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Nyaya Setu: Litigation Support for Corona positive Indian MSMEs

Updated: Feb 10, 2021

by Varsha Aithala

The Covid-19 situation is not only a mega public health nightmare for India, it is proving fatal for small businesses in the country which are struggling to survive. Originally, Micro, Small and Medium Enterprises (MSMEs) were set up in India to generate employment opportunities in the country’s rural and urban areas in the manufacturing and service sectors and remove regional imbalances in India’s development. They now form the backbone of India’s manufacturing sector and are particularly active in the automotive, manufacturing, agricultural and allied sectors. After agriculture, they employ the largest workforce. As of 2019, estimates show that the MSME sector contributes to 6% of the manufacturing GDP, 25% of the services sector, more than 40% of India’s manufacturing output and of the total exports across a diverse range of commodities. Between September 2015 and July 2018, nearly 50 lakh MSMEs registered on the government’s Udyog Aadhar Portal, of which, about 1.34 lakh registered in Karnataka. However, almost 94% of Indian MSMEs are unregistered.

While it is undisputed that MSMEs are very important drivers of the Indian economy, what is clear is that the existing industrial policy framework is not prepared to handle the impact of a force majeure event like Covid-19. The nationwide lockdown announced suddenly in March 2020 forced manufacturing hubs throughout the country to take unprecedented actions. Machines and equipment were forced to stop functioning, production was halted and labour migrated.  As a result, many MSMEs have had to downscale or probably even shut shop. Those still managing to carry on their operations are undertaking substantial preparatory work as they restart operations - machines need massive repairs, there are already inventory management issues and supply chain blockages due to unavailability of transport options and payment delays from buyers. They are also seeing rapid erosion of working capital which is being used to pay employee salaries, local taxes, bills and rents. There is no official data on the number of Indian MSMEs which have been forced to close down due to this pandemic and the subsequent lockdown on economic activities, since the Ministry of Micro, Small and Medium Enterprises, Government of India, does not maintain information on the shut down of MSMEs shut down and consequent job losses. It also does not receive any information reports about this from states and union territories.  In addition what has become evident is that the occupational health and safety support system for workers needs to be urgently overhauled and strengthened to fight the Covid virus.  The regulatory and contractual frameworks currently in place that these businesses are subject to are unprepared for these complexities. 

It is heartening to note that the Reserve Bank of India has announced credit support measures to help MSMEs and state and central governments have declared support packages. However, as press reports have noted, those benefits announced are still to trickle down to MSMEs. In any event, these are not designed to cover legal support for MSMEs to face legal and regulatory challenges arising from the crisis. Legal services are expensive, too slow to respond to the constantly evolving and mainly unpredictable demand from MSMEs and so, quality legal advice has remained the privilege of a few at the cost of others. 

One measure that can be suggested is to provide litigation support through third party funding. What does litigation funding mean? Typically, it is the financing of litigation by a person who is not party to the litigation in return for a portion of the recovery. The funder receives its investment and a pre-agreed return only if the litigation is successful. The value of the litigation itself is used for securing capital from the third party. While basically not conceived as such, litigation finance could include support to generate liquidity for the business. In this pandemic situation when these MSMEs fall into a cash crunch, and are unable to stay afloat, they may need legal support to handle bankruptcy claims and related procedural requirements as well. 

Litigation finance has been practised the world over for several years and has emerged as a parallel investment sector for private capital, with companies like Burford Capital, which despite its latest operational setbacks, continues to be one of the world’s largest litigation funders. Third party financing of litigation redistributes the costs and reallocates the risks of litigation. The transfer of litigation risk to a non-litigant party frees up the resources that small businesses can use to carry on with their commercial activities. In India, the Bar Council of India Rules which govern advocates in India provide that advocates cannot fund litigation on their client’s behalf (Rule 20, Standards of Professional Conduct and Etiquette, Chapter II, Part VI, Bar Council of India Rules 1975 read with Section 49(1)(c) of the Advocate's Act, 1961). However, there is no prohibition on agreements between third parties to litigation which creates a financial interest in the subject matter of the case on a successful determination of the suit. The Supreme Court of India has attempted to infuse some clarity in some of its recent decisions. Some states like Gujarat, Karnataka, Madhya Pradesh and Maharashtra have amended the Civil Procedure Code, 1908 (Order XXV (Security for Costs) Rule 1) to explicitly permit a financier to deposit funds towards a plaintiff’s costs of litigation. 

So, why is the take up on litigation funding so low? Two factors could explain this: first, inter-state variations in implementation of the Civil Procedure Code, since except for this select group, a majority of Indian states are still to provide the power to a third party financier to deposit security on behalf of the litigant and second, failure by courts to explicitly recognise this practice which creates a perception among court users and lawyers that courts may in practice consider these arrangements as being unfair or unconscionable, which could jeopardise their case. The resultant lack of confidence hampers the emergence of the litigation funding ecosystem in the country. 

To remedy this situation, other Indian states could be similarly encouraged to amend their laws and provide legislative backing to a non-party to finance the litigation. This should include safeguards to ensure party autonomy in case management, litigation strategy and settlement discussions and fair disclosure requirements to prevent conflicts of interest and maintain confidentiality and privilege.

Litigation finance can be combined with other forms of assistance. For instance, Canada’s Business Innovation Access programme connects MSMEs with universities, research institutes, and colleges to provide technical, commercial and marketing assistance. Similar support can be extended to Indian MSMEs in the legal sector.  MSMEs and startups could cooperate and collaborate to use their mutual synergies in terms of the market knowledge and labour network of MSMEs and the technology and innovation skills of startups to fight Covid-19 together. The provision of legal advice for small businesses could also include flexible pricing models like sliding scale fees or the payment of legal fees in instalments or even crowdfunding. Non-recourse loans could be made available to MSMEs at attractive rates to finance part of their legal costs.

The situation we describe here applies not just to MSMEs - several micro entrepreneurs and more than 90% of the 50,000 plus Indian startups (including about 1300 new startups set up in 2019 alone), are facing similar funding and compliance related burdens. The third party litigation finance sector is gathering momentum, with large conglomerates in the infrastructure and EPC sectors actively entering into these funding arrangements with investment management companies in an attempt to deal with stressed assets. This makes policy level interventions for protecting the smaller stakeholders like MSMEs in this space, an urgent necessity. 


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