Can a buyer hit back with counter-claims in MSME arbitration? SC says yes

A supplier demanded payment. The buyer didn't just refuse—it filed a counter-claim. The question: is that allowed under a law meant to protect small businesses? The Supreme Court of India answered this question in June 2021, settling a critical ambiguity that had divided High Courts for years.

Two separate disputes—one involving thread rubber for Kerala's state bus fleet, the other involving hydro-mechanical equipment for a different buyer—converged in the Supreme Court on the same day. Both raised the same legal puzzle: when a small supplier invokes the MSMED Act (a law designed to ensure small businesses get paid on time), can the buyer fight back with its own claims? And does the ordinary law of limitation (the time limit within which a legal claim must be filed) apply at all to these special proceedings?

When the supplier demanded payment

Silpi Industries supplied thread rubber to the Kerala State Road Transport Corporation (KSRTC) under multiple purchase orders. The orders were crisp, typed on government letterhead, each specifying a quantity of rubber strips and a price. KSRTC paid 90% of the amount but withheld 10% pending performance reports. Silpi, claiming it was a small enterprise under the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act), approached the MSMED Facilitation Council for recovery of the withheld amount. The Council's conference table was bare except for the file—a thin stack of papers that would soon grow thick with arguments.

Conciliation failed. The matter went to arbitration before the Facilitation Council itself, which passed awards in favour of Silpi. KSRTC challenged these awards in court. On 5 August 2014, the District Court in Kerala dismissed KSRTC's applications to set aside the awards. But on 11 August 2017, the Kerala High Court reversed that decision—it remanded the matters back for fresh consideration, ruling on two crucial points: that the Limitation Act, 1963 (the law that sets time limits for filing legal claims) applies to MSMED arbitrations, and that buyers can raise counter-claims in such proceedings.

Silpi appealed to the Supreme Court.

The second dispute: registration after the contract

In a connected case, Khyaati Engineering had supplied hydro-mechanical equipment to a buyer. The key difference: Khyaati registered itself under Section 8 of the MSMED Act (the provision for filing a memorandum declaring enterprise status) only after the contract was signed and the supplies were made. When the buyer sought appointment of a separate arbitrator under Section 11(6) of the Arbitration and Conciliation Act, 1996 (a provision that allows a party to ask the court to appoint an arbitrator when the other side fails to do so), Khyaati claimed the protection of the MSMED Act.

The question was whether a supplier could claim the benefits of a law designed to protect small businesses for contracts entered into before it even registered under that law.

Two questions, one answer

The Supreme Court bench, led by Justice R. Subhash Reddy, framed two core issues that would determine the fate of both appeals. First, does the Limitation Act, 1963 apply to arbitration proceedings initiated under Section 18(3) of the MSMED Act (the provision that allows the Facilitation Council to arbitrate disputes)? Second, can a buyer raise counter-claims and set-off (a claim that the supplier owes the buyer money, which should be deducted from what the buyer owes) in such arbitration proceedings? The courtroom fell silent as the bench posed these questions—the only sound was the rustle of paper as counsel turned pages.

The third issue—whether registration under Section 8 of the MSMED Act can operate retrospectively—was specific to the Khyaati Engineering case.

The suppliers argued that the MSMED Act was a special beneficial legislation that overrode general laws. They pointed to Section 24 of the MSMED Act (the overriding effect clause, which says the Act prevails over any other law inconsistent with it). They argued that the Limitation Act should not apply, and that counter-claims by buyers would defeat the purpose of a law meant to protect small businesses from delayed payments.

The buyers—KSRTC and the other respondent—argued that the Limitation Act applies by virtue of Section 43 of the Arbitration and Conciliation Act, 1996 (which says the Limitation Act applies to arbitrations as it applies to court proceedings). They also argued that denying counter-claims would be fundamentally unfair—if a supplier can claim money, the buyer should be able to raise its own claims arising from the same transaction.

