Revisiting the ‘Settled’ Law on MSMED and Arbitration Acts: An Alternative Way Forward

[Ameya Sharma and Tassawar Ali are second-year students pursuing B.A., LL.B (Hons.) from NALSAR University of Law, Hyderabad]

In Gujarat State Civil Supplies Corporation Ltd. v. Mahakali Foods Pvt. Ltd., the Supreme Court settled the conflict between the Micro, Small and Medium Enterprises Development Act, 2006 [“MSMED Act”] and the Arbitration and Conciliation Act, 1996 [“A&C Act”]. It was held that the MSMED Act, being a beneficial legislation, holds precedence over the A&C Act. As a result, this ruling held that the arbitration proceedings by the facilitation council [“Council”] would prevail over parties’ arbitration agreement once section 18 of the MSMED Act was invoked.

However, there has been dissatisfaction expressed by MSMEs regarding the dispute resolution process under section 18 of the MSMED Act. These grievances arise from the exclusive power given to the Council during such proceedings, increase in delay and subsequent rise in costs. Recently, the Calcutta High Court in Odisha Power Generation Corporation Limited v. Techniche Consulting Service also took a divergent stance and affirmed the validity of parties’ arbitration agreement while proceedings under section 18 of the MSMED Act were ongoing. Therefore, it appears that this ‘settled’ position of the MSMED Act prevailing over the A&C Act may require reconsideration.  

At the outset, this post underscores the ramifications of Gujarat Civil Corporation and examines the drawbacks of the dispute resolution mechanism provided under section 18 MSMED Act. Subsequently, further attention is directed towards the objective behind section 80 of A&C Act and its importance for any arbitration proceeding. Finally, a harmonious interpretation to reconcile the MSMED Act and A&C Act is proposed.

Section 18 MSMED: A Benefit Without Disadvantage?

It has now become a settled law that the MSMED Act, because it is a beneficial legislation, is declared to take precedence over the A&C Act. However, it is crucial to assess whether the MSMED Act truly delivers these benefits. One such major concern is that the MSMED Act gives the Council complete control over arbitration proceedings without enough ways to hold it accountable. Moreover, the 2023 amendment to the MSMED Act removed time limits for section 18 proceedings, potentially leading to prolonged and uncertain resolutions.

Limited accountability and a web of delays

According to section 18 of the MSMED Act, disputes must first go through conciliation/mediation and then to arbitration, if required. Importantly, any party can invoke section 18 without needing the other party’s consent, making arbitration automatic in such cases. It is also important to note that any such arbitration under section 18 does not require any prior agreement between the parties (SGM Packaging Industries v. Goyal Plywood LLP).

Thus, when any party triggers section 18 of the MSMED Act, an automatic reference is made to the Council which takes up the case for mediation in the first stage. If mediation is not successful, it becomes the burden of the Council to either initiate the arbitration proceedings itself (the Council acts as tribunal) or, the Council must make a reference to any other institution. Such reference to arbitration does not fall within the control of either of the parties, but only the Council. But what if the Council delays this referral? Do disputing parties have any way to appeal against such delay by the Council? Can they approach the courts for relief?

In Bafna Udyog v. MSMED, the Bombay High Court dismissed any such recourse against the Council to the High Courts. In this case, even though conciliation ended, arbitration was not referred promptly. The appellant therefore asked the High Court to appoint an arbitrator in terms of section 11(6)(c) of A&C Act, but the Court refused. The Court relied on Mahanadi Coal Fields v. IVRCL AMR. Joint Venture to hold that the invocation of section 11 is contingent upon the presence of an arbitration agreement within the contractual framework of the parties. Since arbitration was triggered under section 18 of the MSMED Act without an arbitration clause in the contract, the High Court refused to appoint an arbitrator, even if the Council had occasioned delays. It clarified that its authority under section 11 of A&C Act only applies with a valid arbitration agreement. Therefore, when parties use section 18 of the MSMED Act without an arbitration clause in their contract, they lack avenues to hold the Council accountable. The only way to challenge the Council is under section 19 of the MSMED Act. However, this recourse is only available after arbitration has commenced, and the Council has rendered an award. It is not possible to challenge the council before arbitration begins.

After the Supreme Court’s decision in Gujarat Civil Corporation, even parties with a separate arbitration agreement face a similar predicament. The apex court held that once section 18 of the MSMED Act is invoked, the arbitration agreement of parties becomes irrelevant, and all proceedings fall under the exclusive purview of the Council. Hence, an appeal under section 11 of A&C Act by virtue of a party’s arbitration agreement after the invocation of section 18 of the MSMED Act is futile. Unfortunately, without mechanisms to address delays caused by Council, the beneficial intent of section 18 MSMED Act, which aims to allow parties to resolve disputes efficiently, becomes ineffective.

