MSME & IBC Article 1082

Applicability of Interest under Sections 15 and 16 of the Micro, Small and Medium Enterprises Development Act, 2006 in Applications under Sections 7 and 9 of the Insolvency and Bankruptcy Code, 2016

Overview

The relationship between the MSMED Act, 2006 and the IBC, 2016 has been extensively argued in judicial forums, especially concerning the recoverability of statutory interest under Sections 15 and 16 of the MSMED Act in insolvency cases. As the MSMED Act tries to safeguard the interests of micro and small enterprises through prompt payments and imposing penal interest in case of delays in payments, the IBC is an insolvency legislation, not debt collection legislation. This article analyses whether the statutory interest payable under the MSMED Act can be treated as part of "debt" or "default" under Sections 7 and 9 of the IBC. The statutory provisions, judicial decisions, and other policy issues have been analysed herein to conclude that although MSMED interest is a statutory liability, its enforceability in the insolvency regime is difficult.

I. Introduction

The enactment of the MSMED Act, 2006 was a landmark moment for India’s micro, small, and medium enterprises with regards to prompt payments from buyers. Realising that late payments have an adverse effect on liquidity and operational efficiency, the legislature has provided a rigorous regime of paying compound interest at three times the rate notified by Reserve Bank of India in Sections 15 and 16.

On the other hand, the IBC is an act passed in 2016 with the aim of consolidating the insolvency laws and providing time-bound insolvency resolution. It has been repeatedly stated by the Supreme Court that IBC is not a debt recovery mechanism.

This brings forth the critical legal issue: Whether the interest that can be claimed under the MSMED Act can be considered while initiating the insolvency proceedings under Sections 7 and 9 of IBC?

II. Statutory Framework

A. Sections 15 and 16 of the MSMED Act

Section 15 requires payment for supply of goods or service within the prescribed time period which should not be more than forty-five days.

Section 16 states that when there is delay in payment, then the purchaser will be liable to pay compound interest at 3 times the RBI Bank Rate with monthly rests.

The interest prescribed in Section 16 is statutory, mandatory and compensatory.

B. Sections 7 and 9 of the IBC

Section 7 allows the financial creditor to start Corporate Insolvency Resolution Process (CIRP) upon occurrence of the default in relation to the financial debt.

Section 9 allows operational creditor to start CIRP in respect of operational debt on fulfillment of demand notice provisions under Section 8.

The difference between financial debt and operational debt becomes significant when considering MSMED interest.

III. Nature of Statutory Interest under the MSMED Act

The liability created under Section 16 is totally independent of the contractual provision. Even if there is no agreement of interest between the parties, the statutory provisions create the liability of interest.

Moreover, Section 17 stipulates that the buyer is bound to pay both the principal amount and statutory interest.

It is thus clear that statutory interest under the MSMED Act is not simply an incident but a statutory liability that comes straight out of the statute.

IV. Applicability under Section 7 of the IBC

Under Section 5(8), a financial debt would necessarily include an obligation involving disbursement of money in return for consideration on account of time value of money.

Interest due under Sections 15 and 16 of the MSMED Act has been created in consequence of a delay in payment for the supply of goods or services. It does not constitute either a disbursement or even possess any characteristic features of a financial debt.

Thus, MSMED interest cannot convert an operational obligation into a financial debt.

It follows that Sections 15 and 16 of the MSMED Act are inapplicable to the cases coming before Section 7 of the IBC.

V. Applicability under Section 9 of the IBC

This problem gets more complicated in the cases of CIRP instituted by operational creditors.

According to the definition of operational debt provided in Section 5(21), it includes claims in relation to goods and services and explicitly includes interest payable on the above.

Nonetheless, the main problem in this regard pertains to whether statutory interest as per Section 16 could be treated independently as operational debt and whether it would be enough to trigger CIRP.

Legal judgments have consistently differentiated between:

•           contractual interest;

•           admitted statutory interest; and

•           disputed statutory interest.

In cases wherein the primary debt itself is not in dispute, then it is possible to include the contractual interest in calculating operational debt.

On the other hand, in cases wherein there is no contractual interest outstanding or the statutory MSMED interest is in dispute, the general approach adopted in insolvency proceedings is that such disputes could be better addressed under the MSMED Act through the MSEFC.

VI. Judicial Developments

The courts in India have always maintained that the interest as per Section 16 is statutory.