Why the Limitation Act applies

The Supreme Court held that the Limitation Act, 1963 applies to arbitration proceedings initiated under Section 18(3) of the MSMED Act. The reasoning was straightforward: Section 43 of the Arbitration and Conciliation Act, 1996 makes the Limitation Act applicable to all arbitrations. The MSMED Act does not exclude the application of the Limitation Act. The overriding effect under Section 24 of the MSMED Act does not extend to excluding the law of limitation.

The court observed that the MSMED Act is a special beneficial legislation with overriding effect under Section 24—it prevails over the general Arbitration and Conciliation Act, 1996. Even if parties have a separate arbitration agreement, a supplier covered under the MSMED Act can approach the Facilitation Council. But that overriding effect does not mean the Limitation Act disappears. Time limits for filing claims still apply.

The court drew on several precedents to reach this conclusion. In Andhra Pradesh Power Coordination Committee v. Lanco Kondapalli Power Ltd., the court had held that the Limitation Act applies to arbitrations under the 1996 Act unless expressly excluded. In Shanti Conductors Pvt. Ltd. v. Assam State Electricity Board, the court had reinforced that the Limitation Act's application is automatic under Section 43. The court also considered M/s. B.H.P. Engineers Pvt. Ltd. v. Director, Industries, U.P. and M/s. Steel Authority of India Ltd. v. Micro, Small Enterprise Facilitation Council, which had grappled with the interplay between the MSMED Act and the Limitation Act. The weight of these authorities, the court said, pointed in one direction: the Limitation Act applies.

Why counter-claims are maintainable

On the second issue, the court held that counter-claims and set-off by buyers are maintainable in arbitration proceedings under Section 18(3) of the MSMED Act. The court arrived at this conclusion through harmonious construction—reading the MSMED Act together with Section 23(2A) of the Arbitration and Conciliation Act, 1996 (the provision that allows counter-claims and set-off in arbitration proceedings).

The court reasoned that the MSMED Act does not expressly bar counter-claims. The purpose of the Act is to ensure timely payment to small suppliers, not to create a one-sided forum where buyers cannot raise legitimate claims. If a supplier can demand payment through the Facilitation Council, a buyer should be able to raise its own claims arising from the same transaction. Otherwise, the buyer would be forced to file a separate arbitration or court proceeding—defeating the purpose of a single, efficient dispute resolution mechanism.

The court quoted from its own ratio: "Counter-claims and set-off by buyers are maintainable in arbitration proceedings under Section 18(3) of MSMED Act, by harmonious construction with Section 23(2A) of the 1996 Act." This was not a concession to buyers, the court clarified, but a recognition that justice requires both sides to be heard. The Facilitation Council's arbitration, the court said, must be fair to both parties—not just the supplier.

The court also cited GE T&D India Ltd. v. Reliable Engineering Projects and Marketing and Edukanti Kistamma (Dead) through LRs. v. S. Venkatareddy (Dead) through LRs. to support the principle that counter-claims are a natural part of dispute resolution. A buyer who has a claim arising from the same contract should not be forced to file a separate proceeding—that would waste time, money, and judicial resources.

The registration trap

On the third issue, the court held that registration under Section 8 of the MSMED Act operates prospectively. Benefits under the Act cannot be claimed for contracts entered into and supplies made before the filing of the memorandum. Khyaati Engineering had registered after supplying the equipment. It could not claim the protection of the MSMED Act for that contract.

The court dismissed Khyaati's appeal, holding that the supplier was not entitled to MSMED benefits due to post-supply registration. The file on Khyaati's case was thin—a single contract, a single registration, and a single question: could a supplier claim benefits for work done before it registered? The court's answer was firm: no.

What this means for your next contract

For suppliers: register under the MSMED Act before you enter into contracts. Registration after the fact will not protect you for past supplies. For buyers: you can raise counter-claims in MSMED arbitration proceedings. The law does not leave you defenseless. For both sides: the Limitation Act applies. Do not assume the MSMED Act gives you unlimited time to file claims.

THE PLAY: Register under Section 8 of the MSMED Act before signing your first contract—post-supply registration will not protect you for past transactions.

The court ended where it began: with a supplier demanding payment and a buyer fighting back. The law, the court said, allows both.