Arbitration of MSME Disputes: Analyzing the Nexus Between the MSMED Act and the Arbitration Act

Archisman Chatterjee

Introduction

Difficulties faced by small-scale enterprises while carrying out their operations in a heavily competitive market prompted the Indian government to introduce the Micro Small Medium Enterprises Development Act, 2006 (‘MSME Act’). It was done with an aim to promote and facilitate their growth and consolidate the regulations they are subjected to. Section 2(n) of the MSME Act defines who can be considered as a ‘supplier’ for them to avail of the benefits regarding delayed payments by non-MSME buyers. Typically, transactions of this sort are governed by contracts which explicitly contain arbitration clauses to facilitate the resolution of any dispute arising out of it. However, the Act bestows permanency to this practice by incorporating S. 18 which allows any party to a dispute relating to pending dues to refer such matter to the Micro and Small Enterprises Facilitation Council (‘Facilitation Council’).  

In India, arbitration agreements are generally governed under the Arbitration and Conciliation Act, 1996 (‘Arbitration Act’). The Arbitration Act allows parties to set-up arbitration clauses in their agreements on the basis of their own voluntary consent which can subsequently be invoked by any of them on the occurrence of a breach. On the other hand, S.18 of the MSME Act empowers the facilitation council to either act as an arbitral tribunal to settle such dispute or refer it to an arbitration centre or institution provided that the conciliation proceedings started before it as per S.18(2) of said Act stands terminated. This leads to a quagmire surrounding the validity of the arbitration agreement which was entered into by the parties prior to availing of the arbitral mechanism before the facilitation council.

Furthermore, the conflict between the MSME Act and the Arbitration Act was contributing to dampening the purpose of the MSME Act by increasing the procedural difficulties and irregularities faced by the MSME suppliers. The Supreme Court, has in a number of judgments, bestowed ample consideration to this conflict while providing an in-depth clarity in its latest judgment (i.e.) Gujarat Supplies V. Mahakali Food (‘Gujarat Case’). Through this piece, the author delves into the interpretations of high courts regarding the various issues considered by the apex court in the Gujarat case. Further, it would also critically analyse the latest ruling of the apex court. 

Brief Facts

The case dealt with by the Supreme Court comprised of seven appeals against judgements of various high courts on different grounds having a common question of law. In the present case, Gujarat supplies (Appellant) appealed to the Supreme Court against the judgment of the High Court in the first appeal wherein it upheld the verdict of the Ahmedabad Commercial Court confirming the validity of the award given by the Madhya Pradesh MSME Facilitation Council. The Gujarat High Court gave the verdict while holding that the MSME Act overrides the Arbitration Act which had the effect of conferring jurisdiction on the facilitation council. 

Issues Involved

The issues which were considered in the judgment are as follows:

• Would Chapter V of the MSME Act override provisions of the Arbitration Act
• Whether the Arbitration Agreement between the parties is valid
• Whether the bar in S. 80 of the Arbitration Act applies to the facilitation council
• When can a supplier registered under S. 2(n) of the MSME Act derive benefits

The author discusses these issues later  in the article in light of what the High Courts have said prior to the Supreme Court verdict. 

Views of the High Court

The issues settled by the apex court in the Gujarat case previously had various interpretations by the high courts in India. This often led to uncertainty for stakeholders and in turn paved the way for excess litigation. Thus, the author intends to highlight those judgments and pen their views on the same to effectively evaluate them with respect to the Gujarat case. 

Conflict Between the Two Legislations

Primarily, the Bombay High Court in BSNL V. MSME pointed out the lack of any provision in the MSME Act, which would render an Arbitration Agreement between the parties void. The author argues that the court’s interpretation of the non-obstante clause as given in S.23 of the MSME Act is with regard to anything “inconsistent” in any other law. It was potentially incorrect since unlike some other provisions coming under the ambit of S.23 of the MSME Act, the non-obstante clause in S.18 does not specifically regard inconsistency as an essential parameter. One potential consequence of this could be that even Pre-Arbitration Agreements would be set aside if one party so desires. 

Validity of Arbitral Agreements

In Steel Authority V. MSEFC, the Bombay High Court upheld the validity of an Arbitration Agreement due to the non-applicability of the overriding clause in S.23 of the MSME Act. The Court’s ruling was based on the premise that the absence of an express prohibition of Arbitral Agreements renders them valid. It is argued that such a stance failed to accurately adjudicate whether those agreements hold up in the eyes of the law. 

The conflicting opinion as given by Delhi High Court in Ramky V. Micro was that reference to arbitration is in the nature of a statutory one which would invalidate any earlier agreements. The intriguing aspect is that even though the judgment adopted a similar form of reasoning as found in the Gujarat case i.e. prioritizing statutory over contractual requirements, it ultimately ended up only settling the effect a reference to the facilitation council would have on the arbitration agreement. It appears to us that it does not address the question as to the validity of those agreements during the period prior to the reference. 

First Mover Advantage

The Delhi High Court in AVR Enterprises V. UOI opined that where there is a lack of reference by the parties before the facilitation council wherein an arbitration agreement exists, the parties would be barred from utilizing the benefits of the MSME Act. Here it appears to us that the principle of first mover among the parties requires specific attention since it is inextricably linked to the issue of whether the agreements are valid or not in the first place.  For instance, if Party A invokes the Arbitration Agreement before any reference is made to the council, Party B would be restrained from relying upon the MSME Act. Thus, according to the author, this approach of the Court would encourage parties to remain vigilant about their rights and move fast to remedy their infringement.  

