MSMED Act has an Overriding Effect Over Arbitration and Conciliation Act and Private Arbitration Clauses

[Praneeta and Prithviraj are Advocates at Gujarat High Court, NCLT Ahmedabad, MSEFC Gandhinagar and other ancillary forums.]

Party autonomy has always remained central to the governing of arbitration proceedings, as a stark contrast to the traditional litigation framework. However, the tussle between the Micro, Small and Medium Enterprises (MSME) (Development) Act 2006 (MSMED Act) and the Arbitration and Conciliation Act 1996 (A&C Act), has reshaped the contours of applicability of the said doctrine. In a landmark judgment of Gujarat State Civil Supplies Corporation Limited v. Mahakali Foods Private Limited (Mahakali judgment), the Supreme Court (SC) had unequivocally held, adhering to the lex specialis principle that MSMED Act being a special law, would override the provisions of A&C Act, a general law. Therefore, even if there are arbitration clauses in place, a dispute involving an MSME, would be settled as per Section 18 of the MSMED Act, through the intervention of the Facilitation Council mentioned therein. 

Subsequent to this judgment, many High Courts while being faced with a similar dilemma have relied on this binding precedent. However, in certain cases such as the Odisha Power Generation Corporation Limited v. M/s. Techniche Consulting Service, the Calcutta High Court has relied on the mutually agreed arbitration clauses by the parties to resort to the seat of arbitration, while Section 18 MSMED proceedings were underway. These instances have invoked the need for a relook at the arbitration framework under the MSMED Act. It is especially significant in the context of the recent SC judgment of M/s Harcharan Das Gupta v. Union of India (Harcharan Das), wherein the SC has plainly relied on the Mahakali judgment to categorically refute the applicability of private arbitration clauses, without acknowledging the procedural roadblocks within the MSME framework. 

Hence, this article would reveal the conclusions of the Mahakali judgment, how it has been adapted in the recent SC case and thereafter identify the potential need to reimagine the applicability of the disputes governing MSMED Act, considering party-led arbitration agreements under the A&C Act. 

What is the Settled Law?

In the Mahakali judgment, the SC held that Chapter V of the MSMED Act would override the provisions of the A&C Act in a manner that even though an independent arbitration agreement is in place, the parties can refer the matter to the Facilitation Council under section 18(1) of the MSMED Act. The SC opined that the non-obstante clauses of section 18(1) and 18(4) of the MSMED Act, would warrant the interpretation regarding the overriding effect of MSMED Act over A&C Act.

Furthermore, the court also upheld that the Facilitation Council, can go to the extent of stepping in as the arbitrator, post the failure of conciliation proceedings between the parties, thereby bypassing the restriction under section 80 of the A&C Act, wherein a conciliator/mediator is barred from being the arbitrator for the subject matter of the dispute which lay under the conciliation/mediation proceedings.

The Harcharan Das case: Failed Opportunity to Reconcile MSMED Act and Party Autonomy?

In the aforementioned Harcharan Das case, the appellant, a registered supplier under MSMED Act, had invoked the jurisdiction of Facilitation Council of Delhi, under section 18 of MSMED Act, to settle the disputes between the parties. Accordingly, the respondent was issued a notice for the conciliation proceedings under section 18(2) of the MSMED Act, failing which an arbitration proceeding under section 18(3) of the MSMED Act was initiated through the Delhi Arbitration Centre. 

However, instead of participating in the arbitration proceedings, the respondent filed a writ petition before the High Court of Karnataka, to dispute the jurisdiction of Delhi Arbitration Centre (Centre), as the parties had mutually agreed for the seat of arbitration to be in Bengaluru. Thus, the Hon’ble High Court held that the arbitration proceedings through the Centre lacked jurisdiction, as they were contrary to the agreement between the parties, and thereby allowed the writ petition in favor of the respondent. 

Aggrieved, the petitioner filed an appeal with the SC to set aside the judgment of the Karnataka High Court and restore the jurisdiction of the Centre to carry out the arbitration proceedings between the parties. While adjudicating the appeal, the apex court reiterated the Mahakali judgment with respect to three key issues – the overriding effect of MSMED Act over the A&C Act, the inapplicability of mutually agreed arbitration agreement clauses vis-à-vis the MSMED Act, and the seat of arbitration.

With respect to the first issue, the court cited the Mahakali judgment, wherein it was held that the MSMED Act, being a special legislation for MSMEs would have an overriding effect over the general A&C Act. Further the insertion of non-obstante clauses Sections 18(1) and 18(4) in the MSMED Act, were a testament of legislative intention to give effect to the provisions of the MSMED Act over an existing A&C Act.

