Micro, Small, and Medium Enterprises (“MSMEs”) form the backbone of the Indian economy; they contribute roughly one-third of GDP and a large share of employment. Yet entities often face delays in receiving payments from larger buyers, which strains their cash flows.
To address this, the Government of India enacted a special dispute resolution framework in the Micro, Small and Medium Enterprises Development Act, 2006 (“MSMED Act”). Chapter V of this Act mandates timely payments (within 45 days) for supplies made by micro or small enterprises, failing which the buyer must pay huge interest (three times the bank rate) on the amount due.
Notably, the MSMED Act established Micro and Small Enterprises Facilitation Council (“MSEFC”) in each state as dedicated forums to arbitrate and resolve such payment disputes.
This article examines the arbitration mechanism under the MSEFC, its legal status, implementation, successes, and the significant challenges it faces.
Legal Framework under the MSMED Act
- Section 15 requires buyers to pay within the agreed period or in case no period is agreed upon, payment should be made before the appointed day, but in no case the agreed period can be more than 45 days from the day of acceptance.
- Section 16 stipulates that any delay beyond this attracts interest at three times the Reserve Bank of India’s bank rate.
- To enforce these rights, Section 18 empowers either party to a dispute to refer the matter to the MSEFC, “notwithstanding anything contained in any other law”. Each state government is required to establish one or more MSEFCs to administer this process. Once the reference is received, the MSEFCis required to proceed in the following manner, as mentioned below-
- Initiating mediation proceedings: Upon receiving a reference, MSEFC conducts mediation by itself or seeks assistance of any ADR institution for mediation. As per Section 18(2), if the parties settle at this stage, such settlement has a binding effect as that of an award under Section 74 of the Arbitration and Conciliation Act, 1996 (“Arbitration Act”).
- Arbitration: In case mediation fails, MSEFC either takes up the dispute for arbitration by itself or refers it to an external ADR institution for arbitration.
- Overriding effect: Sections 18(1) and 18(4) give this process an overriding effect over any other law. In effect, this means that an MSME can invoke MSEFC’s jurisdiction even if there is an existing arbitration clause or other agreement with the buyer. The Supreme Court of India has also affirmed this position in the case of Gujarat State Civil Supplies Corp. Ltd. V. Mahakali Foods Pvt. Ltd. (2022), holding that the MSMED Act, being a beneficial legislation, prevails over the Arbitration Act[1].
Arbitration process under the MSMED Act
A registered MSME, wanting to invoke this mechanism can file an application on the MSME Samadhaan portal or approach the state’s MSEFC directly. Once such reference is admitted, MSEFC issues a notice to the buyer. The first stage is mediation under Section 18(2) of the MSMED Act. The intent is to arrive at an amicable settlement. If such settlement attempt fructifies, and recorded in writing, it has a force of an Arbitral Award under Section 74 of the Arbitration Act.
However, if no settlement is arrived at, MSEFC proceeds to arbitration as per Section 18(3) of the MSMED Act. MSEFC may either arbitrate the dispute itself or refer it to any institution or centre providing alternate dispute resolution. The procedural law for such arbitration is the Arbitration Act.
An award rendered by the MSEFC is enforceable like any Arbitral Award. Section 19 of the MSMED Act imposes a condition, i.e., any party seeking to challenge or set aside the MSEFC’s arbitral award in court must first deposit 75% of the award amount. Courts usually do not entertain a set-aside application unless this pre-deposit is made.
Benefits and achievements of the MSEFC Mechanism
- No need for a prior Arbitration Clause: Section 18 of the MSMED Act starts with a non-obstante clause (Supra), thereby meaning that parties will be referred to arbitration even without any Arbitration Agreement between them. Moreover, the arbitration mechanism under the MSMED Act provides a legal remedy specifically tailored for MSMEs, intended to eliminate cost and procedural hurdles through formal dispute resolution mechanisms.
- Accessibility through the Samadhaan portal: The launch of the MSME Samadhaan portal has transformed how MSMEs initiate claims. By digitizing the applications and case-tracking process, it has enhanced transparency and accessibility. This has also increased public accountability for large buyers, with over 48502 crores in claims resolved through MSEFC proceedings.[2]
- Strong deterrents against delay: The combined force of Section 16 (interest at three times the RBI rate) and Section 19 (mandatory 75% deposit before appeal) of the MSMED Act creates a strong deterrent for defaulting buyers. These provisions have led even large corporations and PSUs to settle dues promptly to avoid legal and financial penalties.
- Cost-Efficiency and Procedural Simplicity: MSEFC process remains far more affordable than traditional litigation or institutional arbitration. Moreover MSMEs are not required to pay arbitrator fees when MSEFC arbitrates directly, which significantly reduces financial burden of pursuing claims.
- Credible Forum: MSEFCs are chaired by senior government officials including representatives from industry associations. This composition provides credibility and ensures that decisions are informed by both administrative experience and sectoral knowledge, while maintaining a structure that allow MSMEs to raise grievances in a non-intimidating environment.
