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The Pre-Deposition Conundrum: Comparing Section 19 of the MSMED Act with reference to Act, 1996

Updated: Jan 29, 2023

Shubhendra Mishra[1]

Introduction


The Micro Small and Medium Enterprises Development Act, 2006 (hereinafter ‘Act’) was framed as a single comprehensive act for regulating and developing small-scale industries and enterprises, primarily to promote their growth and provide security to their interests. It had always been a longstanding demand of the sector to free itself from a plethora of laws and regulations that acted as a deterrent because of the limited availability of resources and awareness to deal with them. Pursuant to this conundrum, well-deliberated legislation was pronounced to provide adequate solutions. But as with any other legislation in the country, this Act is also influenced by arbitrary aspects which have crept into the roots of the legislation and gone uncatered to. This article aims to deal with a similar noticeable example of the Act, that is, Section 19, highlighting its arbitrary aspects and providing adequate reasoning as to why an amendment for the same is a pressing priority now.


Purpose of Section 19 of the Act: An unjust discrimination between buyer and seller


Section 18(2) of the Act provides for reference to the process of conciliation if a dispute arises between the parties with regard to any amount due under Section 17 of the Act while making a reference to the Micro Small Enterprises Facilitation Council (hereinafter ‘Council’). But if such a settlement process fails to reach a justified conclusion and results in termination, then either the Council takes up the matter for arbitration or refers it to some institution that provides dispute resolution services for such arbitration. The provisions of the Arbitration and Conciliation Act, 1996 (hereinafter ‘Arbitration Act’) shall then apply to the dispute as if the arbitration was in pursuance of an arbitration agreement referred to in sub-section (1) of section 7 of the Arbitration Act. Now, according to section 19 of the Act, if an arbitral award has been passed pursuant to such an arbitration proceeding under section 18 and an application for setting aside any decree, award or other order is to be made before any court of law, the law mandates the deposition of 75% of the total amount of the arbitral award pronounced, and time and again it has been upheld in various High Court and Supreme Court judgements that this provision is mandatory in nature and not merely directory.


An analysis of its jurisprudence will take us to the conclusion that it exists mainly to protect the interests of the seller of a micro or small enterprise by upholding the validity of the arbitral award and to provide for facilitating promotion and development and enhancing the competitiveness of micro, small and medium enterprises and for matters connected therewith or incidental thereto. According to the Courts, this discrimination exists on valid grounds as a buyer, when challenging an adverse award, has to make a pre-deposit. However, when a seller is non-suited, he need not make any pre-deposit for challenging the order, which is adverse to him. Therefore, if a defeated seller is called upon to make some deposit, it will appear irrational or arbitrary. This justification is based on the idea that deposition is necessary with respect to the secured assets if taken possession of or sold, may fall short of the dues therefore, such a deposit may be necessary.


An analysis of this reasoning also points out this provision's arbitrary and discriminatory nature. In the case of Kerala SRTC v Union of India, the counsel for the petitioner argued that Section 19 of the Act is arbitrary and discriminatory and, therefore, violative of Article 14 of the Constitution of India as it creates discrimination between the seller and buyer and militates the right to equality under Article 14 of the constitution. It was also contended that the right to move to a competent court under Section 34 of the Arbitration Act is similar to the right to appeal provided under the unamended Section 17 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (hereinafter ‘the SARFAESI Act’). The judgement of Mardia Chemicals Ltd v Union of India was relied upon as a contention to argue that the stipulation regarding pre-deposit should be declared unenforceable, however, this argument was ultimately rejected. The reason behind such rejection was the dissimilarity that exists in the purpose with which the above-compared acts were framed and the objectives that they aim to fulfil.


Lack of Confidence in Courts and Legislative overreach


Any string of analysis cannot take us to the conclusion as to why the cap has been set mandatorily at 75% since, logically, if the arbitral award passed is pristine in nature, then the courts should simply mandate the deposition of 100% of the arbitral award to save the time and promote efficiency in the pronouncement of judgments. Setting the cap below 100% clearly demonstrates two chains of conclusions that can be derived. Firstly, the legislation deprives the courts of their confidence in determining whether an award passed under the Act is arbitrary and, in this way, undermines their existence and power. Secondly, this is a prime example of legislative overreach as such a law indicates that the legislature can encroach upon the judiciary whenever intended, as it directs the court to take a deposition of 75% of the amount mandatorily. In this way, the power of the court to hear appeals for challenging the award under section 34 of the Arbitration Act gets restricted. Even if the award passed is arbitrary, the courts are now left with no option other than to take a deposition of 75% before hearing the appeal.


