India: Tracking Down The Courts In The Interplay Between The Arbitration Act, 1996 And The MSMED Act, 2006: Who Overrides Whom?

Abstract:

In current times, almost all commercial contracts have an arbitration clause, so, do the contracts between micro, small and medium enterprises (the "MSME") i.e. supplier and non-MSME i.e. buyer. The arbitration clauses are governed by Arbitration and Conciliation Act, 1996 (the "Arbitration Act") in India. However, for the protection and benefit of MSMEs, Indian Parliament has enacted a separate piece of legislation called Micro, Small and Medium Enterprises Development Act, 2006 (the "MSMED Act"). The MSMED Act under Section 18 provides arbitration as a dispute resolution mechanism while simultaneously overriding the Arbitration Act. The Supreme Court in Principal Chief Engineer v. M/s Manibhai and Brothers (Sleepers) has held that the provisions of the MSMED Act shall prevail over the arbitration clause. However, there are few circumstances when the arbitration clause would prevail over the MSMED Act when the reference to the arbitration clause is made first as held in AVR Enterprises v. Union of India, and the supplier is a registered MSME under Section 8 of the MSMED Act on the date of agreement/supply as held in Khyaati Engineering v. Prodigy Hydro Power Pvt. Ltd. in 2021. Further, if a non-MSME i.e. buyer invokes the arbitration clause, the power of the court to appoint an arbitral tribunal under Section 11 of the Arbitration Act would not stand ousted as held in Porwal Sales v. Flame Control Industries. This article attempts to track down these developments by the Indian courts and the related dimensions of conflicts between the Arbitration Act and the MSMED Act.

TRACKING DOWN THE COURTS IN THE INTERPLAY BETWEEN THE ARBITRATION ACT, 1996 AND THE MSMED ACT, 2006: WHO OVERRIDES WHOM?

INTRODUCTION

Party autonomy principle allows parties to an agreement to decide the mode of settlement of disputes and the procedure involved therein. Arbitration, is one such mode and can be defined as: (per the Oxford dictionary)

In current times, arbitration has become a preferred mode of dispute resolution. Almost every commercial contract has an arbitration clause.

Arbitration as a mode of alternate dispute resolution and has been evolving continuously, systematically and, with vigour. It was formally recognised under the Arbitration and Conciliation Act, 1940 and now under the Arbitration and Conciliation Act, 1996 (the "Arbitration Act") in India.

The Arbitration Act was passed to define the law relating to arbitration and conciliation and for matters connected therewith or incidental thereto. As per Section 8 of the Arbitration Act, courts have power to refer parties to arbitration where there is an arbitration agreement under Section 7 of the Arbitration Act. The Arbitration Act also provides the provisions to be dealt in case an arbitrator is appointed and hence, the arbitration proceedings.

ARBITRATION IN MICRO, SMALL AND MEDIUM ENTERPRISES DEVELOPMENT ACT, 2006

It is pertinent to mention that arbitration as a mode of dispute resolution has been incorporated under the Micro, Small and Medium Enterprises Development Act, 2006 (the "MSMED Act").

The MSMED Act was notified in 2006 to address policy issues affecting Micro, Small and Medium Enterprises (the "MSMEs") as well as the coverage and investment ceiling of the sector. The MSMED Act seeks to facilitate the development of these enterprises and also enhance their competitiveness.

The reference of disputes under the MSMED Act is made to a facilitation council which is a statutory tier-wise dispute resolution mechanism. The dispute is initially attempted to be resolved by the facilitation council through conciliation either by itself or by making a reference to an institution/centre for conducting conciliation under the aegis of the Arbitration Act as per Section 18(1) and (2) of the MSMED Act.

The MSMED Act do not provide for a separate method of conducting conciliation and as per Section 18(2), provisions of Sections 65 to 81 of the Arbitration Act shall apply to the dispute "as if the conciliation was initiated under Part III of that Act."¹

Furthermore, under Section 18(3) of the MSMED Act, when the dispute fails to settle through conciliation, then the Council shall either take up the dispute itself for arbitration or refer it to an institution for such arbitration and "..the provisions of the Arbitration and Conciliation Act,1996 shall then apply to the dispute as if the arbitration was in pursuance of an arbitration agreement referred to in sub-section (1) of section 7 of that Act..."²

SO, WHETHER THE FACILITATION COUNCIL IS AN ARBITRAL TRIBUNAL UNDER THE ARBITRATION ACT?