Necessity of Registration as a Supplier

It is evident from the judicial trend in India that the nature of the MSME Act is prospective in nature. Two judgments namely, Silpi Industries V. Kerala Transport & Bajaj Auto V. Maharashtra  showcase that the Date of Registration would act as the gateway for application of the MSME Act to settle disputes. However, it is contented by the author that the rationale behind such a practice is impracticable by preventing parties from invoking claims arising out of contracts entered into by them before they were registered as a supplier under the MSME Act based on two grounds. Firstly, it runs contrary to the object and purpose of the MSME Act, which is elaborated on later in the analysis section. Secondly, only ten percent (10%) of MSMEs in India fall within the registered category which would extinguish such an effective remedy for the remaining lot.

What the Supreme Court Held

Primarily, the Supreme Court settled the conflict between the two laws utilizing the principle of “generalia specialibus non derogant” by holding one as a special law and the other as a general one. In order to determine their nature, the Court delved into the purpose behind the inception of the legislation. The Court attributed to the MSME Act, the purpose of levelling the playing field for the MSMEs to smoothen their operations while establishing a conducive market for them. On the other hand, it stated that the Arbitration Act was brought to consolidate and increase the efficiency of all dispute resolution procedures. This in turn, had the effect of cementing the difference between the two laws. Additionally, the usage of non-obstante clauses in Part V of the MSME Act highlights the legislative intent of giving preference to the said act. 

The second point of Law which revolved around the validity of arbitral agreements was resolved by the Court on similar reasoning which was followed in the previous issue. That an agreement between parties cannot be placed at a higher pedestal over statutory requirements is a settled principle of law and the same was appreciated by the Court. As a consequence, it was held by the Court that a Private Agreement cannot invalidate the option of statutory remedy available to the parties since it is a substantive right vested in them.

The penultimate area of Law regarding S.80 of the Arbitration Act which puts an explicit bar on the conciliator to further act as an arbitrator in the same dispute was resolved by the Supreme Court. The Court opined that since the MSME Act would override the provisions of the Arbitration Act, the said provision cannot be a bar for the Facilitation Council to act as both.  

Lastly, while dealing with the issue of Date of Registration of the supplier, the status quo of the Silpi case was reiterated. The Court accepted the argument of the buyer while stating that the supplier should possess its registration prior to the date of supply of goods to call for benefits under the MSME Act.

Analysis

The decision of the Court in the Gujarat case is in line with current decisions of the Indian Courts and provides more clarity regarding the interaction between the two acts. However, the question of which statute would be given preference becomes contingent on the principle of First Mover. In this current scenario, buyers could simply invoke the Arbitration Agreement before the dispute is referred to the Facilitation Council. This would allow the arbitration agreement to proceed over the Facilitation Council which was held in Porwal Sales V. Flame. This in turn would have the effect of negating the remedy available to the supplier under the MSME Act. 

Herein, the authortries to draw a comparison with the Limitation Act, 1960 since the underlying principle of the statute and the need to make a prompt reference is similar to a considerable degree. The Act places time bar on remedies so that parties do not sleep over their rights and instead act promptly to seek the remedy available to them. Thus, if one were to apply such logic to the dispute between two MSME entities, it would almost always completely extinguish the remedy of one party. This will hinder them from availing the mechanism under the MSME Act while derailing the object of the said act i.e., speedy dispute settlement. In light of this, the author argues that such an outcome is inconsistent with the ratio of the top Court wherein it gave greater preference to the MSME Act on the basis of it being a special legislation.  

However, as regards to the question of which statute would be given preference, the judgment of the Court was in line with its previous stance in the Silpi case as well as in Principal V. Mani Bhai.   In both of those cases the Court underscored the overriding nature of the MSME Act over the Arbitration Act due to the former being a special legislation intended to fulfil a particular agenda. 

On the flipside, certain issues which are specifically the issue of date of registration and the facilitation council having to play the role of conciliator along with arbitrator are some unintended consequences of the judgment. To elucidate on the first issue the Court reasoned that if the benefit of registration is given to parties in a retrospective manner, it would be completely antithetical to the intent of the legislature. Herein the author argues that it is flawed since one objective of the statute was the swift disposal of disputes among MSME entities and the fact that majority of them cannot avail it due to registration date being set as a bar runs contrary to such an objective. Ultimately, this scenario of unreasonable exclusion among the entities will increase the amount of time they spent in litigation.

Secondly, the aftermath of the court’s stance to remove the bar on the facilitation council as imposed by S. 80 of Arbitration Act would only be evident through the passage of time. The bar was put in place to prevent the emergence of bias in the conciliator and ensure a fair arbitration procedure. In light of this, the author would like to state that if there exists any degree of bias during conciliation, it may impact the impartiality of the arbitrators as well since they are the same entity. Additionally, if appointment of such arbitrators ends up being challenged on grounds of bias, it leads to more litigation and defeats the purpose of the MSME Act. Now, the Facilitation Council playing the same role in both the mechanisms leaves the door open for Arbitrary Awards. 

Conclusion

The verdict of the Supreme Court would go a long way in shaping the pathway for resolution of disputes faced by MSMEs while doing business. Reaching to a solution in a dispute in a uniform and expedited manner is the key to achieve high levels of growth in an economy. It can be stated that the ruling was able to iron out some of the major kinks regarding interpretation of the MSME Act. However, certain issues namely, registration date and the dual role of the facilitation council when a reference is made to it, could potentially deny the right to fair hearing or deprive them of the facilitation mechanism. The redressal of such problems through due deliberations would strengthen the foundation for an environment which facilities business.

The author is a student of National Law Univeristy, Odisha.