Clarifying the Issue Between MSMED and Arbitration Act

INTRODUCTION

Arbitration is one of the most sought-after and popular modes of dispute resolution in India. It is observed that almost all the commercial transactions that are entered by the parties have an arbitration clause. The main reasons behind arbitration’s popularity are: i) quick and time-bound resolution, ii) dedicated arbitration institutions and expert arbitrators, and iii) party autonomy. The last point is very important and critical for the parties in arbitration as they are provided with flexibility about the applicability of procedures throughout the arbitration proceedings. But in recent years, lawmakers have introduced the concept of a ‘statutory resolution mechanism’ in which the dispute between the parties is to be resolved mandatorily via the given mechanism, irrespective of the fact whether the parties are willing or have given their consent. One of the examples of such a statutory mechanism is the Micro, Small, and Medium Enterprises Development Act, 2006 (MSMED Act). Section 18 of the MSMED act provides for a specialized mechanism for the resolution of disputes involving MSMEs.

But the major question arises: what shall happen when there is already an arbitration clause in the agreement and there is a statutory law that provides for a resolution mechanism? The author of this article shall be analyzing section 18 of the MSMED act and what shall be the effect of this section in case there is already an arbitration agreement between the parties involved. Before analyzing the clash between the arbitration clause and section 18 of the MSMED Act, let us understand the MSMED act and the resolution mechanism provided under the act.

OBJECTIVE BEHIND MSMED ACT AND ITS IMPORTANT PROVISIONS

MSMEs were introduced to ensure that there is promotion, development, and enhancement of competition among the MSMEs. Further, it was also ensured that the MSMEs have easy and smooth access to credit services and there is a major boost to the MSMEs at an institutional level. One of the unique features of this act is the comprehensive dispute resolution mechanism provided under section 18.

Section 18 provides for a 2-tier mechanism for the dispute resolution process. If the parties have any dispute regarding the amount that is to be paid as per section 17 of the MSMED Act, then the dispute should be referred to the MSME Facilitation Council (herein referred to as Council). As per section 18(2), the role of the Council is to make sure that it shall itself conduct the conciliation or can take the assistance of a center or institution which provides conciliation. For conciliation, Part III of the Arbitration and Conciliation Act shall be applicable (section 65-81). If the parties fail to resolve their dispute through conciliation, then parties have to resolve their dispute via arbitration. Section 18(3) of the MSMED act provides clarification that if the dispute is to be resolved via arbitration, then it shall be considered that the arbitration proceedings have been initiated in pursuance of section 7(1) of the Arbitration and Conciliation Act, 1996. Further, it has also been stated in section 18(4) of the MSMED Act that the arbitrator or conciliator appointed as per section 18(2) or 18(3) shall resolve the dispute between the parties, notwithstanding anything contained in other laws. It is also worth noting that section 24 of the MSMED act states that sections 15 to 23 of the MSMED act shall have overriding effect over other laws in force.

INTERPLAY BETWEEN MSMED AND ARBITRATION ACT

It is important to understand that the buyers and sellers have divergent views on preferred dispute resolution mechanisms. The buyers who have defaulted their payments to MSMEs (also known as sellers) always tend to avoid resolving their dispute via MSMED as the penalties and punishment provided under this act are harsh on buyers. It is provided under section 16 that if the buyer fails to make payment to MSME as per section 15, then the buyer has to pay a penalty interest which is three times the base rate set by RBI. Further, if the buyer is aggrieved by the order or the decree passed by the Council, or by the award passed under the arbitration, then it must deposit 75% of the award. Whereas under the Arbitration Act, neither the buyer nor the seller has any privileges or any special benefits. Both the parties are put on an equal footing. With the amendment under section 36 of the arbitration act, there can be an unconditional stay on an arbitral award. Thus, the parties are always at different ends while choosing the dispute resolution mechanism.

Now the question arises what shall be the situation when there is a clash between the arbitration clause and the mechanism provided under the MSMED act. It has been observed that the courts have had divergent views regarding the issue.