The Punjab & Haryana High Court in Welspur corp. Ltd., v. Micro and small Medium Enterprises Facilitation Council, Punjab & others³ while dealing with a matter filed under Section 11 of the Arbitration Act seeking to appoint a separate arbitrator after filing the reference under MSMED Act held that the facilitation council itself is an arbitrator and hence no need of appointing another arbitrator.

Further, the Division Bench of the Gujarat High Court while dealing with the same proposition in Saryu Plastics Pvt. Ltd. v. Gujarat Water Supply and Sewerage Board⁴ held that, upon a reading of Section 18 of MSMED Act, the facilitation council is authorised to conduct conciliation either itself or refer the same to any center providing alternate dispute resolution services. The council is also authorised to arbitrate and render an award.

DOES THE ARBITRATION ACT AND MSMED ACT CONFLICT?

There is a mixing of the two acts where one takes over from the other after a point. Conflict often arises between the applicability of provisions of the MSMED Act and the Arbitration Act because the parties invariably have an agreement that has an arbitration clause. This could be either a formal arbitration agreement or even an arbitration clause in a purchase order placed by the buyer (which is usually a non-MSME). If one of the parties fall within the definitions of a MSME, then, in case of a dispute, the more preferable option for the MSME entity is to initiate proceedings under the MSMED Act being simpler and convenient.

Interestingly, the MSMED Act itself provides for arbitration proceedings in terms of the Arbitration Act and still seeks to override the Arbitration Act by providing for certain special incentives to the MSMEs.

The special incentives includes but not limited to:

• the requirement of a pre-deposit of 75% is only on the buyer. This is an onerous condition and is one of the biggest factors that discourage the buyer from submitting to the jurisdiction of the MSMED Act. The constitutionality of this provision was put to test before the Kerala High Court in Kerala S.R.T.C. v. Union of India⁵which was upheld subsequently by the Supreme Court in Goodyear India Limited v. Norton Intech Rubbers (P) Ltd.⁶ Thus, the mandatory pre-deposit is a sine qua non for filing an appeal and ought to be followed.
• another is the territorial jurisdiction, that renders the seat of arbitration, as envisaged in the arbitration clause, as inoperable and useless because Section 18(4) of the MSMED Act lays that the jurisdiction will be decided on the basis of where the supplier/MSME is located.

There are a lot of legal conflicts between the MSME and the non-MSME entities are premised on whether the dispute should be decided under the Arbitration Act or the MSMED Act.

MAINTAINABILITY OF AN ARBITRATION CLAUSE AGAINST THE MSMED ACT

• Where the supplier (an MSME) had initiated proceedings under Section 18 of the MSMED Act before the buyer invoked arbitration under the agreement

Section 18 of the MSMED Act provides for reference of a dispute to the facilitation council which has been a subject matter of dispute in various cases where a buyer party involved in a dispute with a supplier filed proceedings in court challenging the applicability of the said Section to their dispute in light of the arbitration agreement entered between the parties.

M/s Steel Authority of India and Anr. v. MSEFC⁷ (Steel Authority of India), was the first noteworthy case on the issue of maintainability of an arbitration clause against the MSMED Act. The Court held that by virtue of the non-obstante clause in Section 18 of the MSMED Act, it cannot be said that an independent arbitration agreement between the parties will cease to have effect as the overriding clause only overrides things inconsistent therewith and there is no inconsistency between an arbitration conducted by the facilitation council under Section 18 and arbitration conducted under an individual clause since both are governed by the provision of the Arbitration Act. It was further held that that since the parties had entered into an independent arbitration agreement, the council could not proceed with the arbitration itself. However, subsequently, there was a change in the judicial trend and the effects of this judgment was weakened.

Also, in Ramky Infrastructure Private Ltd. v. Micro and Small Enterprises Facilitation Council,⁸ the Delhi High Court held that the reference under Section 18 of MSMED Act is a statutory reference and is dehors any arbitration agreement between the parties.

In Bharat Heavy Electricals Limited v. State of Uttar Pradesh,⁹ the Allahabad High Court diverged from the aforesaid case by holding that:

The principle set out in Steel Authority of India was further diluted by the Punjab and Haryana High Court in The Chief Administrator Officer, COFMOW v. MSEFC of Haryana,¹⁰ wherein it was contended that the pre-existing independent arbitration agreement between the parties specifically provided for a procedure to appoint the arbitrator and that this should be upheld. However, the court eventually held that:

In the Principal Chief Engineer v. M/s Manibhai and Brothers (Sleepers)¹¹ before the Gujarat High Court, the Court rejected and overruled the view of the Bombay High Court in Steel Authority of India and held that the provisions of the MSMED Act shall prevail over the arbitration clause. The order of the Gujarat High Court was challenged in the Supreme Court and the Supreme Court upheld the decision. The is the current law prevailing in India.

