Why do MSMEs rarely get compound interest on delayed payment claims?

Explaining the predicament of Micro, Small and Medium Enterprises (MSMEs) when opting for payment claims under the MSME Development Act, 2006, VIVEK SHARMA writes about why, in practice, the statutory compound interest enshrined in the law is rarely executed, and offers suggestions to bolster the law and secure the interests of MSMEs in this regard.


MICRO, Small and Medium Enterprises (MSMEs) play a significant role in India’s GDP and export story. The Micro, Small and Medium Enterprises Development Act, 2006 (MSME Act) has been in operation for some time, with the objective to facilitate promotion, development and enhancing the competitiveness of MSMEs. There are various measures enshrined in this law for achieving the given objective.

The Union Government has the power to bring out programmes, guidelines, and instructions for facilitating, promoting, and developing MSMEs, particularly micro and small enterprises, by developing the skills of the employees, management, and entrepreneurs, providing technological upgradation marketing assistance or infrastructure facilities and cluster development to strengthen backward and forward linkages. Credit facilities to MSMEs are required to be progressive. The State has the power to layout preference policies in respect of procurement of goods and services produced by MSMEs for its ministries, aided institutions, and public sector enterprises. There are other mechanisms of funds and grants provided in the law to be given by the union government.

MSME Act’s provision for clearance of payment claims, and its frequent violation

To safeguard the vulnerability of MSMEs, payment for the supply made by an MSME is required to be mandatorily cleared by the buyer within the outer limit of forty-five days from the date of acceptance/ deemed acceptance of the supply, if not agreed earlier between the parties. Delay in payment results in compound interest with monthly rests to the supplier at three times the bank rate notified by the Reserve Bank of India.

The compound interest provision is a critical deterrent provided in law to ensure that payments to MSMEs are cleared within the statutory timeframe. However, like most things in the country, no deterrent appears to be effective enough as a substantial number of claims is filed by MSMEs to Facilitation Councils seeking assistance to have their dues cleared from its buyers. It is also seen that a number of claims fail to clear the first hurdle itself as the Facilitation Council does not find merit in the same. For the ones that go through the process enshrined in law, recovery of the compound interest element appears a rarity in practice.

There cannot be a straightjacket answer as to why MSMEs effectively manage to get simply the delayed principal amount or any other amount and protection in law of statutory compound interest, most often than not, gets eliminated in the process. Any agreement or resolution arrived between parties to eventually honour only the delayed principal amount is an outcome in law; however, does this bode well for the Indian MSME sector? The objective of the law to harness MSMEs is lost since clearance of only the delayed principal amounts ensures that the vulnerability of enterprises subsists. This results in the continued lax attitude of some buyers towards clearing dues of MSMEs since the buyers have got away from compound interest implications in the past.

Also read: Union Budget 2021 Presents an Unchanging Health and MSME Landscape Amidst Rising Concerns

MSMEs’ unwillingness to demand compound interest rooted in lack of bargaining power

One of the fears of MSMEs vests on being out of contention for new contracts from buyers, having once pushed them to the legal process under MSME laws. It is due to this that the compound interest element gets diluted as a tool of the bargain for a continued relationship.

However, there is little certainty that the relationship persists post the bargain. With thin customer bases and meagre margins, MSMEs have little practical benefit from fighting big corporates or government establishments as such buyers have a way to get back at them one way or another, inspite of some making a practice of delaying payments to MSMEs.

It is here that policy makers have their work cut out. There needs to be a mechanism to identify black sheep buyers and ensure there is no play in the joints for such black sheep in the law. The 75 percent pre-deposit by the buyer who seeks to challenge the award passed by the Facilitation Council is not enough as the agreement between the parties is reached prior to this stage itself. The bargaining power of MSMEs against big corporations or government establishments is limited; this shadow remains at the time of arriving at a consensus even during the process under the MSME Act.

MSMEs must be secured to the extent that triggering their rights under MSME laws cannot simply be reason enough by buyers to terminate them on future or present contracts. The duty of good faith and fair dealing is generally not accepted in common law countries as distinguished from civil law countries. Given this, the present mechanism provides enough maneuverability to black sheep buyers to replace one MSME with another and continue with delayed payment cycles. This entire cycle, if permitted to be continued for long, will result in MSMEs never reaching critical mass to attract large investors or funds to assist them in taking their growth story forward.

Also read: Financial relief package for MSMEs: Did the Government of India, completely miss the bus?

On first brush, the law provides a fast-track mechanism of the resolution, commencing with the reference to the Facilitation Council having to be decided within a period of ninety days from the date of making of the reference. There is a requirement of pre-deposit of 75 percent of the amount in terms of the decree or award if any party seeks to file an application challenging the same in a court of law.

Facilitation Councils must be empowered

In practice, there is prolongment due to one reason or another. Since it is the Facilitation Council which is the fulcrum of the entire exercise of the MSME Act, it should be given necessary powers to sanction the release of the amount awarded to MSMEs. This may save time as MSMEs then will not be required to apply to a court of law for execution proceedings. This will ensure that both the reference and the final outcome in monetary terms get dealt with before one authority itself.

With the pandemic causing the economic cycle to slow down, if not spiral downwards, some MSMEs are likely to be pushed to the brink. The State must come up with policies to safeguard MSMEs and ease their borrowings. There is a critical requirement to bolster and safeguard MSMEs whose payment cycles stand ruptured. Having executed their part of the contract, MSMEs, now more than ever, are required to be assured that their dues are paid within enshrined timelines.

(Vivek Sharma is a Delhi-based lawyer. The views expressed are personal.)