The case of M/s Steel Authority of India and Anr. v. MSEFC, was the first case that dealt with the abovementioned issue elaborately. It was ruled by the Hon’ble Bombay high court that “there is no provision in the Act, which negates or renders an arbitration agreement entered into between the parties ineffective. Moreover, Section 24 of the Act ... would not have the effect of negating an arbitration agreement since that section overrides only such things that are inconsistent with Sections 15 to 23... There is no question of an independent arbitration agreement ceasing to have any effect because the overriding clause only overrides things inconsistent therewith and there is no inconsistency between an arbitration conducted by the Council under Section 18 and arbitration conducted under an individual clause since both are governed by the provision of the Arbitration Act, 1996.” Thus, when there is an independent arbitration agreement between the parties, the Council does not have jurisdiction to go ahead with proceedings under section 18 of the MSMED Act. It was also stated by the hon’ble high court that the Council may go ahead with the conciliation process, which shall run parallel to the arbitration process, since the arbitration clause did not have any provision regarding the same. Similarly, in the case of Porwal Sales v. Flame Control Industries, the Hon’ble Bombay high court disregarded the argument that section 18(4) of the MSMED act created a bar on initiation of arbitration proceedings and stated that “then the legislation would have so expressly provided, namely that in case one such party falls under the present Act, the arbitration agreement, as entered between the parties would not be of any effect and the parties would be deemed to be governed under the MSMED Act in that regard. However, subsection (4) of Section 18 of the MSMED Act does not provide for such a blanket consequence in the absence of any reference made by a party to the Facilitation Council.” The same reasoning was also followed in the case of Hindustan Wires Limited v R Suresh. The Hon’ble Gujarat High Court in the case of Saryu Plastics Pvt Ltd v Gujarat Water came up with a clarification stating that sections 15 to 23 of MSMED shall override other provisions only when the other law has provisions inconsistent with the provisions of MSMED. As section 18 of the MSMED act states only about the forum selection, it cannot be said that Arbitration and Conciliation Act is inconsistent with the MSMED act. The Punjab and Haryana High Court in the case of Chief Administration Officer v MSEFC of Haryana gave a different interpretation to the issue and stated “A contract that provides for the appointment of an arbitrator must be seen as a contract as recognized by law and that provision will stand eclipsed by the non-obstante clause that Section 18 provides for.” Thus, the parties to the dispute can resolve their dispute via arbitration and bypass the proceedings under the MSMED Act if an arbitration clause is already in place. The Hon’ble Delhi High court in the case of AVR Enterprises v. Union of India ruled that if the parties have decided to resolve their dispute through arbitration by the arbitration clause stated in the agreement, then the MSMED provisions will not be applicable.

But there have been divergent views by several high courts regarding the primacy of the arbitration act over the MSMED act. The Hon’ble Allahabad high court in the case of Paper & Board Convertors through partner Rajeev Agarwal v. U.P. State Micro and Small Enterprise ruled that “Once the jurisdiction of the Facilitation Council has been validly invoked, the Council has exclusive jurisdiction to enter upon conciliation in the first instance and after conciliation has ended in failure, to refer the parties to the arbitration. The Facilitation Council could either have conducted the arbitration itself or could have referred the parties to a center or institution providing alternate dispute resolution services. The Facilitation Council was clearly in error in entertaining the objection filed by the respondents and referring the petitioner to the sole arbitrator so designated by the respondents.” In the case of Bharat Heavy Electricals Ltd. v. The Micro and Small Enterprises Facilitation Centre, it was ruled by the Hon’ble Delhi high court “Section 24 of the Act contains a non-obstante provision and, expressly provides that the provisions of Section 15 to 23 of the Act will have an overriding effect. Thus, the provisions of Section 18(3) of the Act cannot be diluted and must be given effect to notwithstanding anything inconsistent, including the arbitration agreement in terms of section 7 of the A&C Act.” In the case of Mangalore Refinery & Petrochemicals Ltd v. Micro and Small Enterprises Facilitation Council, the Hon’ble Delhi high court had stated that the MSMED act being a statutory law shall have primacy over the arbitration clause stated in the agreement entered by the parties. There are several other judgments by various hon’ble high courts wherein it has been ruled that due to the non-obstante clause under section 18(4) and section 24 of the MSMED act and this act being a statutory law, the MSMED act shall prevail over the arbitration clauses of agreements. It is interesting to note that the ratio passed in the case of Principal Chief Engineer, was by the hon’ble Supreme court of India. Despite precedence from the Hon’ble Supreme court, there were still several divergent views and there became an urgent need for clarity and uniformity in the law.

