Worked example 11 — Classifying an enterprise as an MSME, and pricing a delayed payment

Micro, Small and Medium Enterprises form the backbone of India's industrial economy, accounting for approximately 35.4 per cent of manufacturing, around 48.58 per cent of exports, and 31.1 per cent of GDP. There are over 7.47 crore enterprises employing over 32.82 crore persons, and the sector holds its position as the second-largest employer after agriculture. Globally, MSMEs make up about 90 per cent of businesses and are responsible for over 50 per cent of total global employment.

That employment figure is why the classification question is not a technicality. Whether an enterprise is inside the definition decides whether it gets the credit, the procurement preference and — the subject of the second half of this example — the statutory payment protection.

The governing statute is the Micro, Small and Medium Enterprises Development Act, 2006. Section 7(1) empowers the Central Government, notwithstanding section 11B of the Industries (Development and Regulation) Act 1951, to classify by notification any class or classes of enterprises — whether proprietorship, Hindu undivided family, association of persons, co-operative society, partnership firm, company or undertaking, by whatever name called.

Manufacturing or production of goods — an industry specified in the First Schedule to the IDR Act 1951:

| Class | Investment in plant and machinery | |---|---| | Micro | does not exceed twenty-five lakh rupees | | Small | more than twenty-five lakh but not exceeding five crore rupees | | Medium | more than five crore but not exceeding ten crore rupees |

Providing or rendering of services:

| Class | Investment in equipment | |---|---| | Micro | does not exceed ten lakh rupees | | Small | more than ten lakh but not exceeding two crore rupees | | Medium | more than two crore rupees, up to the notified ceiling |

Two defects follow from the design and both were eventually fixed. It distinguished manufacturing from services, putting identical-sized firms in different categories. And it used a single criterion, investment, so a firm with modest machinery and very large turnover stayed micro.

After 14 years since the MSME Development Act came into existence in 2006, a revision in the MSME definition was announced in the Atmanirbhar Bharat package on 13 May 2020, and the new definition and criterion came into effect from 1 July 2020.

Why revise? The Press Information Bureau release is candid: the existing criterion was different for manufacturing and services units, and was also very low in terms of financial limits, and since then the economy had undergone significant changes. After the 13 May announcement there were further representations that the revision was still not in line with market and price conditions, and the Government on 1 June 2020 decided on a further upward revision for medium enterprises — done in order to be realistic with time, to establish an objective system of classification, and to provide ease of doing business.

The composite criterion. A new composite formula of classification for manufacturing and service units was notified. There is now no difference between manufacturing and service sectors, and a new criterion of turnover is added. An enterprise is classified by both investment and turnover, and the same limits apply whatever it does.

| Class | Investment | Turnover | |---|---|---| | Micro | Rs. 1 crore | Rs. 5 crore | | Small | Rs. 10 crore | Rs. 50 crore | | Medium | Rs. 50 crore | Rs. 250 crore |

Exports are excluded from turnover. As part of the new definition, exports will not be counted in turnover for any enterprises, whether micro, small or medium. The reasoning given is an incentive argument worth reproducing: excluding exports from turnover will encourage MSMEs to export more and more without fearing to lose the benefits of an MSME unit, which is expected to add to exports and so to growth and job creation.

The four enterprises below are invented for this exercise. They are not real firms.

| Enterprise | Activity | Investment | Total turnover | of which exports | Turnover counted | Class | |---|---|---|---|---|---|---| | A | Manufacturing | Rs. 0.8 crore | Rs. 4 crore | nil | Rs. 4 crore | Micro — inside both limits | | B | Services | Rs. 0.9 crore | Rs. 12 crore | nil | Rs. 12 crore | Small — investment is micro-sized, but turnover exceeds Rs. 5 crore, so the higher class governs | | C | Services | Rs. 0.9 crore | Rs. 12 crore | Rs. 8 crore | Rs. 4 crore | Micro — exports come out of turnover, and both tests are then satisfied | | D | Manufacturing | Rs. 12 crore | Rs. 45 crore | nil | Rs. 45 crore | Medium — investment exceeds the Rs. 10 crore small limit, even though turnover would fit small |

Three rules of application come straight out of the table.

1. Both criteria must be satisfied for a class. An enterprise that exceeds either limit moves up. Compare B, which is pushed up by turnover alone, and D, which is pushed up by investment alone.
2. The manufacturing/services distinction is gone. B and C are service enterprises measured on the same limits as A and D. Before 1 July 2020 they would have been measured against the equipment ceilings of step 1.
3. Exports change the class, not merely the accounts. B and C differ only in where their sales went, and the difference decides their status.

That exclusion answers a real defect in any size-based benefit regime — the threshold effect. Where benefits stop at a size limit, a firm approaching the limit has a reason not to grow, and the classic complaint against India's small-industry policy was that it produced firms which deliberately stayed small. Removing exports from measured turnover removes that disincentive for one kind of growth.

Enterprise C is the arithmetic of that argument. Without the exclusion it would lose micro status by exporting; with the exclusion it keeps its status and its exports.

For a law student this is the heart of the Act, because it is where the statute gives a small supplier something it could not obtain by contract.

Section 15 — the outer limit. Where a supplier supplies goods or renders services to a buyer, the buyer shall make payment on or before the date agreed upon between him and the supplier in writing or, where there is no agreement, before the appointed day — with a proviso that in no case shall the period agreed upon between the supplier and the buyer in writing exceed forty-five days from the day of acceptance or deemed acceptance.

