Evolving MSME Jurisprudence: A Look At Important Decisions From 2023

Keeping in line with the above objective, the burgeoning importance of MSMEs in India's economic fabric has spurred a parallel need for a robust legal framework, and the year 2023 witnessed the judiciary proactively responding to this necessity. Through a series of crucial decisions, the courts have not only interpreted the intricacies of the MSMED Act but have also provided the much-needed clarity sought by stakeholders navigating through this evolving legislation. Such an approach is clearly reflective of the fact that this legislation has started gaining momentum warranting interpretation of relevant provisions to bring in much needed clarity and consistency on various aspects including the statutorily provided dispute resolution process.

The MSMED Act provides for mandatory conciliation preceding the statutory arbitration process as a mode of dispute resolution. Moreover, the MSMED Act provides for statutory arbitration through the Council which supersedes contractual arbitration, in case of failure of conciliation and in effect, promotes institutional arbitration. This in turn aligns with the larger objective of promoting speedy and efficient resolution/ adjudication of disputes which is at the root of alternative dispute resolution mechanisms.

As we analyse the key judgments referred to in this compilation, it becomes evident that the jurisprudential landscape surrounding the MSMED Act is in a state of continuous evolution. The courts' interpretations and definitive rulings in 2023 have not only addressed specific legal questions but have also laid the foundation for the development and refinement of MSME-related jurisprudence in the years to come. Through these rulings, the judiciary has addressed crucial questions and key issues such as:

Whether the dues under the MSMED Act prevails over the recovery proceedings under the SARFAESI Act?

In Kotak Mahindra Bank v. Girnar Corrugators,^[1]the Supreme Court clarified that the obligations arising under the MSMED Act do not take precedence over the dues of a secured creditor under the SARFAESI Act. The court emphasized that the overriding effect granted to Sections 16-23 of the MSMED Act is limited to the adjudication of disputes and special provisions for the interest component. However, no similar overriding effect is conferred on the recovery of dues.

Drawing a distinction, the court pointed out that, unlike Section 26E of the SARFAESI Act, which accords priority to the secured creditor's dues over all other debts recoverable under any other law, the MSMED Act lacks a comparable provision. Consequently, the court held that the recovery mechanism stipulated in the SARFAESI Act would prevail over the recovery mechanism outlined in the MSMED Act.

Whether the Promoter of an MSME can submit a Resolution Plan when the registration was obtained after the commencement of CIRP?

In Hari Babu Thota^[2] the Supreme Court clarified that Section 29A (c) & (h) of the Insolvency and Bankruptcy Code (IBC), which restricts promoters of corporate debtors from submitting resolution plans, does not apply to Micro, Small, and Medium Enterprises (MSMEs). This exception is based on the special provision outlined in Section 240A (1) of the Code. The Court, relying on the Insolvency Law Committee (ILC) Report 2018, highlighted that MSMEs receive this protection due to the unique nature of their business and the challenge in attracting resolution applicants, making them susceptible to liquidation.

Next, the Court determined the 'cut-off date' for the purpose of application of Section 240(A) (1). It referred to the statement by the then Finance Minister while moving the 2018 Amendment Bill, where the cut-off date was mentioned as the 'date of the application making a bid.' Consequently, the Court clarified that the cut-off date is the date of submitting the resolution plan, not the commencement of the Corporate Insolvency Resolution Process (CIRP). Thus, the Court affirmed that a promoter of an MSME can submit a resolution plan even if MSME registration is obtained after the commencement of CIRP but before the date of applying for the resolution plan.

Whether the location of the Supplier/MSEF Council would be the 'Seat of Arbitration' in presence of a conflicting exclusive jurisdiction clause in the agreement between the parties?

In Ahluwalia Contracts v. Ozone Research^[3] a single judge bench of the High Court of Delhi held that the seat of arbitration would be where the supplier is located in terms of Section 18(4) of the MSMED Act despite any agreement between the parties that provide for jurisdiction on the Courts in a different place. It held that Section 18 r/w Section 24 of the Act overrides the terms of the contract/arbitration agreement between the parties.