Several High Courts have relied on the above decision like in Bata India Limited v. Avs International Private.¹² In fact, the Bombay High Court itself rejected the interpretation in the SAIL judgment and followed the decision in Gujarat State Petronet v. MSEFC¹³ and M/s Porwal Sales v. M/s Flame Control Industries.¹⁴

In Ge T&D India Limited v. Reliable Engineering Projects,¹⁵ Delhi High Court, wherein it was categorically held that the MSMED Act overrides the Arbitration Act to the extent that it provides for a special forum for the adjudication of disputes involving a supplier registered thereunder. The court stated that Section 18(3) of the MSMED Act contemplates only institutional arbitration and not ad hoc arbitration. The court followed this decision in Bharat Heavy Electricals Limited v. The Micro and Small Enterprises Facilitation Centre,¹⁶ and also held "respectfully, unable to concur with the view of the Bombay High Court in Steel Authority of India."

Accordingly, the Bombay High Court's view in Steel Authority of India, that independent arbitration agreements would not cease to exist despite providing for ad hoc arbitration, was held to be unsustainable. This case in fact clarifies the distinction between institutional or statutory arbitration on one hand versus an ad hoc arbitration initiated independently in terms of an agreement between the parties.

In Mangalore Refinery & Petrochemicals Ltd v. Micro and Small Enterprises Facilitation Council,¹⁷ the Delhi High Court relied on Bharat Heavy Electricals Limited v. The Micro and Small Enterprises Facilitation Centre¹⁸ to hold as follows:

• Buyer (Respondent, a non-MSME) invoked arbitration under the agreement

The Bombay High Court in Porwal Sales v. Flame Control Industries,¹⁹ dealt with a situation where the Buyer (Respondent) invoked arbitration under the agreement between the parties without any reference of a dispute to the facilitation council and had 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 contentions of the supplier was that 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.

So, the issue before the Court was whether the power of the court to appoint an arbitral tribunal under Section 11 of the Arbitration Act was ousted even in a case where the MSME entity had not invoked the Council's jurisdiction under Section 18 of the MSMED Act.

The Court rejected the contentions and held that:

• if the intention of Section 18(4) of the MSMED Act was to create a legal bar on a party who has a contract with a supplier under the MSMED Act from invoking Section 11 of the Arbitration Act, then the legislature would have expressly provided that the MSMED Act overrides any arbitration agreement entered into with a supplier under the MSMED Act.
• Section 18(4) would come into play only in cases where a reference was made to the Council under Section 18(1). The Court considered 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.

Recently, the Bombay High Court in the matter of the Microvision Technologies Private Limited v. Union of India,²⁰ inter alia, held that an arbitration agreement between the parties shall not cease to have effect irrespective of the powers of facilitation council under Section 18(3) of the MSMED Act to act as an arbitrator or refer the dispute to arbitration. The High Court relied on the judgment of the Bombay High Court in Steel Authority of India Ltd., wherein it was inter alia held that merely because the Section 18 provides for a forum of arbitration, an independent arbitration agreement entered into between the parties will not cease to have effect.

The High Court accordingly held that though the facilitation council have jurisdiction to take up a dispute for arbitration or refer it to an institution or a centre for arbitration notwithstanding anything contained in an arbitration agreement between the parties, the arbitration agreement shall continue to be valid even in the face of the facilitation council's powers under Section 18 of the MSMED Act.

THE FIRST MOVER ADVANTAGE: THE DISPUTE RESOLUTION MECHANISM INVOKED FIRST SHALL PREVAIL OVER THE OTHER

In AVR Enterprises v. Union of India,²¹ the MSME itself invoked the arbitration clause (instead of making a reference under Section 18 of the MSMED Act) and subsequently, sought to rely on certain beneficial provisions of the MSMED Act.

The Delhi High Court held that even though the petitioner may be covered under the MSMED Act, as it did not invoke its claim under Section 18 of the MSMED Act or seek reference thereunder, there was no question of it taking advantage of the benefit provided under the MSMED Act as:

There was no reference made to facilitation council, initially. The council also did not take up any dispute for arbitration nor did it refer any dispute to institution or centre providing alternate dispute resolution services like arbitration. Arbitration in the this matter was not an Institutional Arbitration as contemplated under Section 18 of the MSMED Act but was conducted under the Arbitration Act by an Arbitrator privately appointed.

