Partial Payments to MSME under Contractual Agreements — Scope of Liability under the MSMED Act

The micro, small and medium enterprises (MSME) sector is a cornerstone of India’s economic growth. Contributing significantly to India’s gross domestic product (GDP), the MSME sector is widely considered as a key player in the Government’s “Make in India” scheme.

Given that the MSME sector comprises businesses which operate with limited commercial resources, they are more susceptible to economic disruptions. In light of this, the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act)¹ was introduced as a beneficial legislation with the objective of facilitating promotion, development and enhancement of the competitiveness of MSMEs.

In a constantly evolving commercial landscape, it is incumbent upon businesses to finalise their commercial terms based on prevailing market conditions. The dynamic nature of these terms may pose a conflict with the provisions of the MSMED Act. One such issue faced by the industry in recent times is regarding the liability of buyers under the MSMED Act in case the parties agree upon partial payments to be made on a milestone basis under a contract with an MSME

This article evaluates the scope of liability of a buyer under the MSMED Act when payment of a part-amount of the order value of goods or services received on a pro rata basis is made in conformity with the scope of work and payment terms (partial payment).

Background

It is standard commercial practice to issue orders where the scope of work encompasses multiple milestones, phases or components — and the supplier is entitled to a consideration. Such commercial orders may either be in the nature of: (i) a works contract; or (ii) an order for purchase of goods or hiring of services.

Furthermore, the consideration under such commercial orders may be payable under two models: (i) the payment terms simply dictate the total amount of consideration payable; or (ii) the payment terms specify the consideration payable against each milestone, phase or component.

Partial payments in works contracts

Applicability of the MSMED Act on works contracts has long been a contested legal issue with the High Courts taking varying views. The Bombay High Court observed that the benefits of the MSMED Act and policies thereunder is limited to contracts for procurement of goods or services and not to contracts which are predominantly of the nature of works contracts.² Similar findings have since been observed by the Andhra Pradesh High Court³ and the Delhi High Court⁴.

However, the Calcutta High Court considered the above findings and observed that there is no legislative distinction made by the MSMED Act in its applicability to works contracts. The Court observed that such distinction flows from revenue jurisprudence and has no nexus with the benefits conferred under the MSMED Act — thus, the Court held that the MSMED Act is applicable upon works contracts as ⁵

In light of the above, for commercial orders in the nature of works contract which stipulate payments terms allowing for partial payments, the applicability of the MSMED Act may itself be challenged. Thus, the scope of liability which may fall upon a buyer under the MSMED Act is extremely limited in such cases.

Partial payments in contracts for supply of goods or services.

While evaluating the enforceability of payment terms stipulating partial payments, it is imperative to note that Section 23 of the Contract Act, 1872⁶ mandates that if a consideration or object of an agreement is such that it defeats the provisions of any law, then such a consideration or object is not lawful and thus such agreement shall be void. Thus, considering the MSMED Act is a beneficial legislation, in case of any conflict with general statutes, the provisions of the MSMED Act must be interpreted in a manner which achieves its intended objective.

Section 15 of the MSMED Act⁷ imposes an obligation upon a purchaser (buyer⁸) to make the payment for any goods or services supplied by an MSME (supplier⁹) on or before the date agreed between the buyer and the supplier. Pertinently, the said period cannot exceed forty-five (45) days from the “day of acceptance”¹⁰ or “the day of deemed acceptance”¹¹. Further, in case no objection has been raised, and the buyer fails to pay the amount for the goods supplied or services rendered, the supplier is entitled to recover the said amount along with interest as per Sections 17¹² and 18¹³ of the MSMED Act.

Furthermore, the obligation upon the buyer to make payments is attributed to the acceptance of the corresponding goods or services supplied by the supplier. Thus, if the commercial order specifies and clearly demarcates the different milestones or phases of supply of goods or services and further provides for corresponding partial payments under the payment terms — the buyer may try and establish that no liability under the MSMED Act can be imposed on account of remainder payment. However, the same is subject to partial payments under the milestones being agreed to be paid within 45 days from the date of completion of such milestone.

Conclusion

Therefore, the scope of liability under the MSMED Act on account of partial payments is a contested legal issue open to determination on specific facts. Depending on the nature of the commercial order, scope of work and the payment terms, the scope of liability on account of partial payments under the MSMED Act may vary. While the jurisprudence indicates that such liability can be effectively contested in cases of works contracts, it may also be possible to contest the liability in cases of orders for supply of goods or services. It is possible to limit the “actual delivery of goods or rendering of services”, as under the MSMED Act to the extent of the partial quantum of such performance — thereby allowing for contractual provisions to effect partial payments on milestone basis. However, this remains a contested issue on both facts and law, subject to the approach and interpretation adopted by the courts.