MSMED Act: Delayed Payment Protections and Commercial Contract Implications

I. Introduction

Late payment is among the most persistent threats to the financial health of a small business. An MSME that supplies goods or services to a large buyer typically has little leverage to enforce its payment terms and limited capacity to absorb the cash flow disruption that a delayed or disputed payment causes. The Micro, Small and Medium Enterprises Development Act, 2006 ("Act") addresses this structural imbalance directly. Chapter V of the Act, covering Sections 15 to 25, creates a mandatory payment framework that overrides contractual arrangements, imposes compound interest at a penal rate on delayed payments, and requires buyer companies to publicly disclose their outstanding dues to MSME suppliers. For an MSME supplier, understanding these provisions is as important as understanding the contract it signs. For a buyer, the Act creates statutory obligations that no payment clause in a supply agreement can contract out of.

This article explains what the Act provides, why it matters practically to MSME suppliers, what obligations it places on buyer companies, and how supply and service agreements between MSME suppliers and their customers should be structured to give full effect to the Act's protections.

II. MSME Classification and Udyam Registration

The Act's delayed payment protections apply only to micro and small enterprises, not to medium enterprises. Classification is determined by investment in plant and machinery or equipment and annual turnover, as revised by the Ministry of MSME notification of June 2020. A micro enterprise is one with investment not exceeding one crore rupees and turnover not exceeding five crore rupees. A small enterprise is one with investment not exceeding ten crore rupees and turnover not exceeding fifty crore rupees. A medium enterprise, with investment up to fifty crore rupees and turnover up to two hundred fifty crore rupees, does not qualify for Chapter V protections.

Classification alone is not sufficient to invoke the Act's protections. The supplier must be registered under the Udyam Registration system, the online portal established by the Ministry of MSME. A supplier who has not obtained Udyam Registration cannot claim the benefit of Sections 15 to 17, even if its turnover and investment place it within the micro or small category. Registration is accordingly a practical prerequisite, and MSME suppliers who are not yet registered should treat Udyam Registration as an immediate priority rather than an optional administrative step. Equally, MSME suppliers should ensure that their Udyam Registration certificate is provided to every customer at the time of contracting, both to put the customer on notice of the statutory framework and to establish a clear record in the event of a later payment dispute.

III. The Payment Obligation: Sections 15 and 16

Section 15 of the Act prescribes the timeline within which a buyer must pay a micro or small enterprise supplier. Where there is a written agreement specifying a payment date, the buyer must pay by that date. The agreement may not, however, specify a payment period exceeding forty-five days from the day of acceptance or deemed acceptance of the goods or services. A payment clause in a supply agreement that purports to extend payment terms beyond forty-five days, whether ninety days, one hundred and twenty days, or any other period, is void to that extent. The forty-five day ceiling is mandatory and overrides any contrary contractual provision.

Where there is no written agreement on payment terms, or where the agreement is silent on the due date, Section 15 provides that payment must be made on or before the appointed day. The appointed day is defined in Section 2(b) as the day following immediately after the expiry of fifteen days from the day of acceptance or deemed acceptance. Deemed acceptance occurs where the buyer raises no written objection within fifteen days of delivery. The practical effect is that in the absence of a written payment clause, the buyer has fifteen days to accept or object to the goods or services, and payment is due the day after that period expires.

Section 16 provides the consequences of default. Where a buyer fails to pay within the Section 15 timeline, it is liable to pay compound interest with monthly rests on the outstanding amount at three times the bank rate notified by the Reserve Bank of India. The interest runs from the appointed day or the day following the agreed payment date, and continues until the amount is paid in full. The language of Section 16 is unequivocal: the liability arises notwithstanding anything contained in any agreement between the buyer and the supplier or in any law for the time being in force. This override provision means that a contractual clause fixing interest on late payment at a lower rate, or excluding interest altogether, is ineffective. The statutory rate of three times the RBI bank rate applies regardless.

