Arbitrations under the MSMED Act: Supreme Court clarifies but falls short

-Rajat Joneja and Kartikey Gupta †

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Introduction

The Micro, Small and Medium Enterprises Development Act, 2006 (“Act”) is a comprehensive legislation that intends to ensure smooth flow of credit to small scale enterprises and boost the development of the micro, small, and medium enterprises (“MSMEs”) at an institutional level. 

Section 18 of the Act envisages a dispute resolution mechanism wherein if a party has a dispute regarding the amounts due under Section 17 of the Act, a reference is required to be made to the Micro and Small Enterprises Facilitation Council (“Council”).  Upon such reference, the Council is empowered to conduct conciliation in the matter, either by itself or through reference to an alternate dispute resolution centre. Sections 65 to 81 of the Arbitration and Conciliation Act, 1996 (“Arbitration Act”) apply to such proceedings as if the conciliation proceedings were initiated under Part III of the Arbitration Act.

If such conciliation proceedings fail, the Council is required to take up the dispute for arbitration or refer it to an alternate dispute resolution centre. The provisions of the Arbitration Act are applicable as if the arbitration were initiated pursuant to an arbitration agreement between the parties, under Section 7(1) of the Arbitration Act.

This article aims to analyse the scope of arbitrations conducted under Section 18 of the Act and its effect on arbitration agreements that may already exist between the parties as well as to understand the nature of claims which fall within the jurisdiction of the Council, in the context of a recent decision of the Supreme Court of India (“Supreme Court”) in Silpi Industries vs. Kerala State Road Transport Corporation & Anr. (“Silpi Industries”).

Decision in Silpi Industries

The Supreme Court in Silpi Industries, considered the maintainability of counterclaims in arbitration proceedings initiated as per Section 18(3) of the Act, among other issues. The judgment deals with a batch of matters wherein similar issues were raised.

In the first batch of appeals, the MSMEs opposed the maintainability of counterclaims in arbitrations initiated under the Act. Briefly, they contended that a comprehensive reading of Chapter V of the Act would show that only claims raised by MSMEs are to be referred to conciliation and arbitration. It was also contended that the Act is a beneficial legislation aimed to aid the MSMEs, and therefore its scope cannot be expanded to allow reference of counterclaims raised by a buyer in arbitration proceedings initiated as per Section 18(3) of the Act.

In the second batch of appeals, the appointment of an arbitrator by the High Court on an application moved by the buyer under Section 11(6) of the Arbitration Act, was under challenge. Under these appeals, the MSME suppliers contended that counterclaims raised by a buyer/service recipient must be adjudicated in arbitration proceedings initiated under Section 18 of the Act. It was contended that denying the Council its jurisdiction to entertain the counterclaims of the buyer, would render the Act otiose and result in denial of the various benefits conferred on MSMEs under the Act.

The Supreme Court observed the overriding effect given to Sections 15 to 23 of the Act under Section 24 of the Act, as per which the provisions shall continue to have effect in spite of any inconsistency with any other law for the time being in force.  It held that while the Arbitration Act is a general law, the Act is a special, beneficial legislation intended to benefit MSMEs. It also observed the following 3 key differences in the mechanism provided under the two enactments: 

  1. While the Council is required to undertake mandatory conciliation before arbitration under the Act, the same is not the case for the arbitrations under the Arbitration Act.
  2. While the Council or the centre identified by it is required to conduct the arbitration, under the Arbitration Act, the parties are free to agree upon the constitution of the tribunal.
  3. Whereas in the event an award in favour of the MSME is challenged, the buyer is required to pre-deposit 75% of the amount awarded, there is no such condition under the Arbitration Act.

Therefore, benefits available under the Act may be denied if the counterclaim is considered non-maintainable.

The Supreme Court held that the abovementioned statutory benefits cannot be denied to an MSME on the specious grounds that a counterclaim cannot be maintained before the Council. The Supreme Court held that if the other party is allowed to institute parallel proceedings before a civil court or arbitral tribunal (depending upon the existence of an arbitration agreement), the same may result in conflicting findings. 

In view of these, the Supreme Court held that the Council would have the jurisdiction to adjudicate counterclaims raised by a buyer/service recipient.

