Why Works Contracts are not covered under the MSMED Act

Introduction to the MSMED Act

The Indian legislature has enacted The Micro, Small and Medium Enterprises Development Act, 2006 (hereinafter referred to as “MSMED Act”) in order to facilitate the promotion, development and enhancement of micro, small, and medium enterprises (MSMEs), and to further enhance their competitiveness in the market.

However, in order to facilitate promotion of MSMEs, it is imperative that payments due to such entities from other Companies/Individuals is remitted to them on time so that they do not suffer from lack of working capital for operating their business. In this regard, an essential feature of the MSMED Act is covered under Chapter V of the said Act which stipulates provisions regarding ‘Delayed Payments to Micro and Small Enterprises’. Chapter V of the MSMED Act was enacted with the intent to protect micro and small enterprises from delayed payments, which often cripple their liquidity and operations. The intention was to ensure prompt payment for simple transactions involving goods and services, without the procedural delays of civil litigation.

As enunciated under section 15 of the MSMED Act, liability of a buyer to pay a micro or small enterprise arises when such an enterprise either ‘supplies any goods’ or ‘renders any services’ to such a buyer. The key aspect to be noted here is that ‘works contract’; i.e., composite contract – wherein goods and services are indivisible and cannot be segregated – are not covered under Section 15 of Chapter V of the MSMED Act.

What is a Works contract? Why are they not covered under the MSMED Act?

As defined under Section 2(119) of the CGST Act, 2017, “works contract means a contract for building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance renovation, alteration or commissioning of any immovable property wherein transfer of property in goods (whether as goods or in some other form) is involved in the execution of such contract. As per Para 6(a) of Schedule II to the CGST Act, 2017, works contracts shall be treated as a supply of services.”^[1]

Works contracts are a distinct category of contract and involve a combination of supplying goods and providing labour and services in an integrated and indivisible manner.. To put it simply, works contracts are composite contracts that involve a blend of goods and services. For instance, a contract for the construction of a building, the setting up of infrastructure, or the installation of equipment, all require both the supply of goods and provision of services.

Sections 15, 16, and 18 of the MSMED Act, 2006 collectively provide for a dispute resolution and protection mechanism for micro and small enterprises against delayed payments. However, these sections apply only when the supplier either “supplies goods” or “renders services”, as specifically stated in Section 15. A works contract, however, is a composite contract and involves both supply of goods and provision of services bundled together, and not the rendering of services or sale of goods in isolation. Section 16 only mandates, to the exclusion of ‘works contract’, for interest on delayed payments for “goods supplied or services rendered”; whilst Section 18 further allows the supplier to refer disputes to the Micro and Small Enterprises Facilitation Council (MSEFC) only for amounts due under Section 17, which again relates solely to transactions which either deal with supply of goods or services in isolation..

The term “rendered services” includes but is not limited to  standalone services like legal advice, designing, or transport, where only the service is being provided. Such services are easy to identify and are covered under the MSMED Act. On the other hand, a “composite supply,” is a mix of both goods and services given together under one contract which is usually the case in a “works contract”. For example, building and installing a lift involves supplying parts (goods) and installing them (service), all under one agreement. Therefore, because both parts are tightly linked and cannot be separated, it is not treated as a simple service or supply of goods. That is why such composite contracts fall outside the protection offered by the MSMED Act, which only covers a categorical and clear supply of either goods or services.

Judicial Precedents

The Hon’ble Courts have also held that works contracts cannot be bifurcated into service and goods components for the purpose of MSME protection. Therefore, enterprises engaged in works contracts cannot invoke these sections for redressal; thereby making them effectively excluded from the MSMED Act’s protective mechanism. In the case of M/s Kone Elevators India Pvt Ltd v. State of Tamil Nadu^[2], The Hon’ble Supreme Court observed that if a contractor was required to install a lift, the nature of work would be a works contract, as it would include not just purchasing and suppling the components of the lift, but provide expert services for its installation.

