INTRODUCTION
The implementation of the Micro, Small and Medium Enterprises Development Act, 2006 ("MSMED") Act aimed to provide assistance and protection to Micro, Small, and Medium Enterprises ("MSMEs") by addressing issues related to their growth and payments. The establishment of the Micro and Small Enterprises Facilitation Council ("MSEFC") was intended to ensure fairness and safeguard the interests of MSMEs. However, challenges arise in applying the MSEFC framework to Works Contracts, as such contracts do not conform to the Act's typical definition of an enterprise involving goods or services production. Consequently, uncertainty surrounds the applicability of the Act and the jurisdiction of Facilitation Councils in Works Contracts. This article seeks to clarify the interaction and constraints of the MSMES Act and Arbitration and Conciliation Act, 1996 ("Arbitration") Act in the context of Works Contracts. It aims to provide valuable insights to SMEs, buyers, arbitrators, and arbitral institutions, aiding them in effectively navigating this intricate landscape.
UNDERSTANDING WORKS CONTRACTS
According to the Central Goods and Services Tax Act, a Works Contract is legally characterized under Section 2 (119) as "a contract for building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning of any immovable property wherein transfer of property in goods (whether as goods or in some other form) is involved in the execution of such contract".
Works Contracts are legally binding agreements that involve construction, repair, or maintenance work and disputes in Works Contracts can arise from issues like non-payment, delays, defects, or changes in the scope of work. Resolving such disputes typically involves legal procedures, negotiations, or alternative dispute resolution methods like mediation or arbitration. Interestingly, Works Contracts are recognized as a distinct category by the Hon'ble Supreme Court due to their integration of goods and services, setting them apart from standard commercial agreements. However, determining the jurisdiction of MSME Facilitation Councils becomes challenging for Works Contracts as they don't fit neatly into the existing framework.
In the ordinary course of MSME-related business, any disputes are typically directed to the Micro and Small Enterprise Facilitation Councils (MSEFCs) established at district and state levels, as well as the National Board for Micro, Small, and Medium Enterprises operating nationally. These entities are tasked with adjudicating issues involving payment delays, breaches of contracts, and other complaints that arise between MSMEs and their buyers.
EXCLUSION OF WORKS CONTRACTS FROM MSMED ACT
The exclusion of Works Contracts from the jurisdiction of MSME Facilitation Councils has been a significant concern for the MSME sector. This exclusion leaves MSMEs involved in Works Contracts vulnerable without the protection and support offered by the council, raising doubts about the effectiveness of the MSMED Act. This exclusion is solely based on the unique nature of Works Contracts, which combine goods and services and involve complex project management.
However, this exclusion raises queries about the availability of effective mechanisms to resolve payment disputes in this specific sector, exclusively for those MSMEs engaged in Works Contracts that may now need to resort to alternative legal avenues or dispute resolution methods. It is difficult to ascertain whether a works contract primarily involves the sale of goods or the provision of services, which is crucial in establishing the council's jurisdiction and the composite and continuous nature of Works Contracts, encompassing supply, installation, and services, further complicates this determination. These jurisdictional challenges have implications for the application of the MSMED Act.
LEGAL JURISPRUDENCE
The legal doctrine vis-à-vis Works Contracts has experienced substantial progress via diverse progressive judgments pronounced by the Hon'ble Supreme Court and its Puisne Courts.
- What constitutes a works contract?
In the case of Kone Elevators India Pvt Ltd v. State of Tamil Nadu,1 the Supreme Court held that the substance of a contract is pivotal in determining its nature, irrespective of its form. The distinction between a contract for the sale of goods and a works contract lacks a fixed rule. The analysis should consider the attachment of the lift to the building and the labour involved. Contracts for lift supply and installation involve both goods and services. Lift components become permanent fixtures after skilled on-site assembly. If a composite contract combines supply and installation, it's a works contract, not a mere sale of goods. The previous ruling in Kone Elevators (supra), which differentiated based on incidental service, is overturned. The obligation to supply goods and perform installation fulfils the essential characteristics of a works contract. Consequently, the decision in Kone Elevators (supra), is not valid, and show-cause notices for reassessment were quashed and the assessment orders under dispute were annulled.
