Author - Putul Mehta
Putul is a fourth-year student at National Law University Odisha. She has a penchant for legal research and is passionate about exploring various aspects of commercial disputes.
Abstract
The central objective of Alternative Dispute Resolution (ADR) is to fashion effective, flexible, and less confrontational methods for resolving disputes, moving beyond traditional judicial litigation. However, in the nuanced legal framework of ADR Mechanisms in India, one of the most interesting contradictions has emerged. The Micro, Small and Medium Enterprises Development (MSMED) Act stands as a bulwark against arbitration, invalidating such agreements to protect the smaller enterprises and undermining the Arbitration and Conciliation 1996 Act (A&C Act).
This blog addresses these conflicts, specifically the limitations of Section 18 of the MSMED Act, and proposes reforms toward harmonization of conciliation and arbitration processes to increasethe effectiveness and fairness of the dispute resolution mechanism in a fast-changing Indian legal environment.
Exclusive Jurisdiction of the Facilitation Council
In the recent ruling of Gujarat State Civil Supplies Corporation Ltd. v. Mahakali Foods Pvt. Ltd., the conflict between the A&C Act and the MSMED Act was arguably resolved by the Supreme Court. It was decided that the MSMED Act supersedes the A&C Act since it is a specific statute. This decision maintained that, if section 18 of the MSMED Act was triggered, the facilitation council's ["Council"] arbitration proceedings would take precedence over the parties' arbitration agreement.
The court ruled that once section 18 is invoked, it overrides any other agreement independently entered into by the parties, and the Council has sole jurisdiction over the entire process. Therefore, an appeal pursuant to a party's arbitration agreement under section 11 of the A&C Act following the invocation of section 18 of the MSMED Act is futile. Unfortunately, without mechanisms to address delays caused by the Council, the beneficial intent of section 18 MSMED Act, which aims to allow parties to resolve disputes efficiently, becomes ineffective.
Breakdown of Section 18 – a compromise on party autonomy
It must be noted that party autonomy lies at the heart of this issue. When parties enter into an arbitration agreement, they choose their arbitration agreement after careful consideration of various factors akin to their dispute and the business relationship. Using the MSMED Act's mechanism to automatically override these agreements would seriously damage this important component and perhaps create uncertainty and unpredictability in business dealings.
Moreover, a closer inspection of the MSMED Act’s language reflects that the legislative intent favors a rather nuanced approach. Section 18 of the Act uses the word "may" in place of "shall"when discussing dispute settlement. This wording implies that the lawmakers intended to offer a dispute resolution option rather than a mandatory mechanism for eventual arbitration. This interpretation is reinforced by the fact that, in contrast to Section 16 of the same Act, the non-obstante language in Section 18 does not specifically mention "agreement." Therefore, these minor but important nuances in the language indicate that the Act was not designed to automatically replace pre-existing arbitration agreements between parties.
Substantive Features of Arbitration vs Procedural Aspects of Section 18
This interpretation is further supported by examining the nature of Section 18. Characterized as procedural and not substantive, this section represents an alternate dispute resolution option, without creating new substantive rights for the parties. Given that this is so, it is difficult to justify that section 18 has the effect of derogating from substantive contractual rights which are typically embodied in an arbitration agreement. This procedural characterization indicates that Section 18 should be regarded as concurrent with, and not necessarily displacing the existing dispute resolution mechanisms.
However, even if we consider the provision as a valid substantive alternative, its implementation raises significant concerns. The first issue that arises here is the dual role assigned to the Council.Under the same clause, the same entity will be responsible for conciliation as well as arbitration. This arrangement not only compromises the principles of natural justice but also violates the established practice of conciliation and arbitration being conducted by different panels. The reason for this practice is, evident – there may be a possibility of the arbitrator developing biases or dispositions that can undermine its impartiality in subsequent arbitration proceedings. The very pillars of effective dispute resolution, namely, fairness and neutrality, stand the risk of being undermined by such an arrangement.
Discontent of MSMEs
Additionally, MSMEs have voiced discontent with the MSMED Act's section 18 dispute settlement procedure. These complaints stem from the Council's exclusive authority and the resulting delays and increased costs. In a recent decision in Odisha Power Generation Corporation Limited v. Techniche Consulting Service, the Calcutta High Court used a different approach and upheld the parties' arbitration agreement even though section 18 of the MSMED Act was still in effect. Thus, this ruling demands a need to reevaluate the "settled" stance that the MSMED Act supersedes the A&C Act.
This reassessment is all the more crucial for parties with existing arbitration agreements. Such parties likely prefer control over their resolution process. They probably would not have gone through the trouble of drafting and consenting to a separate arbitration clause if they had wanted the Council to have such broad jurisdiction. This glaring contradiction between the parties’ intentions (as specified in the agreement) and the mandatory arbitration under Section 18, creates significant tension in applying and understanding the law coherently.