Following this case, The Hon’ble High Court of Bombay in Sterling Wilson Pvt Limited v. Union of India & Ors^[3], observed that in cases of disputes arising out of performance or non-performance of a works contract, the MSMED Act cannot be invoked due to its composite nature. As aforementioned, the rationale behind this is that works contracts have a fundamentally different nature compared to pure goods or services contracts and cannot be easily broken down and categorized as goods, services for the purposes of the MSMED Act. Additionally, the case provides reasoning as to why works contracts are not covered under the Act even when they include elements of goods and services. The courts recognise works contracts as a distinct contracting model that falls outside the scope of the Act and provide as a legal and conceptual basis for the exclusion of the same.

In the case of Tata Power Company Ltd. v. Genesis Engineering Company^[4], the Delhi High Court reaffirmed that works contracts do not fall within the ambit of the MSMED Act, 2006. The Hon’ble Court examined the nature of the work orders issued which involved both supply of goods and installation of services, and further applied the test laid down in the case of Kone Elevators to classify the arrangements as a composite works contract. In the Judgment, the Hon’ble court observed that “20. Applying the judgment to the instant case, the Works Orders as executed by the parties in the instant case falls within category (a) as it comprises of two contracts which include supply of goods such as Cables, wire, connectors, street lights and poles and subsequent involvement of work and labour for its installation.”

This clear classification confirms that the contract is a composite works contract, not a standalone goods or services contract. Further, the Hon’ble Court also stated that “It is a settled principle of law that dispute/claims arising from Works Contract are not amenable to the jurisdiction of Facilitation Council constituted under the MSME Act. It is evident that the Work Orders under question qualify as Work Contracts, therefore, the Respondent is not entitled to take the benefit of provisions of MSME Act and to assail the maintainability of the instant proceedings.” This observation justifies that even if an enterprise is registered as an MSME, the nature of the contract determines applicability of the said Act.

Since the MSMED Act under Sections 15–18 only covers claims arising from goods supplied or services rendered in isolation, works contracts, by their integrated nature, fall outside its scope. The Court also cited and relied on Sterling and Wilson Pvt. Ltd. and Shree Gee Enterprises, reinforcing that MSME protection only applies to “goods produced and services rendered”, and not to indivisible, composite contracts like those in works contracts. Thus, the Tata Power ruling applies prior judicial reasoning and also provides a direct and contemporary reiteration that works contracts cannot be artificially split to avail remedies under the MSMED Act.

Conclusion

It is evident from the statutory language and judicial interpretation that works contracts do not fall within the ambit of protection provided under Chapter V of the MSMED Act, 2006. The Act is limited in its scope to transactions involving the supply of goods or the rendering of services in a clear and standalone manner. Works contracts, being inherently composite in nature and involving a blend of goods and services that are inseparable, do not satisfy this statutory requirement. Even if a MSME claims that it is only supplying goods or rendering services, courts have consistently applied the principle of “substance over form” and examined the actual nature of the agreement. If the dominant intention and execution of the contract reflect the characteristics of a works contract, then such classification prevails, irrespective of how the parties have labelled their obligations. As a result, even registered MSMEs engaged in the execution of works contracts are excluded from invoking the remedy under Sections 15 to 18 of the Act.

This interpretation, reinforced through multiple judicial precedents, confirms the current legal position. While the rationale behind this exclusion lies in the structure and intent of the MSMED Act, it nevertheless leaves a considerable gap for MSMEs operating in infrastructure, engineering, and construction sectors. These enterprises remain without the statutory protection against delayed payments, despite often facing the most significant delays. Unless the legislature chooses to revisit the wording or scope of the Act, works contracts will remain outside the coverage of the MSMED framework.

Authored by Mr. Aman Abbi (Associate Partner) and Ms. Pratistha Dahiya (Associate)

[1] CGST Act, 2017 s2(119)

[2] Kone Elevators India Pvt Ltd v. State of Tamil Nadu, AIR 2014 7 SCC

[3] Sterling Wilson Pvt Limited v. Union of India & Ors. AIR (2017) Bom 242

[4] TATA Power Co. Ltd. v. Genesis Engineering Co., 2023 SCC OnLine Del 2366