- Is a Works Contract amenable to the MSMED Act?
The Bombay High Court, in the case of Sterling and Wilson Private Limited and Ors. v. Union of India and Ors.2 dealt with a dispute stemming from a bid related to the design, installation, and servicing of firefighting and detection systems. The central issue revolved around whether Micro and Small Enterprises (MSEs) registered under the MSMED Act could avail of benefits in this context.
The High Court of Bombay scrutinized the contract at hand and concluded that its fundamental nature wasn't centred around a typical sale of goods, but rather constituted a works contract. Drawing from legal precedents such as Kone Elevators, the court noted that when conflicts arise from the execution or non-execution of Works Contracts, the provisions of the MSMED Act cannot be invoked. This constraint was attributed to the intricate composition of Works Contracts, encompassing elements beyond simple goods transactions.
Based on this evaluation, the court determined that the advantages and policies outlined in the MSMED Act couldn't be extended to the contesting MSEs involved in this scenario due to the specific nature of the contract. The verdict underscored the distinction between contracts primarily focused on goods sales versus those involving complex works, highlighting the limitations of employing the MSMED Act to address disputes emerging from Works Contracts.
- Can MSEFC refer disputes to Arbitration even when prior
arbitration agreements exist?
The case of Mackintosh Burn Limited v. Micro and Small Enterprises Facilitation Council3 centred on the authority granted by the MSMED Act of 2006 to the MSEFC for dispute resolution, particularly its ability to refer disputes to arbitration under Section 18. The dispute arose due to a payment discrepancy between Mackintosh Burn Limited and MSME, the third party involved.
MSME invoked the MSEFC to recover outstanding payments related to a demineralized water plant agreement. Section 18 of the Act outlines the process for initiating references to the Council, allowing parties engaged in disputes over amounts due under Section 17 to approach the Council. The Council can initiate conciliation or refer the dispute to alternative dispute resolution avenues. If conciliation fails, the Council can proceed with arbitration or refer the dispute to other entities following the Arbitration Act.
The Court thoroughly examined the provisions available under the MSMED Act, with a focus on Section 18(3)'s legal framework. It concluded that when the Council opts for arbitration or a referral, the parties are deemed to have entered into an arbitration agreement according to Section 7(1) of the Arbitration Act. This supersedes any prior arbitration agreement. The Court upheld the Council's authority to refer disputes to arbitration as outlined in Section 18(3).
As a result, the appeal was rejected, with the Court highlighting the significance of Section 18(3) and confirming the Council's capacity to refer disputes to arbitration, even when previous arbitration agreements existed.
- Dispute resolution in the absence of an Arbitration clause
under Works Contract?
The case of PL Adke v. Wardha Municipal Council4 was centred on a contract encompassing the planning, design, construction, operation, and maintenance of a water supply and sewerage system. A pivotal question emerged: Should the MSMED Act's provisions apply to the contracting party claiming Micro and Small Enterprise (MSE) status?
The Bombay High Court dissected the contract's essence, finding it to be an integrated, continuous, and indivisible works contract. This characterization stemmed from its ongoing execution, going beyond a mere sale of goods. Consequently, the court determined that the MSMED Act's benefits were inapplicable due to the contract's composite and sustained nature. Moreover, the absence of an arbitration clause rendered even the Arbitration Act's provisions inapplicable.
In essence, the court's judgment clarified that the MSMED Act's advantages could be curtailed when dealing with intricate and continuous Works Contracts. Furthermore, the absence of an arbitration clause could also restrict the scope of the Arbitration Act's application. This ruling emphasized that the contract's nature and clauses play a pivotal role in delineating the applicability of pertinent legal provisions.