The practical significance of the compound interest provision for an MSME supplier is substantial. At the current RBI bank rate of six and a half per cent, the Section 16 interest rate is nineteen and a half per cent per annum, compounded monthly. On an unpaid invoice of twenty lakhs overdue by one year, the compound interest at this rate amounts to approximately four lakhs thirty thousand rupees. For a buyer who has allowed multiple invoices to remain unpaid across several accounting periods, the accumulated statutory interest liability can be considerable, particularly because Section 23 of the Act provides that interest paid under Section 16 is not deductible for income tax purposes, adding a further cost to the delay.

IV. The Disclosure Obligation: Section 22 and Form MSME-1

Section 22 of the Act imposes a disclosure obligation on every company that is a buyer of goods or services from micro or small enterprise suppliers and whose payment to such suppliers is outstanding beyond forty-five days. Such companies are required to include in their annual statement of accounts the following information: the principal amount and interest due and remaining unpaid to each supplier at the end of the accounting year, the amount of interest paid under Section 16 together with the payments made beyond the appointed day, the amount of interest accrued and remaining due at the end of the accounting year and any further interest remaining due in succeeding years until fully paid.

In addition to the Section 22 annual disclosure, the Ministry of Corporate Affairs has, through notification under the Companies Act, 2013, required every company that receives supplies from micro or small enterprises to file Form MSME-1 with the Registrar of Companies on a half-yearly basis if payment to any such supplier is outstanding beyond forty-five days. The first half-year covers April to September, with the return due by October 31. The second covers October to March, with the return due by April 30. A company that fails to file Form MSME-1 within the prescribed period is liable to a penalty of twenty thousand rupees for initial default and a further penalty of one thousand rupees per day for continuing default, subject to a maximum of three lakh rupees, with liability extending to officers in default.

From the perspective of an MSME supplier, the Section 22 disclosure requirement and Form MSME-1 filing obligation serve a function beyond regulatory compliance. They create a publicly accessible record of the buyer's payment conduct. A pattern of repeated late payment disclosures in a buyer's statutory filings is evidence that can be used by an MSME supplier in enforcement proceedings before the Micro and Small Enterprise Facilitation Council. They also create reputational pressure on buyers: a company whose annual accounts consistently disclose large outstanding balances owed to small suppliers signals a payment culture that counterparties and investors may find relevant.

V. Enforcement: The MSEFC and MSME Samadhaan

Where a buyer disputes a payment or refuses to pay, Section 18 of the Act provides the MSME supplier with a dedicated dispute resolution mechanism. The supplier may refer the dispute to the Micro and Small Enterprise Facilitation Council established by the State Government. The Council is required to attempt conciliation and, if conciliation fails, to either take up arbitration itself or refer the matter to an institution for arbitration. The Council must endeavour to resolve the dispute within ninety days. Awards made by or through the Council carry the same force as a decree of a civil court and may be executed accordingly.

A buyer who challenges a Council award in court is required under Section 19 to deposit seventy-five per cent of the amount awarded as a pre-condition of the court entertaining the challenge. This mandatory pre-deposit requirement significantly reduces the practical attractiveness of challenging MSEFC awards in court and operates as a strong incentive for buyers to settle disputes at the Council stage. The Supreme Court in Silpi Industries v. Kerala State Road Transport Corporation (2021 SCC OnLine SC 439) affirmed that the MSMED Act is a special beneficial legislation and that its provisions, including the interest provisions, prevail over inconsistent terms in other agreements or statutes including the Arbitration and Conciliation Act, 1996. An MSME supplier who has a contractual arbitration clause with its buyer may still approach the MSEFC; the buyer cannot use the arbitration clause to prevent the supplier from accessing the statutory remedy.

The Ministry of MSME operates an online portal, MSME Samadhaan, through which micro and small enterprise suppliers with Udyam Registration can file applications against buyers for delayed payments. The portal allows tracking of cases filed, amounts claimed, and the status of proceedings before the relevant MSEFC. Filing through the portal is straightforward and does not require the supplier to engage lawyers for the initial stages of the process, which is an important practical advantage for smaller enterprises with limited administrative resources.

