The MSME Act and Arbitration Agreements: First Mover Advantage?

[Vaishnavi Chillakuru is a lawyer based in Mumbai]

The primary objective of the Micro Small and Medium Enterprises Development Act, 2006 (“MSME Act”) is to “provide for facilitating the promotion and development and enhancing the competitiveness” of micro, small and medium enterprises. To further this objective, the MSME Act contains provisions for dispute resolution which are applicable to disputes involving suppliers (“Supplier”) as defined under the MSME Act i.e. a micro or small enterprise which has filed a memorandum of authority as set out in section 8(1) of the MSME Act.

Section 18 of the MSME Act provides that any party with a dispute regarding amount due to a Supplier may make a reference to the MSME Facilitation Council (“Council”) for conciliation. If conciliation is unsuccessful, the Council may either take up the dispute itself for arbitration or refer the parties to an arbitral institution. Section 18(4) further provides that the Council or center providing the alternative dispute resolution services shall have jurisdiction to act as an arbitrator or conciliator in a dispute between the Supplier located within its jurisdiction and a buyer i.e. anyone who buys goods or receives services from a Supplier (“Buyer”) located anywhere in India.  

Dispute Resolution under MSME Act vs. Arbitration Agreements – Porwal Sales case

Section 18 of the MSME Act became contentious when multiple cases arose where a party involved in a dispute with a Supplier filed proceedings in court challenging its applicability to their dispute in light of the arbitration agreement entered between the parties. This issue was considered by various high courts and the general consensus was that presence of an arbitration agreement between the parties would not invalidate arbitration proceedings that have been initiated under the MSME Act, since the MSME Act is a special statute which would override any agreement between the parties. This position was also upheld by the Supreme Court in an order in a special leave petition filed in Principal Chief Engineer v. Manibhai And Bros (Sleeper) in appeal from a decision of the Gujarat High Court.

It is pertinent to note, however, that in those cases, the Supplier had initiated proceedings under section 18 of the MSME Act before the Buyer invoked arbitration under the agreement. These cases did not deal with a scenario where the Buyer invoked arbitration under the agreement between the parties where there was no reference of a dispute to the Council. Such a scenario came up before the Bombay High Court in Porwal Sales v. Flame Control Industries, where the issue before the Court was whether the power of the court to appoint an arbitral tribunal under section 11 of the Arbitration and Conciliation Act, 1996 (“Arbitration Act”) was ousted even in a case where the Supplier had not invoked the Council’s jurisdiction under section 18 of the MSME Act.

Porwal Sales, the Buyer in this case, filed an application under section 11 of the Arbitration Act for appointment of an arbitral tribunal under an arbitration agreement between the parties. One of the objections raised by Flame Control Industries was that since it was a supplier within the meaning of the MSME Act, and in light of section 18(4), the jurisdiction of the court to entertain an application under section 11 of the Arbitration Act would be ousted.

The Court rejected the contentions of Flame Control Industries. It held that, if the intention of section 18(4) of the MSME Act was to create a legal bar on a party who has a contract with a Supplier under the MSME Act from invoking section 11 of the Arbitration Act, then the legislature would have expressly provided that the MSME Act overrides any arbitration agreement entered into with a Supplier under the MSME Act. It also observed that section 18(4) would come into play only in cases where a reference was made to the Council under section 18(1). The Court noted the use of the word “may” in section 18(1) and held that in light of the language used, it cannot be said to be mandatory for a Buyer to refer its dispute to the Council under section 18. It further distinguished the present case from precedent relied upon by Flame Control Industries. In the present case, since the jurisdiction of the Council had not yet been invoked, there was nothing barring the court from appointing an arbitrator in terms of the arbitration agreement between the parties. In previous cases however, Suppliers had already referred the dispute to the Council. The Court also held that section 18(1) is attracted only when the dispute is with regard to an amount due under section 17 of the MSME Act which provides that a reference to the Council may be made with respect to any dispute regarding amount due to a Supplier for goods or services provided to a Buyer. The Court noted that in the present case, there was admittedly no claims of non-payment being raised by the Supplier against the Buyer.  

A Way out for Buyers?

The decision of the Bombay High Court in Porwal Sales has highlighted an incongruity in the MSME Act – in case of a dispute between parties where one of the parties is a Supplier, if the Supplier invokes the jurisdiction of the Council first, then the provisions of the MSME Act would be applicable to the dispute. But if the Buyer invokes arbitration first under the contract between the parties, the provisions of the MSME Act may not be applicable to such arbitration proceedings. This essentially implies that if the Buyer wants to avoid arbitrating under the MSME Act, it merely has to pull the trigger first and invoke arbitration under the contract before the Supplier invokes the jurisdiction of the Council.

Though the Bombay High Court in Porwal Sales also noted that the dispute in the said case did not involve delayed payments within the meaning of section 17 of the MSME Act and hence reference of the said dispute need not be made to the Council, the fact that section 18(1) of the MSME Act does not use mandatory language, as noted in the said decision, allows Buyers to invoke the arbitration agreement even in cases involving payment disputes, as long as a reference has not already been made to the Council.

Conclusion

The provisions for statutory arbitration within the MSME Act were introduced to provide certain distinct advantages to Suppliers, including time bound resolution of disputes, a conciliation process before referring the dispute to arbitration, and mandatory deposit of 75 percent of the award amount in court by the Buyer as a pre-condition for challenging an award passed by the Council. These provisions have been introduced presumably recognizing that micro or small enterprises may not have the required bargaining power to undertake lengthy and expensive legal proceedings against other entities. However, by making section 18 of the MSME Act directory, Buyers have been given a way out to circumvent the provisions under the MSME Act. If the statutory arbitration mechanism under the MSME Act is to be given more teeth, and if the intent is to protect the interests of Suppliers during the dispute resolution process, these loopholes in the MSME Act ought to be addressed.

– Vaishnavi Chillakuru

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