OVERRIDING BY SPECIAL STATUTES

The High Court of Bombay in the case of Bharat Sanchar Nigam Limited v. Maharashtra Micro and Small Enterprises,²² held that there is no provision in the MSMED Act which negates or renders an arbitration agreement entered into between the parties as ineffective. Hence, it cannot be said that because Section 18 provides for a forum of arbitration to the extent that an independent arbitration agreement entered into between the parties will cease to have effect.

There is no question of an independent arbitration agreement ceasing to have any effect because the overriding clause only overrides provisions of law that are 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.

However, later, the court in Principal Chief Engineer v. Manibhai And Bros (Sleeper)²³ wherein it held that the MSME can invoke the provisions of the MSMED Act and refer a dispute to the facilitation council, in spite of the existence of an arbitration clause. The Hon'ble Supreme Court upheld the Gujarat High Court's judgment on the interpretation of Section 18 of the MSMED Act stating that since the MSMED Act is a special legislation and has an overriding effect, the parties governed by it are bound to follow the mechanism provided under Section 18 of the MSMED Act. Similar view has been taken by the High Courts in various other cases.

In M/s Silpi Industries v. Kerala State Road Transport Corporation²⁴ decided in June 2021, the Hon'ble Supreme Court held that the MSMED Act is a special statute and the Arbitration Act is a general Act. It was further, held that even if there was an agreement between the parties for settlement of disputes by arbitration and the supplier is covered by the MSMED Act, the supplier can certainly approach the competent authority to make its claim under the said act. If any agreement between the parties is there, same shall be ignored in view of the statutory obligation and mechanism provided under the MSMED Act.

WHAT IF THE MSME NOT REGISTERED ON THE DATE OF THE AGREEMENT/SUPPLY

Section 2(n) of the MSMED Act defines the term 'supplier', however, it does not specify whether registration under Section 8 of the MSMED Act is mandatory in order to avail the remedy of making a reference to the facilitation council.

In Hameed Leather Finishers v. Associated Chemical²⁵, Indur District Cooperative Marketing Society Ltd. v. Microplex (India) Hyderabad and Ors.²⁶ and GE T&D India ltd. v. Reliable Engineering Projects and Marketing²⁷ the courts held that registration of a supplier as a micro / small enterprise is not relevant for initiating proceedings before the Facilitation Council and hence, not mandatory. However, the same has been overruled.

Recently, in Khyaati Engineering v. Prodigy Hydro Power Pvt. Ltd.²⁸ where claimed Khyaati Engineering to be supplier under MSMED Act, executed a contract to for supply of hydro-mechanical instrument. Later, the buyer refused to make payment on the ground the supplier had breached the terms and conditions of the contract. As per the arbitration clause of the contract both parties shall appoint their own arbitrators. The buyer invoked the clause, nominated its own arbitrator and approached the Madras High Court for appointment of second arbitrator on supplier's failure to appoint its arbitrator who appointed the same.

The decision was challenged in the Supreme Court and the court held that the supplier did not had registration under the MSMED Act on the date the goods were supplied by the supplier. The Court held that to seek the benefit of provisions under the MSMED Act, the supplier should have registered under the provisions of the MSMED Act, as on the date of entering into the contract. And since in this case, since there was no such registration, the Madras High Court was right in appointing the second arbitrator and the proceeding could not be governed under the MSMED Act as per the arbitration agreement executed between the parties.

Hence, the Hon'ble Court has cleared the confusion that arises regarding applicability of the MSMED Act when there is a separate arbitration clause in the agreement and the supplier is an unregistered MSME. Earlier, in Nik San Engineering Co. Ltd v. Easun Reyrolle Ltd.,²⁹ Frick India Ltd. v. Madhya Pradesh Micro And Small Enterprises Facilitation Council³⁰ and Scigen Biopharma Pvt. Ltd. v. Jagtap Horticulture Pvt. Ltd.³¹ respectively and now the Supreme Court in 2021 in M/s Silpi Industries v. Kerala State Road Transport Corporation³² and Khyaati Engineering v. Prodigy Hydro Power Pvt. Ltd.³³ held that the unit must be registered under Section 8 of the MSMED Act on the date the transaction took place in order to qualify as a supplier under Section 2(n) and to take this advantage of the mechanism provided under Chapter V. It was further held that a subsequent registration also would not confer any benefit upon the unit.