However, the Division Bench in a subsequent judgment in IRCON International Ltd v. Pioneer Fabricators^[4] disagreed with the view expressed by the single bench in Ahluwalia Contracts. The Court held that the location of MSEF Council in terms of Section 18(4) of the MSMED Act would be the venue of arbitration and not the seat. The Court relied upon the decision of a coordinate bench in IOCL v. FEPL Engineering^[5] wherein the Court held that, for an arbitration upon a reference under Section 18(2) of the MSMED Act, the seat would still be determined in accordance with the terms of the arbitration agreement between the parties.

In Gammon Engineers v. Sahay Industries^[6] the High Court of Bombay ruled on similar lines and followed the judgment by the Delhi High Court in IOCL. The Court held that the once an award is passed by the Facilitation Council and the agreement between the parties provide for an exclusive jurisdiction clause, then only the Court upon which the parties have conferred exclusive jurisdiction shall entertain a petition challenging the award. Further, it held that the location of the Facilitation Council would remain the venue of arbitration in such a situation.

Whether the 'Buyer' can independently approach the Facilitation Council for adjudication of its claims?

In Uniseven Engineering v. MSEF Council^[7]the High Court of Delhi held that Sections 15-17 of the MSMED Act exclusively empower only the 'supplier' to approach the Facilitation Council for the recovery of dues. The court emphasized that these provisions do not pertain to an autonomous claim initiated by the 'Buyer' against the supplier. The court underlined that a straightforward interpretation of the statute clearly restricts its applicability to claims recoverable by Suppliers registered under the Act as Micro or Small Enterprises. Given that the MSMED Act of 2006 is specifically enacted to extend benefits to such Suppliers, it does not envisage the reverse obligation – claims related to the amount recoverable from Suppliers under the Act.

Nevertheless, the court clarified that if the 'Supplier' initiates a reference under Section 18 of the Act, the 'Buyer' can subsequently file a counter-claim against the Supplier.

Does the MSMED Act pose limitations on a party's ability to seek interim reliefs under Section 9 of the Arbitration and Conciliation (A&C) Act?

This issue was examined by the High Court of Calcutta in IOCL v. Union of India^[8] wherein the Court held that a reference under Section 18 of the MSMED Act would not be barred merely because the applicant had first approached the Court for interim reliefs under Section 9 of the A&C Act. It held that there is no conflict between the provisions of Section 18 of the MSMED Act and Section 9 of the A&C Act. Further, it held that doctrine of election of remedies would have no application in this context, given that the MSMED Act lacks corresponding provisions for interim relief.

Can the MSEF Council delegate the task of calculating the interest component to a Chartered Accountant?

This issue recently fell for consideration before the High Court of Calcutta in Government of Maharashtra v. Shrivin Pharma.^[9] The court unequivocally ruled that the Facilitation Council is not permitted to delegate the calculation task to a third party, including Chartered Accountants. The court emphasized the significance of the matter in light of Section 16 of the Act, which establishes the buyer's responsibility for compound interest with monthly rests at three times the bank rate.

According to the court's analysis, Section 16 outlines a comprehensive procedure for determining interest, covering not only the rate but also specifying the duration for which interest is payable. The court highlighted the complexity of calculating the rate and the commencement date for the buyer's interest payment under Section 16 of the MSMED Act, emphasizing that such calculations are integral to the tribunal's decision and an inseparable part of the award. Accordingly, the Court held that delegation of such an important part of adjudication process is not permissible under the A&C Act.

Whether a 'Medium Enterprise' can maintain a reference u/s 18 of the MSMED Act if it was either a 'Micro' or a 'Small' enterprise at the relevant time?

In Sterlite Power Transmission v. EPC Solutions^[10] the High Court of Delhi held that a reference application moved by a 'Medium Enterprise' for the recovery of dues would be maintainable if it was either a 'micro' or a 'small' enterprise at the relevant time. It held that the relevant time for the purpose of Section 18 reference would be date of the agreement or date when the supplies were made, therefore, any subsequent upgradation of the enterprise would not preclude it from getting the benefits of the beneficial legislation.

Whether a reference u/s 18 can be filed for recovery of the interest when the principal amount it already paid?

In State Project Director v. National Printers,^[11] the Jharkhand High Court held that a Section 18 reference under the MSMED Act can extend to the recovery of interest, specifically when the principal amount has been settled belatedly. It held that under the Act, the liability is not restricted to the mere payment of the principal amount, but liability separately crystalises for both the principal as well as the interest amount. It held that non-payment of interest on the belated payment of the principal amount is a due under Section 17 of the Act for which a reference under Section 18 is payable.

