Compound interest

Why do MSMEs rarely receive compound interest on late payment requests?


Explain the predicament of micro, small and medium enterprises (MSMEs) when opting for payment claims under the MSME Development Act, 2006, VIVEK SHARMA explains why, in practice, statutory compound interest enshrined in law is rarely enforced, and offers suggestions to strengthen the law and protect MSME interests in this regard.


MICRO, Small and Medium Enterprises (MSMEs) play an important role in India’s GDP and exports. The Micro, Small and Medium Enterprise Development Act 2006 (MSME Act) has been in force for some time, with the objective of facilitating the promotion, development and improvement of the competitiveness of MSMEs. Various measures are 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 managers. entrepreneurs, providing assistance or a marketing infrastructure to upgrade technology. installations and the development of clusters to strengthen upstream and downstream links. Credit facilities to MSMEs should be progressive. The state has the power to put in place preference policies for the purchase 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 by law and to be granted by the Union government.

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

In order to preserve the vulnerability of MSMEs, payment for the supply made by a MSME must be paid by the buyer within forty-five days from the date of acceptance / presumption of acceptance of the supply, if it has not been agreed earlier between the parties. Late payment results in compound interest with rests to the supplier at three times the discount rate notified by the Reserve Bank of India.

The compound interest provision is a key disincentive provided by law to ensure that payments to MSMEs are cleared within the legal deadlines. However, like most things in the country, no deterrent seems to be effective enough as a substantial number of complaints are lodged by MSMEs with the Facilitating Boards asking for help to have their dues reimbursed by their members. buyers. It is also noted that a number of complaints fail to overcome the first hurdle itself, as the Facilitation Council finds no basis in it. For those who go through the process enshrined in law, the recovery of the compound of interest element appears to be a rarity in practice.

There can be no straightforward answer as to why MSMEs are effective in simply getting the principal amount deferred or any other amount and the statutory compound interest protection, more often than not, is eliminated in the process. Any agreement or resolution between the parties to possibly honor only the principal late amount is a legal issue; However, does this bode well for the Indian MSME sector? The objective of the law to capture MSMEs is lost since the clearance of only the delayed principal amounts guarantees that the vulnerability of companies remains. This is reflected in the continued laxity of some buyers towards offsetting MSME contributions, as buyers have moved away from the implications of compound interest in the past.

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MSME reluctance to charge compound interest due to lack of bargaining power

One of the fears of MSMEs is that they may not be vying for new contracts with buyers, which once pushed them into legal process under MSME laws. It is for this reason that the compound interest element dilutes as a negotiating tool for an ongoing relationship.

However, there is little certainty that the relationship will continue after the deal. With a small customer base and low margins, MSMEs have little practical advantage in fighting large corporations or public establishments, as these buyers have a way to get revenge on them one way or another, despite some practice delay payments to MSMEs.

This is where policymakers have their work cut out for them. There must be a mechanism to identify buyers of black sheep and ensure that there is no play in the joints for these black sheep in the law. The pre-deposit of 75 percent of the buyer seeking to challenge the award made by the Facilitation Board is not sufficient as the agreement between the parties is reached before this stage itself. The bargaining power of MSMEs against large companies or public institutions is limited; this shadow persists when reaching consensus even during the process under the MSME law.

MSMEs need to be secure as the triggering of their rights under MSME laws cannot simply be sufficient reason 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 opposed to civil law countries. In view of this, the current mechanism provides sufficient maneuverability for buyers of black sheep to replace one MSME with another and continue with delayed payment cycles. This entire cycle, if allowed to continue for a long time, will ensure that MSMEs will never reach critical mass to attract large investors or funds to help them advance their growth.

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At first glance, the law provides for an accelerated resolution mechanism, starting with the referral to the Facilitation Council to be decided within ninety days of the date of referral. There is a pre-deposit requirement of 75 percent of the amount in terms of an order or award if a party seeks to file a claim challenging the same in court.

Facilitating boards must be empowered

In practice, there is an extension for one reason or another. Since it is the Facilitation Council that is the backbone of the entire exercise of the MSME law, 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 benchmark and the end result in monetary terms will be dealt with before a single authority itself.

With the pandemic causing a slowdown or even a downward spiral in the business cycle, some MSMEs are likely to be pushed to the brink. The state must come up with policies to protect MSMEs and facilitate their borrowing. It is essential to support and protect MSMEs whose payment cycles are broken. After fulfilling their part of the contract, MSMEs more than ever need to be assured that their contributions are paid on time.

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