No Backdoor Remedy If The Arbitral Award Passed was Adverse: Abuse of provisions of Section 19


There are multiple loopholes through which the provisions of this law can be abused without any hindrance. Firstly, the courts also fail to consider the facts as to the unruly or arbitrary nature of the award passed due to an arbitration proceeding commenced ex-parte through section 18(3) of the Act. It should be noted that the law provides that an arbitration proceeding cannot be commenced ex-parte if any of the parties are not provided with sufficient opportunity of hearing even though an arbitral tribunal has been vested with the power of a civil court, because it will lead to a violation of the principle of natural justice of audi alteram partem, which mean no case should be decided without hearing both the parties. But still, by the skilful use of the provisions of section 19 of the Act, an award can be passed ex-parte with utmost arbitrariness. Still, no remedy will lie against it unless the aggrieved party deposits 75% of the arbitral award to the court.


Secondly, in a situation where a party has to deposit the said amount, does not possess adequate funds for the same, will not be able to file an appeal before the court. Thus, the only option left with the party would be to declare itself insolvent or dilute its existing assets, which will not be justified in every case, especially where the arbitral proceeding has resulted in an unfavourable award. The courts also fail to consider the situation where a dispute may arise between enterprises of similar standards, for example, two micro or small enterprises. In such a situation, where the buyer itself is a micro or small enterprise, it becomes very difficult or almost impossible for the buyer to make a deposit of 75% of the award, which in the majority of the circumstances is a hefty amount and such deposition is too big of a sacrifice to be done before their appeal is heard and a justified conclusion is reached by the courts. Therefore, the deposition of 75% of the award before the dispute is resolved could be prejudicial to the interests of the buyer.


Thirdly, situations may arise where an arbitral proceeding is presided over by three arbitrators, that is, the minimum number of arbitrators required for constituting an arbitral tribunal under Section 11(3) of the Arbitration Act, but the award is passed only by two of the arbitrators because one of the arbitrators has expired or retired or was not involved for any other reason when the award was passed or was unable to sign the arbitral award passed. In such a scenario, the scope for passing an adverse or arbitrary award expands tremendously. For dealing with such a situation, no exception or alternate remedy exists.


The Way Forward


Need of the hour is an amendment for adding an exception to Section 19 of the Act. The exception should cover majorly the aspects including any of the following: firstly, if the chances of the aggrieved going insolvent are evident and can be adequately proved by them, then the courts should allow the appeal of such a person to be heard before them without mandating the deposition. Secondly, if the provision of a mandatory deposition is to be upheld, then the percentage of such deposition should be reduced to an extent so as to not give rise to the impossibility of satisfaction of the provision. In totality, the financial conditions of the aggrieved at the time of the appeal before the court should be the primary factor to be considered before the imposition of the statutory mandates because a deposition of 75% of the award could be burdensome for the buyer and could have a detrimental effect on the ability of the buyer to make the remaining payment.


If no exceptions are added, the courts can follow the precedence of Mardia Chemicals Ltd. Etc v UOI & Ors. Etc, which resulted in the striking down of a similar provision in the SARFAESI Act. In this case, it was contended and held that such an oppressive provision should not have been made. It works as a deterrent or as a disabling provision impeding access to a forum meant for the redressal of the grievance of a borrower. The amount of deposit of 75% of the demand, at the initial proceeding itself, sounds unreasonable and oppressive more particularly when the secured assets/the management thereof, along with the right to transfer such interest has been taken over by the secured creditor or in some cases property is also sold. The requirement of a deposit of such a heavy amount on the basis of a one-sided claim alone, cannot be said to be a reasonable condition at the first instance itself before the start of adjudication of the dispute. The courts can also follow a similar line of reasoning to address this issue with respect to section 19 of the Act. This section deprives the courts of their power to hear appeals and is manifestly arbitrary under certain circumstances which have been previously enumerated in the article. In the case of Seth Nandlal v State of Haryana, it was held that – “right of appeal is a creature of the statute and while granting the right the legislature can impose conditions for the exercise of such right so long as the conditions are not so onerous as to amount to unreasonable restrictions rendering the right almost illusory.” Therefore, if an existing provision unreasonably hampers the power of the courts and the right of the people to appeal, it should either be amended or struck down completely.


Conclusion


The main thrust of the contentions in this article to challenge the validity of the impugned enactment is that no adjudicatory mechanism is available to the other party to ventilate their grievance through an adjudicatory authority when access to the justice is the hallmark of any legal system. The effectiveness of an enactment decreases when it is at odds with the basic principle of law-making, that is, the law should be lenient, but its enforcement should be strict. Indeed, when a transaction of a similar nature as enumerated under the Act takes place and there is a default with respect to the same, logically the seller will be at the suffering the end but that should not prevent the legislature as well as the courts to foresee the possible loopholes that exist as a result of one-sided legislation and its possible misuse, which can grow rampant if left unattended to.


 

[1] Shubhendra Mishra is an undergraduate law student from Dr Ram Manohar Lohiya National Law University, India. He holds interests in various fields of law, including Arbitration Law, Insolvency law, Corporate Law, Mergers and Acquisitions and Securities Law. He can be reached at shubhendra.rajat102@gmail.com.

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