Arbitration regimes applicable to small and medium businesses in India

Although the Indian Supreme Court has tackled some of the conflicts around the validity of arbitration clauses for micro, small and medium-sized enterprises, clarity is still required on how such clauses should apply

Two pieces of legislation governing the same set of circumstances is often a recipe for conflict. This is exactly the situation playing out when it comes to resolving disputes involving ‘micro, small, and medium enterprises’, often called “MSMEs” in India.

MSMEs make up about 45% of India’s manufacturing output, and have long been thought of as needing their own regulatory and legal framework. This is on account of their ‘limited awareness and resources’, and the legislative aim has been to ‘free [MSMEs] from a plethora of laws and regulations’.

The Micro, Small, and Medium Enterprises Development (MSME) Act, 2006 (MSME Act)  was passed to facilitate the development of MSMEs and enhance their competitiveness. The MSME Act governs diverse aspects of MSME businesses, including dispute resolution and arbitration.

Conflicting laws

The overarching nature of the MSME Act means that sometimes there are areas of overlap and conflict with other legislations. One such aspect is arbitration, which in India is regulated by the Arbitration & Conciliation Act, 1996 (the Arbitration Act).

The MSME Act’s objective of protecting MSME interests often leads to a situation where its arbitration-related provisions are in direct conflict with the Arbitration Act. These include questions of which court has jurisdiction to entertain claims involving an MSME, how an arbitral award can be challenged, and the ease and conditions of any challenge to an arbitral award in an MSME dispute. These provisions are often not uniform and tilt in favour of MSMEs.

For instance, Section 18 of the MSME Act says that an MSME dispute is to be referred to the MSME Facilitation Council (Council). The Council can then choose to either conduct conciliation proceedings itself, or refer it to another institution for conciliation. If the conciliation is not successful, the Council can then either arbitrate the dispute itself, or refer it to an arbitral institution for arbitration proceedings.

The MSME Act says that these proceedings will be regulated by the process set out in the Arbitration Act. However, despite the reference to the Arbitration Act, disputes under the MSME Act have several peculiarities that can’t be found in other arbitrations. For instance, if there is a challenge to an arbitral award, the conditions for the non-MSME party to challenge it are much more stringent than those applicable to MSMEs.

The territorial jurisdiction for courts under the MSME Act also introduces other process-related conflicts with the Arbitration Act. Again, if there is an arbitration clause in a contract between an MSME and a non-MSME, there are questions of whether the non-MSME party is to be forced to approach the Council or can use the arbitration clause in the contract.

Finally, the Arbitration Act also specifies that a conciliator cannot act as an arbitrator in the same dispute: a position that is at odds with the MSME Act where the Council can act as both.

Indian Supreme Court’s attempt at conflict resolution

The Indian Supreme Court recently attempted to resolve this conflict in its decision in Gujarat State Civil Supplies Corporation v. Mahakali Foods Private Limited.

The court observed that the MSME Act would override the Arbitration Act since it was enacted later in time.  So even if the Arbitration and Conciliation Act is a special law, the MSME Act, having been enacted subsequently, would have an overriding effect.

The court said that the Council could not be stopped from sending a dispute to arbitration, or acting as an arbitrator itself, even if there was an independent arbitration agreement in a contract between parties. The court said that any contrary law in the Arbitration Act would not affect the situation.

Implications for small business

However, the decision still leaves a large question answered: what happens to arbitration clauses in contracts where one party is an MSME? Do they automatically become invalid?

A situation could arise where a contracting counterparty to an MSME has an arbitration agreement in the contract and could want to pursue arbitration under the Arbitration Act instead of the MSME Act.

Whether they can do so, and how valid the arbitration agreement is, are questions that have not yet been tested. However, until there is clarity on the issue, vendors and customers of MSMEs would do well to remember that an arbitration agreement may not necessarily be enough to preserve party autonomy on dispute resolution.