Even though the judgement clears the confusion on applicability of the MSMED Act. The financial distress being faced by micro and small enterprises due to the COVID-19 pandemic is likely to lead to an increase in disputes. The judgement negated this aspect and seems to overlook the objective of the MSMED Act to provide a forum and mechanism for speedy recovery of delayed payments to MSMEs. However, in light of this judgment, such entities would not be able to avail the benefit unless they had obtained registration under the MSMED Act prior to execution of the contract.

CONCLUSION

Plenty of legal tussles between the MSME and the non-MSME entities are premised on whether the dispute should be decided under the Arbitration Act or under the MSMED Act. In Steel Authority of India,³⁴ the Bombay High Court had restricted the facilitation council to proceed under the provisions of Section 18(3) of the MSMED Act in view of independent arbitration agreement between the parties. However, the judgement was later diluted by the courts and finally overruled in Principal Chief Engineer v. M/s Manibhai and Brothers (Sleepers)³⁵ and subsequent judgements. The provisions of the MSMED Act shall prevail over the arbitration clause provided the supplier has not invoked the arbitration clause first.

However, there are circumstances when arbitration clause shall prevail e.g. the supplier is not a registered MSME as on the date of supply agreement as per Supreme Court in the 2021 judgement given in the Khyaati Engineering v. Prodigy Hydro Power Pvt. Ltd.³⁶ Further, if the reference to the arbitration clause is made first, the arbitration shall be continued and no benefits of proceedings as under the MSMED Act shall be available as held in AVR Enterprises v. Union of India.³⁷ Finally, if a non-MSME i.e. buyer invokes the arbitration clause, the power of the court to appoint an arbitral tribunal under Section 11 of the Arbitration Act would not stand ousted as held in Porwal Sales v. Flame Control Industries.³⁸

On the one hand, proceeding with the MSMED Act caters the special needs of an MSME which may not have the resources of financially opting for ad hoc arbitrations. But, on the other hand, the party autonomy, which is a core feature of arbitration is put to test and at times negated due to such statutory dispute resolution. The courts have attempted to recognise the lines of demarcation when the arbitration clause shall prevail, however, more effort is needed to strike balance between the statutory resolution and party autonomy mechanism.

Abhishek is a student of Hidayatullah National Law University and a Winner in the Honourable Mention category of the 8^th Ed. Arb Excel Essay Writing Competition.

Footnotes

1. Section 18 (2), Micro, Small and Medium Enterprises Development Act, 2006.

2. Section 18 (3), Micro, Small and Medium Enterprises Development Act, 2006.

3. C.W.P. No. 23016 of 2011.

4. Special Civil Appl. No. 12769 of 2017.

5. 2009 SCC OnLine Ker 6621.

6. (2012) 6 SCC 345.

7. Bombay HC WP 2145/2010 OR AIR 2012 Bom 178.

8. 2018 SCC OnLine Del 9671.

9. (2014) (4) ALJ 52.

10. CWP 277/2015 High Court of Punjab & Haryana.

11. AIR 2016 Guj 151.

12. O.M.P.(I) (COMM.) 201/2019.

13. WRIT PETITION NO.5459 OF 2015.

14. Bombay HC, Arbitration Petition No. 77 Of 2017.

15. 2017 SCC OnLine Del 6978.

16. 2017 SCC Online Del 10604.

17. 2019 SCC Online DEL 6860.

18. 2017 SCC Online Del 10604.

19. Judgment dated August 14, 2019, Bombay HC, Arbitration Petition No. 77 Of 2017.

20. Commercial Arbitration Petition (L) NO. 855 OF 2018.

21. CM(M) No. 769/2018.

22. Arbitration Petition No. 990 OF 2014.

23. AIR 2016 Guj 151.

24. 2021 SCC OnLine SC 439.

25. 2013 SCC OnLine ALL 9058.

26. 2016 (3) ALD 588.

27. 2017 SCC OnLine Del 6978.

28. Civil Appeal No. 1620 -1622 of 2021.

29. 2019 SCC OnLine Guj 2474.

30. 2020 GLH (1) 636.

31. Bombay High Court Arbitration Appeal No. 23 of 2018.

32. 2021 SCC OnLine SC 439.

33. Civil Appeal No. 1620 -1622 of 2021.

34. Bombay HC WP 2145/2010 OR AIR 2012 Bom 178.

35. AIR 2016 Guj 151.

36. Civil Appeal No. 1620 -1622 of 2021.

37. (M) No. 769/2018.

38. Judgment dated August 14, 2019, Bombay HC, Arbitration Petition No. 77 Of 2017.

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