Compound interest

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

Explain the plight of micro, small and medium-sized enterprises (MSMEs) when opting for payment claims under the MSME Development Act 2006, VIVEK SHARMA explains why, in practice, legal compound interest enshrined in law is rarely enforced, and offers suggestions to strengthen 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 exports. Micro, Small and Medium Enterprises Development Act 2006 (MSME Law) has been in force for some time, with the aim of facilitating the promotion, development and improvement of the competitiveness of MSMEs. There are various measures enshrined in this law to achieve the given objective.

The Union Government has the power to develop programs, guidelines and instructions to facilitate, promote and develop MSMEs, especially micro and small enterprises, by developing the skills of employees, management and entrepreneurs, providing support for technological or infrastructure upgrading. facilities and development of clusters to strengthen backward and forward linkages. Credit facilities to MSMEs should be progressive. The State has the power to develop preferential policies for the procurement of goods and services produced by MSMEs for its ministries, assisted institutions and public sector enterprises. There are other mechanisms of funds and grants provided for in the law to be granted by the union government.

The provision of the MSME law relating to the clearance of payment claims and its frequent violation

In order to preserve the vulnerability of MSMEs, payment for the supply made by an MSME must be authorized by the buyer within the external period of forty-five days from the date of acceptance/deemed acceptance of the supply , if not agreed earlier between the parties. Late payment results in monthly compound interest to rest oneself to the supplier at three times the discount rate notified by the Reserve Bank of India.

The compound interest provision is a key legal deterrent to ensure that payments to MSMEs are cleared within the legal timeframe. However, like most things in the country, no single deterrent seems to be effective enough to substantial number claims are lodged by MSMEs with Facilitation Councils asking for assistance in getting their rights settled by their buyers. We also see that a number of claims fail to pass the first hurdle itself, because the Facilitation Board finds no merit in it. For those who go through the process enshrined in law, the recovery of the compound interest element appears a rarity in practice.

There can be no definitive answer as to why MSMEs actually manage to simply obtain the deferred principal amount or any other amount and the legal protection of statutory compound interest, more often than not, is eliminated in the process. Any agreement or resolution reached between the parties to ultimately honor only the delayed principal amount is a result in law; however, does this bode well for the Indian MSME sector? The objective of the law to exploit MSMEs is lost since the clearance of only the delayed principal amounts ensures that the vulnerability of companies remains. This is reflected in the continued lax attitude of some buyers towards clearing MSME dues, as buyers have moved away from the implications of compound interest in the past.

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Reluctance of MSMEs to charge compound interest due to lack of bargaining power

One of the fears of MSMEs is that they will not be in the running for new contracts from buyers, having pushed them into legal proceedings under MSME laws. It is for this reason that the element of compound interest becomes diluted as a negotiating tool for an ongoing relationship.

However, there is little certainty that the relationship persists after the negotiation. With thin customer bases and thin margins, MSMEs have little practical advantage in competing against large corporations or government establishments, as these buyers have a way of getting revenge one way or another, even if some make a practice to delay payments to MSMEs.

This is where policy makers have their work cut out for them. There must be a mechanism to identify buyers of black sheep and ensure that there is no slack in the joints for these black sheep in the law. The pre-deposit of 75% by the buyer who seeks to contest the award pronounced by the Facilitation Council is not sufficient because the agreement between the parties is concluded before this stage itself. The bargaining power of MSMEs vis-à-vis large companies or public establishments is limited; this shadow remains when reaching consensus even during the process under the MSME Act.

MSMEs need to be secured as the triggering of their rights under MSME laws cannot simply be sufficient reason for buyers to terminate them on future or current contracts. The duty of good faith and fair dealing is generally not accepted in common law countries as opposed to civil law countries. Given this, the current mechanism provides enough maneuverability for black sheep buyers to replace one MSME with another and continue with deferred payment cycles. This entire cycle, if allowed to continue for a long time, will prevent MSMEs from reaching the critical mass to attract large investors or funds to help drive their growth story forward.

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On the face of it, the law provides for an expedited resolution mechanism, starting with referral to the Facilitation Council to be decided within ninety days from the date of referral. There is a pre-filing requirement of 75 percent of the amount in terms of decree or award if a party seeks to file a claim challenging the same in court.

Facilitation boards must be empowered

In practice, there is lengthening due to one reason or another. Since it is the Facilitation Council that is the fulcrum of the whole MSME law exercise, it should be given the necessary powers to sanction the release of the amount granted to MSMEs. This can save time as MSMEs will then not be required to go to court for enforcement proceedings. This will ensure that the reference and the final result in monetary terms will be processed before a single authority itself.

With the pandemic causing the business cycle to slow down or even spiral, some MSMEs risk being pushed to the brink. The state should come up with policies to protect MSMEs and facilitate their borrowing. It is essential to strengthen and protect MSMEs whose payment cycles are interrupted. Having fulfilled their part of the bargain, MSMEs, now more than ever, need to be assured that their dues are paid on time.

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