VI. What the Customer Contract Should Look Like

Given the statutory framework described above, the supply or service agreement between an MSME supplier and its customer should be structured to give full effect to the Act's protections rather than to dilute them. Several specific points of drafting deserve attention.

Payment terms within the statutory ceiling. The contract should specify a payment due date that does not exceed forty-five days from the date of acceptance or deemed acceptance of the goods or services. A common and effective formulation is to tie the due date to the date of the supplier's invoice, with a specified number of days for payment not exceeding forty-five. Where the payment cycle of the buyer's accounts payable system means that invoices are processed in batches, the contract should ensure that the batch processing cycle does not extend the effective payment period beyond forty-five days.

Acceptance procedure and deemed acceptance. The contract should specify a clear acceptance procedure, including a defined period, not exceeding fifteen days, within which the buyer must raise any written objection to goods delivered or services rendered. Where the buyer raises no objection within this period, the delivery date should be recorded as the date of deemed acceptance for the purposes of Section 2(b) of the Act. The MSME supplier should maintain delivery records, acknowledgment receipts, and email confirmations that establish the date of delivery and the absence of any timely objection, since these records determine when the appointed day falls and when interest begins to run.

Interest on delayed payment. The contract should record that interest on delayed payment is payable at the rate prescribed under Section 16 of the MSMED Act, 2006, being compound interest with monthly rests at three times the RBI bank rate from time to time. Including this provision in the contract serves two purposes: it puts the buyer on express notice of the statutory liability, and it creates a contractual record that the parties understood and accepted the applicable interest regime. Any attempt by a buyer to include a lower contractual interest rate should be resisted by the MSME supplier on the ground that Section 16 overrides it; if the buyer insists on including such a provision, the supplier should ensure that the contract also records that the statutory rate prevails to the extent of any inconsistency.

MSME status and Udyam Registration. The contract should record the supplier's Udyam Registration number and classification as a micro or small enterprise, and should include a representation by the supplier that it holds valid Udyam Registration as of the date of the agreement. The contract should also include an obligation on the supplier to notify the buyer if its classification changes. This provision benefits both parties: it ensures that the buyer cannot later claim ignorance of the supplier's MSME status, and it creates a contractual basis for the buyer's Section 22 disclosure obligations.

Dispute resolution. Where the contract includes an arbitration clause, the clause should acknowledge the supplier's right to approach the MSEFC under Section 18 of the MSMED Act notwithstanding the arbitration clause, consistent with the position affirmed in Silpi Industries. A contractual arbitration clause that purports to be the exclusive dispute resolution mechanism and to exclude access to the MSEFC is contrary to the Act and unenforceable to that extent. The contract should not attempt to waive or restrict the MSME supplier's statutory rights; any such waiver is void by reason of Section 24's overriding effect.

VII. Conclusion

The MSMED Act's delayed payment regime is a genuine and practically effective protection for micro and small enterprise suppliers. The forty-five day payment ceiling, the compound interest at three times the RBI bank rate, the mandatory public disclosure obligations, the pre-deposit requirement for court challenges to MSEFC awards, and the override provision that renders contractual departures void together constitute a framework that tilts the playing field meaningfully in favour of smaller suppliers. The protection is not automatic, however. It requires Udyam Registration, clear contractual documentation of delivery and acceptance, and a willingness to use the MSEFC mechanism when payment is withheld.

For MSME suppliers, the commercial contract with their customer is the first line of protection. A well-drafted agreement that records the supplier's Udyam Registration, specifies payment terms within the statutory ceiling, documents the acceptance procedure, and acknowledges the Section 16 interest rate ensures that the statutory framework operates as intended rather than being obscured by payment clauses that favour the buyer. The Act gives micro and small enterprises the right to be paid promptly and expensively if they are not; the contract and the documentation behind it determine whether that right can be effectively exercised.