there are various States which are similarly situated, this judgment may be helpful in providing legitimacy to arbitration proceedings conducted under the MSME Act in a similar manner.