Arbitration And MSME's Tuff: Can Interest Rates Under The MSME Act Survive Outside Of Section 18 Proceedings?

In a dynamic commercial ecosystem of India as it is today, delays in payments to micro, small and medium enterprises ("MSMEs") are a normal challenge. The Micro, Small and Medium Enterprises Development Act, 2006 ("Act") introduced a well thought of regime to curb such delays by imposing a statutory interest rate of three times the bank rate notified by the Reserved Bank of India under Section 16 of the Act for any buyer who fails to make payment within the agreed or stipulated timelines. This mechanism motivates the facilitation framework of the MSME Act wherein Section 15 creates the liability of the buyer, Section 16 mandates interest, Section 17 facilitates recovery and Section 18 delineates the mechanism for reference to the Micro and Small Enterprises Facilitation Council ("Facilitation Council").

Yet, in parallel commercial contracts parties routinely incorporate arbitration agreements under the Arbitration and Conciliation Act, 1996 ("A&C Act") to govern disputes. These overlapping provisions prompt a critical question: If parties enforce a contract via an arbitration clause, thereby bypassing Section 18 of the MSME Act, can the statutory interest rate under Section 16 still be claimed?

The Statutory Framework

Enacted to promote, develop and enhance the competitiveness of MSMEs, the Act seeks to ensure timely payment for goods supplied or services rendered by enterprises. Section 15 of the Act provides that where a supplier supplies goods or renders services to a buyer, the buyer must make the payment on or before the date agreed upon in writing between the parties. Where there is no such agreement, payment must be made before the appointed day as defined under Section 2(b) of the Act that is within fifteen days from the day of acceptance or deemed acceptance of the goods or services. The capping on any agreed payment period is of maximum forty-five days from such acceptance or deemed acceptance. Section 16 provides where a buyer fails to make payment to the supplier as required under Section 15, the buyer shall be liable to pay compound interest with monthly rests at three times the bank rate notified by the RBI. The provision expressly applies notwithstanding anything contained in any agreement between the buyer and the supplier or in any law for the time being in force thereby giving overriding effect. Section 17 declares that for any goods supplied or services rendered by a supplier, the buyer shall be liable to pay the amount with the interest specified under Section 16. Section 18 has then provided the enforcement mechanism wherein reference can be made to the Facilitation Council established by the respective State Government. The Council may first conduct conciliation under Sections 65–81 of the A&C Act and if conciliation fails, the Council shall either itself take up arbitration or refer the matter to an arbitral institution and the provisions of the A&C Act shall apply to such proceedings. Every reference under Section 18 is to be decided within ninety days of its filing. Finally, Section 24 reinforces the legislative intent that the MSME payment and interest regime overrides conflicting contractual or statutory provisions.

Arbitration and Party Autonomy

Under the A&C Act, parties by agreement may refer their disputes to arbitration and submit to its outcomes. Section 31(7) of the A&C Act empowers the arbitral tribunal to award interest at such rate as it deems reasonable. Party autonomy is one of the foundational principles of the A&C Act. The tension arises when that autonomy interacts with the special regime of MSMEs. The special statute versus general statute doctrine dictates where a later special legislation covers a field exhaustively, it may override the general law. Here, the Act is special and targeting MSMEs whereas the A&C Act is general. Historically, courts have held that arbitration agreements cannot displace statutory rights which are conferred for a public interest.

Judicial Divergence

The Supreme Court in Silpi Industries v. Kerala SRTC¹ emphasised the special statute nature of the Act and held that its framework has overriding effect. In that view, once the Act is invoked, the buyer cannot opt out via an arbitration clause. In Gujarat State Civil Supplies Corporation Ltd. v. Mahakali Foods Pvt. Ltd.², the Supreme Court reaffirmed that even an arbitration agreement cannot preclude reference under Section 18 of the Act. It held that the right under Section 17 of the Act for recovery cannot be opted out of and any contract clause inconsistent with the Act is void.

By contrast, several High Court decisions have adopted a narrower interpretation. For instance, in Indian Highways Management v. Sowil Ltd.³, the Court held that Sections 15 and 16 confer substantive rights independent of Section 18 invocation and thus an arbitration award could award interest under these sections even without reference to the Facilitation Council. Similarly, in Shristi Infrastructure Development v. Scorpio Engineering (P) Ltd.⁴, the Court held the same. On the other hand, the decision in Idemia Syscom India (P) Ltd. v. Conjoinix Total Solutions (P) Ltd.⁵ holds that if parties proceed under an arbitration agreement and do not invoke Section 18, then right to interest may not automatically apply. The splits produce practical uncertainty, while the statutory right is strong, its survival in pure commercial arbitration remains contested.

Critical Analysis

From a doctrinal standpoint, three positions emerge. The interest rate under Section 16 of the Act is a substantive right per se and thus enforceable in any forum be it the Facilitation Council or Arbitration. This view leans on the non-obstante clause and special statute doctrine. This would be the first position. The interest rate applies only when the supplier triggers the mechanism under Section 18 of the Act and follows the respective framework. Here, if an arbitration agreement is used instead and Section 18 mechanism is not invoked, the special MSME regime may not apply and the tribunal is limited to exercising interest powers under Section 31(7) of the A&C Act. This forms the second position. There exists a hybrid approach wherein the right to interest continues to exist as a substantive statutory right. However, its enforceability in arbitration instead of Faciliatation Council depends on procedural compliance and context like supplier's MSME registration and delayed payment under the Act. While the right itself must not be extinguished by choosing contractual arbitration, its practical enforcement may be based on these procedural prerequisites or on the arbitral tribunal's acceptance that the MSME interest regime applies to the dispute.

Our Two Cents

For MSMEs:

Maintaining registration under the Act and ensuring invoices note the day of acceptance or deemed acceptance and track the appointed day. Further, evaluating whether to initiate Facilitation Council under Section 18 of the Act or not in order to strengthen interest claim in case of disputes. Also, draft contracts to preserve rights and avoiding clauses waiving interest under Section 16 and if arbitration clause exists, explicitly ensuring bifurcated choice of forum.

For Buyers:

Reviewing standard supply contracts wherein payment terms should comply with Section 15 or negotiate acceptable modifications keeping MSME registration in mind. Deciding whether to include arbitration clause or not and if yes, factoring in interest under the Act. Tracking payment obligations and avoiding delay as registration of liability under the Act may create compound interest with monthly rests making the financial exposure significant.

Conclusion

The Act's interest regime is a potent tool for MSME suppliers; it serves as a structural deterrent against delayed payments and strengthens supplier bargaining power. The presence of an arbitration agreement does not automatically extinguish those rights but it complicates the enforcement path. Until the Supreme Court issues a definitive ruling, businesses must treat forum choice, contract drafting and dispute resolution strategy as central to managing interest risk. Legal and compliance teams must align supply-chain terms, contract clauses and dispute-resolution mechanisms with the present statutory framework, rather than assume arbitration will circumvent the statutory rate.

Footnotes

1 (2021) 18 SCC 790

2 (2023) 6 SCC 401

3 (2021) SCC OnLine Del 5523

4 (2025) SCC OnLine Del 2985

5 (2025) SCC OnLine Del 1023

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