This confusion was recently sorted by the hon’ble supreme court in the case of M/s Silpi Industries Vs Kerala State Road Transport Corporation & Khyaati Engineering Vs. Prodigy Hydro Power Pvt. Ltd. It was observed by the Hon’ble Supreme court that “When such beneficial provisions are there in the special enactment, such benefits cannot be denied on the ground that counter-claim is not maintainable before the Council. In any case, whenever a buyer wishes to avoid the jurisdiction of the Council, the buyer can do on the specious plea of counter-claim, without responding to the claims of the seller. When the provisions of Sections 15 to 23 are given overriding effect under Section 24 of the Act and further the 2006 Act is a beneficial legislation, we are of the view that even the buyer, if any claim is there, can very well be subject to the jurisdiction before the Council and make its claim/ counterclaim as otherwise, it will defeat the very objects of the Act which is beneficial legislation to micro, small and medium enterprises.”

Further, the Supreme court shed some light on the issue of parallel proceedings of the disputes involving MSMEs. It was stated “Even in cases where there is no agreement for resolution of disputes by way of arbitration, if the seller is a party covered by Micro, Small and Medium Enterprises Development Act, 2006, if such party approaches the Council for resolution of a dispute, other party may approach the civil court or any other forum making claims on the same issue. If two parallel proceedings are allowed, it may result in conflicting findings there can very well be subject to the jurisdiction before the Council and make its claim/ counterclaim as otherwise, it will defeat the very objects of the Act which is beneficial legislation to micro, small and medium enterprises. Even in cases where there is no agreement for resolution of disputes by way of arbitration, if the seller is a party covered by the Micro, Small and Medium Enterprises Development Act, 2006, if such party approaches the Council for resolution of the dispute, other party may approach the civil court or any other forum making claims on the same issue. If two parallel proceedings are allowed, it may result in conflicting findings.

The Hon’ble Supreme court reiterated the principle of Generalis Specialibus non Derogant at this instance. It was stated that “At this stage, it is relevant to notice the judgment of this Court in the case of Edukanti Kistamma (Dead) through LRs. v. S. Venkatareddy (Dead) through LRs. & Ors. where this Court has held that a special Statute would be preferred over a general one where it is a beneficial one. It was explained that the purport and object of the Act must be given its full effect by applying the principles of purposive construction.”

Therefore, it was ruled and clarified by the Hon’ble Supreme Court that “out of the two legislations, the provisions of MSMED Act will prevail, especially when it has an overriding provision under Section 24 thereof. Thus, we hold that MSMED Act, being a special Statute, will have an overriding effect vis-à-vis Arbitration and Conciliation Act, 1996, which is a general Act. Even if there is an agreement between the parties for the resolution of disputes by arbitration, if a seller is covered by the Micro, Small, and Medium Enterprises Development Act, 2006, the seller can certainly approach the competent authority to make its claim. If any agreement between the parties is there, same is to be ignored given the statutory obligations and mechanism provided under the 2006 Act.”

CONCLUSION

It is important to note that in the case of Silpi Industries, the court also clarified that benefits under the MSMED act cannot be availed retrospectively if an entity has not done the required registration as per section 8 of the MSMED Act. Therefore, before entering into a contract with the buyer, the seller must do the required registration. This was also highlighted by the Bombay high court in the case of Scigen Biopharma Pvt. Ltd. v. Jagtap Horticulatuer Pvt. Ltd, stating that “by taking recourse to sub-section (1) of Section 8, the respondent merely filing at its discretion an entrepreneur’s memorandum, could not have assumed a legal status of being classified under the MSMED Act as a small enterprise, retrospectively from the day on which the appellant entered into a contract with the respondent. The respondent thus could not have become a small enterprise or a supplier within the purview of MSMED Act, 2006 by such prospective filing of an entrepreneur’s memorandum which on the face of it had a consequence from a prospective date and not retrospectively to enable the respondent to take benefit of Chapter V and more particularly of Section 18."

The judgment passed by the Supreme Court clarifies issues of jurisdiction, interplay, conflict of laws, and the applicability of the MSMED act. This judgment has resolved a lot of confusion that arose during the disputes involving MSME’s. Most importantly it is also observed that by adopting the principle of purposive construction, the Hon’ble Supreme court has helped in avoiding multiple proceedings in different forums.