Pertinently, the Supreme Court also held that if there is an arbitration agreement between the parties, the same is to be ignored because of the statutory obligations and mechanism provided under the Act. While the Supreme Court upheld the appointment of the arbitrator in the second batch of appeals, it was only because the supplier in those cases was not registered as an MSME under the Act as on the date when the contract was entered into; and therefore barred from invoking the jurisdiction of the Council.

Analysis 

From the judgment, it is clear that a tribunal constituted under the Act shall be treated as the ‘exclusive forum’ before which the buyer is required to submit its counterclaim. The judgment seems to be in line with the Supreme Court’s decision in Principal Chief Engineer v. Manibhai and Bros (Sleeper), wherein it upheld a similar interpretation adopted by the Gujarat High Court. 

However, it still remains unclear whether a party that has received services or supplies from an MSME and has a claim against such MSME would be required to seek relief in terms of the Contract, or whether Section 18 of the Act would apply and such party would also be required to approach the Council.

Additionally, once such party has initiated proceedings against the MSME and the MSME wishes to raise a counterclaim, would the MSME be required to submit to the jurisdiction of the arbitral tribunal/Court or refer the disputes to the Council? In case the MSME is then allowed to approach the Council, would it not result in a multiplicity of proceedings? These aspects have not been clarified by the Supreme Court.

As per the Act, reference to the Council can only be made when the dispute pertains to amounts due to an MSME from the buyer/service recipient. However, what happens when the buyer seeks to invoke the arbitration agreement between the parties in cases where the MSME has executed the contract poorly or failed to perform altogether and is, therefore, liable to refund the amount received or pay damages under the Contract? To conclude that the buyer would have to raise its claim before the Council even in relation to such disputes, may amount to expanding the scope of the Act. 

The Bombay High Court in Porwal Sales vs. Flame Control Industries,  held that when an MSME has not raised any claim invoking the jurisdiction of the Council, Section 18(4) of the Act would not be attracted, and the buyer would be free to seek the appointment of an arbitrator under Section 11 of the Arbitration Act. It held that Section 18(4) cannot be read as creating an absolute bar to the institution of any proceedings other than as provided under section 18(1) of the Act. It reasoned that if the intention of the legislation had been to bar any appointment under Section 11 of the Arbitration Act, the Act would have expressly provided for the same. 

It held that if such a statutory bar were read into the provision, the same would lead to the following consequences:

  1. It would amount to reading something in the provision which the provision itself does not provide. 
  2. It would render an arbitration agreement between the parties meaningless and may create a situation where a party who is not falling within the purview of Section 17 and Section 18(1) is foisted a remedy, which the law does not prescribe. 

Lastly, the Bombay High Court held that the use of the word “may” in Section 18(1) cannot be read to mean “shall”, making it mandatory for a person who is not an MSME to invoke the jurisdiction of the Council. 

Therefore, while the questions raised in this article seem to have been sufficiently answered by the Bombay High Court, whether the Supreme Court wishes to adopt the same interpretation has not been considered by it. The Supreme Court’s judgment seems to indicate a prima facie difference of opinion with the Bombay High Court’s interpretation since the former thrusts the remedy of arbitration under Section 18 of the Act on both parties and directs them to ignore a mutually agreed arbitration agreement, without clarifying whether the situation would be different had the MSME not referred the disputes to the Council under Section 18 of the Act or had the original claimant been the buyer/service recipient.  

From its judgment, the Supreme Court has clarified the scope of arbitrations under the Act but has also left the buyers in a quagmire regarding the options available to them.

As per the data available with the Ministry of MSMEs, out of the 32,835 cases filed with the Council only 11,135 have been disposed of. The amount involved in the pending cases is approximately 9,370 crores. Clearly, the Councils are already overburdened with cases with minimal infrastructure to manage them efficiently. This may have been the perfect opportunity for the Supreme Court, to not only clarify the various issues and reduce unnecessary, ancillary litigation revolving around the jurisdiction of the Council, but also to pass directions to streamline its functioning under the Act. 

 

†Rajat Joneja is a Partner and Kartikey Gupta is an Associate at J. Sagar Associate