Thereafter, regarding the second issue too, the court relied on the Mahakali judgment to uphold that the independent arbitration agreement between the parties could not override the statutory provisions of the MSMED Act, once the dispute resolution mechanism is triggered by any party under Section 18(1) of the MSMED Act. In such a context, any arbitration proceeding as per Section 18(3) of the MSMED Act, carried out by the Facilitation Council or any other appointed arbitrator, would operate in a deeming legal fiction as if the proceeding is under the A&C Act, and such an arbitrator would accordingly have all the powers under Section 7 of the A&C Act, to settle such dispute between the parties.

Lastly, with respect to the issue of ‘seat’ of arbitration, the apex court upheld that the Facilitation Council or any other arbitrator would have the jurisdiction to act as the arbitrator under Section 18(4) of the MSMED Act, which is in the jurisdiction of the supplier. Thus, the respondent’s argument that the seat of arbitration was in Bengaluru, and hence the Centre lacked jurisdiction, was held to be moot, since the appellant supplier was located within the jurisdiction of Delhi. Hence, the apex court dismissed the appeal in the favor of the appellant and set aside the order passed by the Karnataka High Court in the said matter.

It is pertinent to note that even when the constitutionality of Section 18(4) of the MSMED Act, was challenged before the Delhi High Court in a writ petition filed in the matter of Kalamkari Lifestyle Tech Private Limited v. MSME Facilitation Council, Mumbai and Others, the court brushed aside the matter citing the Mahakali judgment. It upheld that the statutory provisions of the MSMED Act, mandating adjudication of dispute at supplier’s location, would take precedence over the mutually agreed seat of arbitration under the arbitration agreement.

A stoic critic of the present jurisprudence is that, once the conduct of arbitration proceedings as per the arbitration agreement is replaced by the statutory mechanism of the MSMED Act, it gravely undermines party autonomy, as the parties cannot act independently to settle the dispute at their desired venue and with the arbitrator of their choice at the helm. Such a situation often leads to unnecessary delays in the arbitration proceedings, due to a backlog of cases and often chokes the operational efficiency of the MSME involved in the dispute. This can be substantiated from the fact that out of nearly 2,36,000 applications, with an amount payable of nearly 51,300 crores, filed with different Facilitation Councils, a staggering 1,01,288 cases are pending blocking amounts to the tune of 22,050 crores.

In this context, the only glimmer of hope for the parties involved has been the judgment of the Gujarat High Court in the case of Uttar Gujarat Vij Company Limited v. Gupta Power Infrastructure Limited, where the court reconciled Section 19 of the MSMED Act with Section 34 of the A&C Act and upheld that in case a party wants to set aside or appeal against the arbitral award, or enforce/implement the award passed by the Facilitation Council or the arbitrator appointed by it, then the ‘court’ within whose jurisdiction such petition can be filed, would be according to what the parties mutually agreed upon in the arbitration agreement.

Thus, the Gujarat High Court reiterated that the mode and manner of the appointment of the arbitral tribunal has been replaced by the statutory provisions of MSMED Act, however, as there is no reference to the jurisdiction of any dispute arising due to correctness or validity, execution or implementation of the arbitral award, the provisions of the A&C Act would be adhered to, and as a result the ‘court’ upon which the parties have conferred such jurisdiction would be valid.

Conclusion

Subsequent to the Mahakali judgment adopting a clear stance that the MSMED Act would override the provisions of A&C Act, the party autonomy in the arbitration agreements involving an MSME, has taken a backseat. Considering the MSMED Act, as a beneficial legislation, with non-obstante clauses, the SC has interpreted the legislative intention in such a manner as to provide the MSMEs a statutorily backed mechanism to settle their disputes. Even the latest judgment of the SC in the Harcharan Das case has echoed that interpretation, while setting aside the notion of any ‘seat’ or ‘venue’ of arbitration which was pre-agreed in the arbitration agreements. 

The lack of party autonomy has appeared to do more harm than good as nearly half of the applications with the Facilitation Council lie pending, causing significant financial strain on the MSMEs involved. Even though the parties can at a later stage, challenge the arbitral award at a court of their choosing with exclusive jurisdiction, it most often is too late for them to exercise their autonomy after a significant amount of time and cost has been lost. 

The fact that the Facilitation Council, engaged in conciliation proceedings of the same matter, can act as the arbitrator, is another impediment for the smooth conduction of the proceedings, for it is diametrically contrary to Section 80 of the A&C Act. However, the issue having been referred to a larger bench of 5 judges in the case of Tamil Nadu Cements Corporation Limited v. Micro and Small Enterprises Facilitation Council, might offer some respite to the parties involved in this process. Considering the existing roadblocks to the arbitration proceedings under the MSMED Act, it is essential that the courts aim to adopt a more conducive interpretation of Section 18 of the Act, so as to reconcile the principle of party autonomy without compromising on the statutory safeguards put in place for the benefit of the MSMEs.