The Delhi High Court in Indian Highways Management Company Ltd. v. Sowil Ltd. stated that the liability imposed by Sections 15, 16 and 17 is statutory and is irrespective of any contractual provisions.

Moreover, the Supreme Court in Silpi Industries v. Kerala State Road Transport Corporation has acknowledged the protection available to MSMEs under the MSMED Act in case of late payment.

However, some decisions of the National Company Law Appellate Tribunal have clarified that an insolvency proceeding cannot be used to adjudicate a disputed claim concerning statutory MSMED interest. In cases where the liability of interest needs to be examined in detail, the usual remedy is MSEFC.

Additionally, the Supreme Court’s observations in Mobilox Innovations Pvt. Ltd. v. Kirusa Software Pvt. Ltd. indicate that in the presence of genuine dispute, an application under Section 9 cannot be accepted.

Further, in the case of Swiss Ribbons Pvt. Ltd. v. Union of India, it is reiterated that the objective of IBC is insolvency resolution and not debt recovery.

NCLAT (Honorable) in Tamil Nadu Generation and Distribution Corporation Ltd. v. Micro Dynamics, 2022 SCC OnLine NCLAT 7, directly applies to the case at hand. The Appellate Tribunal ruled that: "Where a supplier registered under the MSMED Act invokes Sections 15-18 of such Act without getting any award from Facilitation Council and where the principal amount has been substantially paid, then such an invocation shall not be the ground for initiation of CIRP under Section 9 of the IBC."

VII. Harmonious Construction of the Two Legislations

The MSMED Act and the IBC belong to different spheres of operation.

The MSMED Act confers certain rights in the event of late payments and provides for an alternate dispute resolution process by way of the Facilitation Council.

The IBC on the other hand is a collective insolvency regime designed to rescue companies in distress.

For a harmonious construction, the rights available to debtors under the MSMED Act must be honored without making the insolvency proceedings a tool of recovery.

If the underlying debt is admitted and there is compliance with statutory provisions under the IBC, a Section 9 application can be made. However, when the dispute is confined to statutory interest or liability, then the proper forum would be the MSMED Act.

VIII. Critical Analysis

However, the current law demonstrates the effort made to achieve a reconciliation between two competing legislative aims.

First, MSMEs need to be protected from late payment. The statutory interest scheme dissuades large customers from delaying payment and compensates suppliers for their trouble.

Secondly, opening the possibility for insolvency cases based solely on disputes regarding statutory interest may defeat the purposes of the Insolvency and Bankruptcy Code and make insolvency a method of debt recovery.

However, mentioning the interest as part of operational debt in Section 5(21) does not mean that each case of statutory interest would be sufficient for initiating CIRP. The insolvency process does not serve as a place for thorough evaluation of disputed calculation of compound interest.

Therefore, the exercise of judicial caution in accepting Section 9 applications founded solely on MSMED interest seems justified by the purposes of both laws.

IX. Conclusion

The provisions contained in Sections 15 and 16 of the MSMED Act impose a statutory liability on defaulting buyers that owe money to the MSMEs. Interest due under such provisions is statutory in nature and can be recovered through the processes provided under the MSMED Act.

However, interest of the said nature cannot be regarded as a financial debt under Section 7 of the IBC. In Section 9 proceedings, even though interest qualifies to be an operational debt under the wide definition of the same, insolvency tribunals have tended to dismiss applications brought only on the grounds of disputed MSMED interest or where the case is more of debt recovery.

From the emerging jurisprudence, it is evident that the MSMED Act and the IBC should be harmoniously interpreted. While the former seeks to safeguard the commercial liquidity of small businesses, the latter ensures the sanctity of the insolvency regime in India.

References

1. The Insolvency and Bankruptcy Code, 2016.

2. The Micro, Small and Medium Enterprises Development Act, 2006.

3. Mobilox Innovations Pvt. Ltd. v. Kirusa Software Pvt. Ltd., (2018) 1 SCC 353.

4. Swiss Ribbons Pvt. Ltd. v. Union of India, (2019) 4 SCC 17.

5. Silpi Industries v. Kerala State Road Transport Corporation, (2021) 18 SCC 790.

6. Indian Highways Management Company Ltd. v. Sowil Ltd., Delhi High Court.

7. Tamil Nadu Generation and Distribution Corporation Ltd. v. Micro Dynamics, 2022 SCC OnLine NCLAT 7.