APPLICABILITY OF THE ARBITRATION AND CONCILIATION ACT, 1996:
The applicability of the Arbitration 1996 to Works Contracts had earlier remained a contentious issue. Nevertheless, with the ever-evolving and growing legal jurisprudence and precedence, it has now become a settled principle of law that disputes/claims arising from Works Contracts are not amenable to the jurisdiction of the Facilitation Council constituted under the MSMED Act. However, Works Contracts are complex agreements, and the presence of an arbitration clause is crucial for resolving disputes. However, when Works Contracts don't include an arbitration clause, the Arbitration Act would fail to apply. In the case of M/S. P.L. Adke vs. Wardha Municipal Corporation5 it was clarified that the MSMED Act's benefits could be restricted in cases involving composite and continuous Works Contracts and that the application of the Arbitration Act could also be limited by the absence of an arbitration clause in the contract.
A recent ruling by the Delhi High Court in the Tata Power Company Limited (TPCL) v. Genesis Engineering Company (GEC)6 dispute clarified that the inclusion of an Arbitration clause in a Works Contract subjects the dispute to the Arbitration Act. The court ruled that the Work Orders from TPCL to GEC meet the criteria of Works Contracts based on the legal precedent set by the Supreme Court's "Kone Elevator India Private Limited vs. State of Tamil Nadu" (2014) as the said contract involves two components; the supply of materials like cables, wires, connectors, streetlights, and poles, followed by labour for installation.
During the ongoing Arbitration Petition, GEC initiated a reference under Section 18 of the MSMED Act to the Facilitation Council. The High Court, after examining cases like "Sterling and Wilson Private Limited vs. Union of India & Ors." and "Shree Gee Enterprises vs. Union of India," ruled that such disputes did not fall under the MSMED Act's purview. Consequently, GEC couldn't avail of MSME Act benefits and contested the proceedings. The court noted the presence of an Arbitration clause in the Contract's General Conditions, allowing Tata Power's Section 11(6) petition under the Arbitration Act. Thus, the Court became inclined to appoint a sole arbitrator to resolve the disputes.
Hence, even if an MSME operating within a Works Contract is not subject to the MSMED Act, it can seek safeguards under the Arbitration Act in the presence of a valid Arbitration Clause.
CONCLUSION
Addressing the practical hindrances encountered by MSMED Act when pursuing payment for Works Contracts necessitates the provision of unequivocal guidance concerning the jurisdiction of the Facilitation Council. Furthermore, despite a limited number of legal precedents regarding the applicability of the Arbitration Act to Works Contracts devoid of arbitration clauses, there is a definite requirement for explicit directives regarding its applicability. The establishment of a framework to handle disputes arising from Works Contracts, particularly those involving MSMEs, could further ensure an equitable and efficient mechanism for dispute resolution.
In conclusion, the jurisdiction of the MSME's Facilitation Council in matters of payment disputes within Works Contracts remains a subject that should be addressed individually for each case. The unique attributes of Works Contracts, their intricate composition, and the complexities in categorizing them within the existing legal structure pose challenges in the application of the provisions of the MSMED Act. While the legal precedents set by the Hon'ble Court of our nation provide guidance, there is an evident imperative for legislative clarity to establish an effective mechanism for resolving such disputes.
Until such clarity is attained, MSMEs should adopt a pragmatic approach, meticulously considering payment terms and collaboratively formulating contracts with their buyers when engaged in Works Contracts.
Footnotes
1. Kone Elevator India Pvt. Ltd. v. State of Tamil Nadu and Ors., MANU/SC/0424/2014.
2. Sterling and Wilson Private Limited and Ors. v. Union of India and Ors., MANU/MH/1631/2017
3. Mackintosh Burn Limited v. Micro and Small Enterprises Facilitation Council, MANU/WB/0243/2020
4. PL Adke v. Wardha Municipal Council, MANU/MH/2179/2021.
5. Ibid at 5
6. ARB.P. 1415/2022 Delhi High Court
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