Read the proviso carefully. It does not merely supply a default term; it caps what the parties may agree. A credit period of ninety days, freely negotiated and signed, is ineffective beyond forty-five. This is a statutory inroad into freedom of contract, justified by the inequality of bargaining power between a large buyer and a small supplier.

Section 16 — the consequence. Where the buyer fails to pay as required by section 15, then notwithstanding anything contained in any agreement between the buyer and the supplier or in any law for the time being in force, the buyer is liable to pay compound interest with monthly rests to the supplier on that amount from the appointed day, or from the day after the date agreed upon, at three times of the bank rate notified by the Reserve Bank. Section 17 makes the buyer liable to pay the principal along with that interest.

Three features make this powerful, and each should be named in an answer:

• the non obstante clause overrides both the contract and other law;
• the interest is compound, with monthly rests — not simple;
• the rate is a punitive multiple, three times the bank rate, not a compensatory one.

*Illustrative arithmetic.

Let the invoice be Rs. 40,00,000, the contract say ninety days, and the buyer pay on day 165.

(a) When does interest start? Not on day 90. Section 15's proviso caps the agreed period at forty-five days, so the agreed ninety-day term is ineffective beyond forty-five, and the appointed day is reached at day 45. The delay for which interest runs is therefore 120 days, not 75.

That is the single most valuable point in the whole example. The contract that the parties actually signed does not govern the interest start date.

(b) At what rate? Three times the bank rate notified by the Reserve Bank, compounded with monthly rests. Write the bank rate as b per cent per annum. The applicable annual rate is 3b, and the monthly rest converts it to a compounding rate of 3b ÷ 12 per month.

(c) The arithmetic, with an assumed rate. Assume, purely for the illustration and not as a statement of fact, that the notified bank rate were 6 per cent per annum. Then the applicable rate is 18 per cent per annum, or 1.5 per cent per month, compounded monthly. Over four monthly rests (120 days), the multiplier is 1.015⁴ = 1.0614, so:

• Interest = Rs. 40,00,000 × 0.0614 = about Rs. 2,45,000
• Total payable under section 17 = principal plus that interest.

(d) Compare simple interest at the same rate: 40,00,000 × 18 per cent × 120/365 = about Rs. 2,36,700. The compounding adds only a little over four months — but the gap widens sharply on a longer default, which is exactly the design intention. Do not quote either figure as a real liability; the bank rate must be taken from the Reserve Bank's own notification.

The Act reinforces the interest with two further devices.

Disclosure. The amount of interest paid by a buyer under section 16 must be stated in its accounts. A buyer that delays payment must therefore publish the fact.

Penalty. Under section 27(2), where a buyer contravenes the provisions of section 22, he shall be punishable with fine which shall not be less than rupees ten thousand. Under section 28, no court inferior to that of a Metropolitan Magistrate or a Magistrate of the first class shall try any offence punishable under this Act.

Why does a statute need to do any of this? Because a small supplier who sues its largest customer wins the case and loses the customer. The Act's technique is to make delay automatically expensive and publicly visible, so that the remedy does not depend on the supplier's willingness to litigate. That is the point to make in an answer, and it generalises: wherever bargaining power is grossly unequal, a right that must be enforced by suit is worth less than a rule that operates by itself.

Even correctly classified and promptly paid, the sector's binding constraint is finance. Despite expanding credit footprints and rising digital integration, access to formal credit remains a binding constraint for many micro-enterprises due to limited collateral and documentation readiness, as is generally the case worldwide. The World Bank's Financial Sector Assessment Report for India (2025) noted that 27 per cent of MSMEs identify finance as their biggest obstacle, and women-owned MSMEs account for a small fraction of commercial credit, though formalisation under Udyam and targeted credit guidelines are gradually addressing this gap.

State the mechanism as an economist would: a micro-enterprise typically lacks two things a lender needs, collateral and documentation — audited accounts, filed returns, a verifiable transaction history. Without them the lender cannot price the risk, so it either refuses or charges a rate that makes the loan useless. Every policy response therefore attacks one of those two gaps: formalisation (Udyam registration, digital transaction records) supplies documentation, and credit guarantee schemes substitute a public guarantee for private collateral.

The Survey records that MSME credit remained the primary driver of industrial credit growth in the first half of FY26, bolstered by several government interventions aimed at enhancing credit flow to the sector.

The four enterprises and the invoice are invented for the exercise. Nor does any source here describe the Micro and Small Enterprises Facilitation Council procedure or any decided reference; do not describe it from memory.

1. MSMED Act 2006, s. 7 — original classification by investment alone, separately for manufacturing (25 lakh / 5 crore / 10 crore) and services (10 lakh / 2 crore / above).
2. From 1 July 2020 (announced 13 May 2020, revised upward 1 June 2020): a composite criterion of investment and turnover, no manufacturing/services distinction — Micro 1 / 5 crore, Small 10 / 50 crore, Medium 50 / 250 crore. Both tests must be met; exceeding either moves the enterprise up.
3. Exports are excluded from turnover, which removes the threshold effect that made firms stay small.
4. s. 15 — payment by the agreed date, and the agreed period may in no case exceed forty-five days; the cap overrides the contract, so interest runs from day 45 however long the contract said.
5. s. 16 — compound interest with monthly rests at three times the RBI bank rate, notwithstanding any agreement or any law; s. 17 principal plus interest; s. 27(2) fine not less than Rs. 10,000; s. 28 triable by no court below a Metropolitan Magistrate or Magistrate of the first class.