A related point is that section 18 deals merely with disputes arising from late payment. Indeed, this narrow focus calls for scrutiny, especially in multi-sectoral commercial agreements where potential disputes may go beyond payment issues. It appears impracticable to compel parties to a dispute resolution process, which cannot effectively resolve all issues when a group of conflicts involves matters that are not covered by Section 18. This limitation requires a serious reconsideration of the settled legal position as far as the conflict between the MSMED Act and the A&C Act is concerned. The parties must be allowed to proceed with independent arbitration procedures in line with their agreement for those disagreements that go beyond the narrow scope of Section 18.
Inadequate Remedies Available against the Facilitation Council
While the legislative intent of the Act was to provide swift remedies and reduce the burden of civil courts, the procedural overlaps and, lack of accountability for the Facilitation Councils have compromised this goal. This closely intertwined cause-and-effect relationship manifests itself in various ways, especially owing to inadequate remedies against the Facilitation Council.
The Bombay High Court recently rejected any appeal against the award granted by the Council to the High Courts in Bafna Udyog v. MSMED. In this instance, arbitration was not initiated swiftly even after conciliation concluded by the council. As a result, the appellant requested that the High Court name an arbitrator in accordance with A&C Act section 11(6)(c), but the Court denied his request. The Court used Mahanadi Coal Fields v. IVRCL AMR. Joint Venture to support its conclusion that the existence of an arbitration agreement inside the parties' contractual framework is a requirement for using section 11.
The Court made it clear that it can only exercise its authority under section 11 of the A&C Act in cases where there are legitimate arbitration agreements. Consequently, in the absence of a contractual arbitration clause, parties using section 18 of the MSMED Act cannot hold the Council liable for delays. Section 19 of the MSMED Act is the only way to dispute the Council, and it may only be used once arbitration has started and an award has been made, leaving no remedy for pre-arbitration delays caused by the Council. This lack of recourse directly undermines the beneficial intent of the MSMED Act.
Disadvantageous position for the Buyers
This situation puts buyers at a significant disadvantage when it comes to challenging the arbitral awards delivered by the Council. Compliance with section 19 of the MSMED Act is mandatory for seeking a stay of an award. Calcutta High Court recently discussed this in Board of Major Port Authority for the Shyama Prasad Mookerjee Port, Kolkata v. Marine Craft Engineers (P) Ltd., wherein the court dismissed the petitioner’s application for a stay on the arbitral award.
The Court pointed out that in order to challenge an award, buyers must first pay 75% of the money awarded under Section 19 of the MSMED Act. Any application to set aside or stay the award is deemed invalid from the outset without this deposit. The Court further stressed without this pre-deposit under Section 19, a Section 34 application is considered invalid and cannot be used as justification for asking a stay of the award under Section 36(2) of the 1996.The Court determined that the request for a stay under Section 36(2) could not be considered without a proper Section 34 application.
In India, given the size of many Indian enterprises, the need for buyers to pay 75% of the price awarded can be rather onerous. For example, to appeal an award worth ₹1 crore (10 million rupees), for example, a buyer would have to pay ₹75 lakhs (7.5 million rupees).In the country, a large number of small and medium-sized businesses rely on tight margins and little funding. They can be forced into debt or have their working capital destroyed by a ₹75 lakh deposit. Micro, small, and medium-sized enterprises (MSME) are classified as having an annual revenue of up to ₹5 crore and an investment of up to ₹1 crore in India. A ₹75 lakh deposit would represent a significant amount of the business's total capital.
By imposing such a requirement and such a substantial deposit, the law seems to presume that the buyers’ challenges are likely to be frivolous. The decision establishes a procedural trap in which a violation of one legislation (MSMED) impairs rights under that act and invalidates applications under another (Arbitration). Buyers may be taken aback by this intricacy, which could result in the loss of their legal rights.
Way Forward – A Suggestive Model
A significant reform, which would help overcome the current deficiencies of the MSMED Act and be more attuned to party needs, is by the means of a legislative amendment, that segregates conciliation and arbitration into two different sections rather than having them in two different clauses of the same section. Such segregation would bring in clarity of procedure and reduce the chances of biases or conflicts of interest that may otherwise arise when both functions are performed by the same entity.
Another effective amendment for the legislature to adopt would be that all disputes shall be compulsorily referred to the Facilitation Council for conciliation, prior to any other forum. If a dispute cannot be resolved by conciliation, then the parties should be at liberty to continue further by arbitration before the Facilitation Council or to continue further under the pre-existing agreement. Such an approach would not only respect the initial choice of the parties for arbitration agreements but also respect their autonomy in choosing a suitable arbitration forum that would best handle their case in line with their needs and preferences.
If the parties wish to proceed with the arbitration under the auspices of the Facilitation Council, it is incumbent upon the Council to either appoint or refer the matter to an arbitrator or the institution for arbitration, which one of the parties considers unsatisfactory. This will ensure fairness and impartiality of the arbitration process, while respecting choice by parties and making effective use of resources available to the Council. These changes would make the MSMED Act present a flexible, party-oriented dispute resolution mechanism that reconciles efficiency with respect for contractual agreements and also preserves the integrity of arbitration.
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