Commercial Law

[By Rajnandan Gadhi & Aadithya J Nair] The authors are students of The National University of Advanced Legal Studies, Kochi.   Introduction The Micro, Small and Medium Enterprises Development Act, 2006 (‘the Act’) was envisioned by the Government of India in its quest “to make provisions for ensuring timely and smooth flow of credit to small and medium enterprises to minimise the incidence of sickness among and enhancing the competitiveness of such enterprises.” The Act replaced the erstwhile Interest on Delayed Payments to Small Scale and Ancillary Industrial Undertakings Act, 1993 as it did not provide small enterprises with a mechanism to settle disputes.  The legislative intent behind the delayed payments regime stemmed from the government’s view that insufficient working capital in small-scale or ancillary industrial enterprises leads to significant and widespread issues impacting their health. Consequently, it was deemed necessary to legally ensure timely payments by buyers and to introduce mandatory provisions for the payment of interest on overdue amounts in case of default.  Recently, the Supreme Court of India dismissed a petition where an MSME association challenged a provision under the Income Tax Act, 1961 which prohibited the assessee from claiming tax deduction if it did not pay its dues as required under the MSMED Act within the same year. The effectiveness of this regime, considering its practical implications, was questioned as it hinders business.   This piece intends to point out the glaring issues that have plagued this regime since its institution and discuss certain policy changes that may be the way forward to continued ease of business and development of Indian small businesses. Accordingly, section I of the blog briefly explains the current delayed payments regime and the issues, actual and potential, associated with it. Section II evaluates the treatment of statutory interest on delayed payments under the IBC. Section III puts forth remedies and suggests policy changes to alleviate the problems discussed.  Delayed Payments Regime Under the Act Micro, Small, and Medium Enterprises (‘MSMEs’) undertake numerous transactions involving the purchase and sale of goods. However, as with any commercial transaction, business risks such as delayed payment of consideration for the supply of goods or services are inevitable. Hence, the Act intends a scheme whereby the micro and small suppliers may recover debts due to them from buyers.  Section 15 of the Act mandates the buyer to make payment for goods or services obtained from the supplier; within 45 days from the day of acceptance of the product. Additionally, Section 16 imposes an interest on the buyer, who fails to make payment within the given period. This interest is compounded at three times the bank rate as determined by the Reserve Bank of India.  Disputes arising out of delayed payments are to be settled by Micro and Small Enterprises Facilitation Councils (‘MSEFCs’) through the multi-tiered dispute resolution mechanism provided under Section 18 which includes conciliation and arbitration.  It is pertinent to note that the definition of supplier under the Act specifically excludes medium enterprises and consequently, bars them from being eligible to claim benefits of the delayed payments scheme prescribed in chapter five of the Act, leaving them without remedy. Leniency in penal interest on delayed payments to MSMEs under the Act continues because MSMEs hesitate to demand it, fearing it might harm business relationships.  Thus, despite the 45-day limit, buyers can still significantly delay payments without consequences, as in practice, very little penal interest is paid on overdue payments. Additionally, the fear of tedious dispute proceedings and the requirement of 75% of the award to be deposited by the buyer to appeal deter big businesses from working with MSMEs.   To protect their interests, large corporations might shift their sourcing to larger firms or request that their vendors relinquish their MSME registration to continue doing business with them. Additionally, large companies are not the only players who regularly conduct transactions with MSMEs; rather, other MSMEs procure goods from MSME suppliers as well. The delayed payment regime stifles their ability to buy goods and services from other MSMEs without apprehension and intra-MSME transaction channels will continue to be seriously impacted. Compoundable interest at thrice the bank rate is a burden that has been put on enterprises that may be in the same economic standing as the suppliers. Therefore, the argument that such interest is meant to protect MSMEs is infructuous.    Effect of the IBC on Interest on Delayed Payment A situation may arise where the Corporate Insolvency Resolution Process (‘CIRP’) is initiated against the buyer and the supplier may seek to treat the principal amount and statutory interest due under Section 16 as “operational debt” under the Insolvency and Bankruptcy Code, 2016 (‘IBC’). Still, the National Company Law Tribunal (‘NCLT’), in Melange Systems Private Limited v. PME lnfratech Private Limited, held that interest under Section 16 of the Act can be claimed before the MSEFC; not before the NCLT as an outstanding debt and that the claim of interest on operational debt at the statutory rate of interest Act, when no interest was stipulated in the invoices was unsustainable. The view taken in Govind Sales v. Gammon India, which has been misinterpreted by NCLTs and practitioners, is that if a pre-existing dispute such as a doubt regarding the enterprise’s MSE status is raised, the Section 9 petition under the IBC may be rejected. In Satish Agro Industries v. The Maharashtra Agro Industries Development Corporation Ltd., NCLT Mumbai found that where the principal amount due meets the IBC threshold, the question of interest on delayed payments under the Act need not be addressed. On the corollary, NCLT Hyderabad in Shri Shri Krishna Rail Engineers Pvt Ltd v. Madhucon Projects Ltd. held that the MSE Operational Creditor is entitled to interest despite the absence of a provision for interest on delayed payments in the Letter of Intent and even though the Operational Creditor did not approach the MSEFC as per the Act. Thus, the position of law is unsettled and open to the discretion of the courts, to say