Whether the benefit of Section 16 of the MSMED Act can be extended to a 'Medium Enterprise'?

The High Court of Calcutta in New India Assurance Co. Ltd v. WinsomeInternational Ltd^[12] held that the benefit of Section 16 extends only to a 'supplier' as defined under Section 2(n) of the Act which does not include a 'Medium Enterprise', therefore, the Facilitation Council cannot calculate the rate of interest by applying the provisions of Section 16 to a claim by the Medium Enterprise.

Whether the failure of the Facilitation Council to Conciliate between the parties is a ground for setting aside of the consequent award?

In National Aluminium Company v. Orissa Coal Chem^[13] the High Court of Orissa held that an award passed by the Facilitation Council, without conducting the mandatory conciliation as stipulated under Section 18(2) of the MSMED Act, is liable to be set aside under Section 34 of the A&C Act.

The Court emphasized that merely directing parties to attempt amicable settlement does not suffice as compliance with Section 18. It stressed that the Council must appoint a conciliator to actively facilitate dialogue between the parties. Consequently, the Court nullified the award due to the Council's failure to effectively mediate between the disputing parties.

Whether the order of the Facilitation Council, dismissing reference at the threshold, can be termed an 'award' for the purpose of challenge under Section 34 of the A&C Act?

In State Project Director v. National Printers^[14] the Jharkhand High Court clarified that an order from the Facilitation Council, dismissing a reference at the initial stage without engaging in conciliation or arbitral proceedings, does not qualify as an arbitral award for the purpose of challenging under Section 34 of the Arbitration and Conciliation (A&C) Act read with Section 19 of the MSMED Act. In this case, the facilitation council dismissed the reference on the ground that no reference is maintainable for the recovery of the interest amount when the principal has been belatedly paid.

The Court emphasized that as the order doesn't meet the criteria of an award, the remedy provided under Section 34 is unavailable to the aggrieved party. Consequently, the aggrieved party is entitled to directly challenge the decision through a writ petition.

Whether the award passed by the MSEF Council can be stayed in absence of mandatory deposit of 75% awarded amount?

In Borad of Major Port Authority v. Marine CraftEngineers^[15] the High Court of Calcutta clarified that the stay of an arbitration award by the MSEF Council under Section 36(2) of the A&C Act is contingent upon the petitioner depositing 75% of the awarded amount along with the Section 34 petition, as mandated by Section 19 of the MSMED Act. The Court held that a petition under Section 34 of the A&C Act remains 'stillborn' for the purpose of stay on the award under Section 36(2) in absence of the mandatory deposit of the awarded amount.

Whether the CA Firms appointed as 'Special Auditors' under Section 142(2A) of the Income Tax Act can invoke MSMED Act against the Department for recovery of dues for their services?

In Commissioner of Income Tax v. MSEFC^[16] the High Court of Delhi held that a Chartered Accountancy firm, appointed as a 'Special Auditor' by the department under Section 142(2A) of the IT Act, 1961, is not eligible to file a reference under Section 18 of the MSMED Act to recover dues for conducting audits on behalf of the department.

The Court emphasized that the appointment under Section 142(2A) constitutes a statutory assignment, distinct from a contractual relationship governed by the MSMED Act. It clarified that payments received for such audits should not be considered as 'consideration,' as the firm is fulfilling a statutory duty on behalf of the Assessing Officer (AO). Furthermore, the Court asserted that determining the remuneration for these services rests solely with the department, as outlined in Section 142(2D) of the Act read in conjunction with Section 14B of the IT Rules.

In 2023, the Indian judiciary played a crucial role in shaping the MSME legal landscape. Key decisions addressed critical issues like arbitration seat determination, the synergy between the MSMED Act and arbitration agreements, award enforceability, and the unique challenges faced by MSMEs in insolvency matters.

These decisions underscore the importance of a nuanced understanding of MSME legal framework, fostering both legal certainty and fair practices for businesses operating in this sector. As MSME law continues to evolve, these judgments serve as guidance for further development and refinement in the legal framework, contributing to the overall growth and sustainability of micro and small enterprises in India.

Jeevan Ballav Panda, Advocate at Supreme Court and Delhi High Court. Ausaf Ayyub, Arbitration Correspondent at LiveLaw. Views are personal.