Transition from time-bounded to open-ended delays

This problem of lack of accountability is further exacerbated by the absence of a maximum time period for the conclusion of both proceedings. Earlier, section 18(5) of the MSMED Act provided a 90-day time limit for each proceeding (mediation and arbitration) to be concluded after a reference for each had been made. The authors do recognize that this time period did not resolve the delay in reference to arbitration by the Council. This is because there was no time limit provided for referring to arbitration, if conciliation proceedings are terminated unsuccessfully. Time for such reference was left at the discretion of the Council. Nevertheless, this provision ensured a relatively expedient resolution and partially upheld the MSMED Act’s underlying objectives.

However, with the amendment brought about in 2023 to the MSMED Act, section 18 (5) has been omitted thereby removing any restriction on the maximum time period for resolution. Additionally, section 18(3) now has replaced the ‘conciliation’ proceedings with mediation proceedings and the same will be governed by the Mediation Act 2023 [“Mediation Act”]. This means that the conciliation and arbitration proceedings will be concluded according to the time given in the respective legislation.

In terms of section 18 of the Mediation Act, the proceedings should be completed within 120 days with an extension of 60 days, at the parties’ discretion. Hence, the proceeding that was bound to be completed within 90 days earlier can now be stretched up to 180 days. To add to the slow process, this settlement will be further stalled if the mediation fails and arbitration has to be mandatorily pursued.

The Facilitation Councils are government-run bodies that are currently overwhelmed with a backlog of cases. According to the latest data from the MSME Samadhaan, 80,239 cases have been brought to these centres, out of which 40,277 have been resolved. However, a significant amount of Rs. 17,744 crores is still pending for the resolution. These statistics indicate that the Facilitation Centres are facing a backlog of approximately 50%. With mandatory mediation proceedings taking up to 120 or 180 days, and arbitration likely to add further strain, there is a high risk of detrimental consequences for MSMEs in the long run.

Intention Behind Section 80 A&C Act: An Aspect Overlooked

The various judgments passed by the Supreme Court and various High Courts have always emphasised on the special and specific intent of the MSMED Act and, hence, allowed it to prevail over the A&C Act. However, in doing so, the courts have failed to provide the focus that the rationale behind each provision of A&C Act deserves. This is especially for section 80 of the A&C Act, which is also reproduced in section 17 of Mediation Act. Section 80 of the A&C Act places a bar on a conciliator from acting as an arbitrator in any arbitral or judicial proceedings in respect of the dispute that has been the subject matter of conciliation proceedings. This is in line with one of the objectives behind the A&C Act, i.e., to ensure that arbitration proceedings are conducted in a just, fair and effective manner.

The Supreme Court in Gujarat Civil Corporation held that such provision does not apply to section 18 of the MSMED Act. Since this bar is not applicable on the Council, it can act as both conciliator as well as arbitrators in the same subject matter. The rationale behind such overriding effect of MSMED over the provisions of A&C Act has primarily been that the former is a beneficial, special legislation while the latter is a general one.

However, in upholding the overall special nature of MSMED Act, the Supreme Court may have overlooked the careful intent and objective behind section 80 of the A&C Act. By precluding a conciliator from acting as an arbitrator, the legislation seeks to avoid any personal bias, prior knowledge or conflict of interest to disrupt the final award of arbitration. In doing away with the bar under section 80 A&C, the Court allows a potential risk of a bias against one of the parties or risk of prior information revealed to the conciliator in private mediation proceedings to disrupt the fresh arbitration proceedings.

Collaborative approach to MSME Arbitration

This post suggests a liberal interpretation of section 18(3) of MSMED in order to avoid delays in arbitration proceedings and uphold the core principle of party autonomy in arbitration proceedings. Such an interpretation may allow the functions of the Council and the party’s arbitration agreement to co-exist in harmony.

Section 18(3) of the MSMED Act allows the Council to make a reference to arbitration after the conciliation proceedings to itself or to any other institute. If this provision is read broadly, it could also include the institute/arbitrators chosen by the parties in their private arbitration agreement. Hence, in cases where mediation proceedings fail, and the Council has referred to arbitration, the legislature and courts could reconsider their approach. Instead of bluntly overriding section 80 of the A&C Act, its intent should be respected. This can be done if the Council itself takes or is directed to take steps to refer to arbitration as per the party agreement. This way, the parties’ agreement can be respected, and the Council can act as a supervisory body instead of an adjudicating body.

A similar approach was suggested by the Madras High Court in Ved Prakash v. P. Ponram (2019). Even though this case did not take party agreement into consideration, an innovative aspect of this judgment was that the Court directed the Council to ensure that the same member who served as the conciliator in the previous conciliation proceeding does not serve as an arbitrator unless the relevant parties agree otherwise. In this manner, the core objective behind the inclusion of section 80 of the A&C Act will also be preserved as there will be no bias or previous knowledge in the hold of arbitrators that can unduly influence their decision.

In this way, the Council will also not be over burdened with a plethora of cases and the parties’ arbitration agreement will also be respected. As a result, the delay is likely to be reduced and the arbitrators can be held accountable by the parties as well as the Council acting as a supervisory body.

– Ameya Sharma & Tassawar Ali