Challenges to MSEFC mechanism
- Backlogs and Delays: MSEFC arbitration mechanism suffers from several institutional and operational shortcomings that limit its effectiveness. A primary concern is the backlog of unresolved cases, which has grown in recent years. As per government data, over 58000 are yet to be viewed by the MSEFC, and over 44000 currently under consideration by MSEFC[3]. As one can understand, such backlog is attributable to the fact that MSEFCs are non-dedicated forums with full-time members which operate as part of broader departmental duties. Additionally, although law emphasizes a time-bound resolution, in practice, delays at every stage are common and recurring. This is further compounded by the procedural ambiguity regarding timelines, especially after the 2023 amendments removed the 90-day time limit for arbitration following failed mediation.
- Uneven quality of awards delivered by MSEFCs: Since most MSEFC members are not trained legal professionals or full-time arbitrators, the resulting decisions can sometimes suffer from lack of clarity, inadequate reasoning, or procedural lapses. Such shortcomings invite court challenges and prolong the dispute resolution process, thereby undermining the goal of swift and final adjudication.
- Enforcement issues and Post-Award Challenges: Many buyers, especially those with greater financial muscle, file objections under Section 34 of the Arbitration Act seeking set aside of the Award, knowing that the burden of delay often weighs heavier on the MSME.
- Capacity Constraints: The reach and effectiveness of the MSEFC mechanism vary widely across states. Some MSEFCs are proactive and regularly conduct hearings, while others are understaffed and function inconsistently with inadequate infrastructure. The absence of standard operating procedures, coupled with varying administrative practices, mean that access to justice through this mechanism is inconsistent and, in some regions, effectively non-existent.
Recent developments and reforms
Recognizing the aforementioned challenges, both the central and state governments have undertaken multiple reform initiatives aimed at enhancing the effectiveness of the MSEFC arbitration framework.
- Digital Platform and ODR: In 2023-24, the Ministry of MSME moved to upgrade dispute resolution through technology. An Online Dispute Resolution (“ODR”) platform dedicated to MSME payment disputes is set to be in place[4]. This platform will allow hearings and mediation to occur virtually, which can expand access for MSMEs in remote areas and reduce delays. By cutting down the need for physical appearances and enabling digital case management, ODR could help clear the backlog faster. For instance – e-notices, online submission of evidence, and video-conference hearings can potentially streamline proceedings.
- Mediation Act, 2023 integration: The enactment of the Mediation Act, 2023 (“Mediation Act”) has led to a minor but meaningful change in the MSMED Act – replacing “conciliation” with “mediation” in Section 18 of the MSMED Act. The Mediation Act provides a more robust framework for conduct of mediations (e.g., confidentiality, mediator standards, timelines) which now applies to MSEFC proceedings. This professionalization of the mediation stage may improve settlement rates. The government is also parallelly encouraging MSEFCs to refer matters to certified mediators (many of whom are being trained under the new regime) to inject neutrality and expertise at the pre-arbitration stage. Over time, this could ensure that only truly unamicable disputes proceed to arbitration, while simpler payment conflicts get resolved in mediation itself – easing the burden on MSEFCs.
- Complementary Policy Measures: The arbitration mechanism does not exist in isolation; the government has introduced complementary measures to tackle the root problem of delayed payments. One significant reform is in the tax law: effective April 1, 2024, Section 43B(h) of the Income Tax Act was amended to disallow as a deductible expense any sum payable to an MSME beyond the statutory credit period (45 days or 15 days, as the case may be) unless actually paid within the grace period.[5] This creates an income tax incentive for buyers to pay MSME dues on time (or shortly thereafter), otherwise their taxable income will not get the benefit of those expenses.
Conclusion
MSEFC’s arbitration mechanism represents a landmark attempt by India to provide a fast-track, specialized remedy for the country’s small businesses facing delayed payments. However, the effectiveness of this mechanism has been questioned by serious practical challenges. The gap between the Act’s promise of quick justice and the reality of cases stuck for years in the system is a concern that policymakers and administrators are actively trying to bridge. As detailed above, steps like digitization ODR, strengthening institutional capacity, and legal clarifications are underway to address these issues. If these reforms are implemented well, they could significantly enhance the speed and efficacy of the MSME arbitration framework.
It is also important to strike a balance so that the mechanism remains fair and credible. While MSMEs deserve protection, the process must ensure that buyers have a fair chance to present defences and that arbitral awards are impartial.
As a final analysis, MSEFC’s arbitration mechanism is a crucial tool for empowering small businesses in India, but one that requires constant support. As a responsive dispute resolution system, the need of the hour is understanding the needs of MSMEs through improved business environment. With continued government attention and judicial oversight, the mechanism can be refined to deliver on its original intent, i.e., providing MSMEs with timely justice and thereby fostering a culture of prompt payment in the Indian business ecosystem.
—
[1] Gujarat State Civil Supplies Corporation Ltd. v. Mahakali Foods Pvt. Ltd. (Unit 2) & Anr., (2022) 4 SCC 182
[2] https://samadhaan.msme.gov.in/MyMsme/MSEFC/MSEFC_Welcome.aspx
[3] https://samadhaan.msme.gov.in/MyMsme/MSEFC/MSEFC_Welcome.aspx
AUTHORS: Sanampreet Singh (Senior Associate) | Suraj Dhawan (Associate)