Validity Of An Arbitration Agreement In An Unstamped Agreement: A Step Forward
3/Feb/2021, 12:50 PM, Authored by Hiroo Advani & Mahi Mehta
The Apex Court on 11 January, 2021 took a giant progressive leap towards developing a more liberal arbitration regime in the country by holding that non-payment of stamp duty would not invalidate the arbitration agreement. A bench comprising of Hon’ble Dr. Justice D.Y. Chandrachud, Justice Indu Malhotra and Justice Indira Banerjee in the matter of N.N. Global Mercantile Pvt. Ltd v. Indo Unique Flame Ltd. & Others1 has interestingly referred the issue ‘whether non-payment of Stamp duty on Commercial Contract will invalidate an Arbitration Agreement’ to be authoritatively settled by a Constitution Bench.
The Court also held that the allegations of fraud with respect to the invocation of the Bank Guarantee are arbitrable, since it arises out of disputes between parties inter se, and is not in the realm of public law.
Indo Unique Limited (“Indo Unique”) being the respondents in the matter were awarded a work order for beneficiation/washing of coal by Karnataka Power Corporation Limited (“KPCL”). Subsequently, Indo Unique entered into a sub-contract with the appellant company, i.e. N.N. Global Mercantile Pvt. Ltd. (“Global Mercantile”), for transportation of coal from its washery to the stockyard. In pursuance of the terms of the sub-contract, Global Mercantile had also furnished a Bank Guarantee in favour of Indo Unique to secure the stocks at the backyard. However, on account of certain disputes between Indo Unique and KPCL under the principal contract, KPCL invoked the bank guarantee furnished by Indo Unique, in consequence to which, Indo Unique, further invoked the bank guarantee furnished by Global Mercantile under the sub-contract.
DECISIONS OF THE COMMERCIAL COURT AND THE BOMBAY HIGH COURT
Being aggrieved of such invocation of their bank guarantee, Indo Unique filed an application under Section 8 of the Arbitration and Conciliation Act, 1996, seeking reference of the dispute for arbitration. The Commercial Court, had refused to refer the parties to arbitration. Consequently, Indo Unique filed a civil revision petition before the Bombay High Court challenging the Impugned Order passed by the Commercial Court. The High Court allowed the writ petition filed by Indo Unique aggrieved by the non-reference and set aside the order of the commercial court. The Bombay High Court further opined that “On the issue of the arbitration agreement being unenforceable since the Work Order was unstamped, it was held that the plaintiff/ Appellant herein, could raise the issue either under Section 11 of the Arbitration Act, or before the arbitral tribunal at the appropriate stage”.
ISSUE BEFORE THE SUPREME COURT
Aggrieved by the order of the High Court of Bombay, Global Mercantile filed a special leave petition before the Supreme Court to adjudicate upon the issues as to ‘Whether non-payment of Stamp duty on Commercial Contract will invalidate an Arbitration Agreement” and also ‘Whether the fraudulent invocation of the Bank Guarantee is arbitrable’?
FINDINGS OF THE SUPREME COURT
While considering the issue regarding validity of an arbitration agreement in an unstamped agreement, the bench of the Apex Court extensively analysed two landmark judgments namely SMS Tea Estates Pvt. Ltd v. M/s Chandmari Tea Co. Pvt. Ltd. (“SMS Tea Estate”)2 and Garware Wall Ropes Limited v. Coastal Marine Constructions and Engineering Limited 3 (“Garware Ropes”). The Supreme Court overruled their decision in SMS Tea Estate with respect to the two contentious issues – (a) that an arbitration agreement in an unstamped commercial contract cannot be acted upon, or is rendered un-enforceable in law; and (b) that an arbitration agreement would be invalid where the contract or instrument is voidable at the option of a party, such as u/s. 19 of the Indian Contract Act, 1872.
The Court held that since the arbitration agreement is an independent agreement between the parties, and is not chargeable to payment of stamp duty, the non-payment of stamp duty on the commercial contract, would not invalidate the arbitration clause, or render it un-enforceable, since it has an independent existence of its own. On the second issue, the Court clarified that the allegations made by a party that the substantive contract has been obtained by coercion, fraud, or misrepresentation has to be proved by leading evidence on the issue and can certainly be adjudicated through arbitration.
The Court further noticed that the judgment in Garware Ropes has been cited with approval by a co-ordinate bench of Supreme Court in Vidya Drolia & Ors. v. Durga Trading Corporation4 (“Vidya Drolia “), the paragraph 92 of which judgment reads:
“In Garware Wall Ropes Ltd., this Court had examined the question of stamp duty in an underlying contract with an arbitration clause and in the context had drawn a distinction between the first and second part of Section 7(2) of the Arbitration Act, albeit the observations made and quoted above with reference to ‘existence’ and ‘validity’ of the arbitration agreement being apposite and extremely important, we would repeat the same by reproducing paragraph 29 thereof :
This judgment in Hyundai Engg. case is important in that what was specifically under consideration was an arbitration clause which would get activated only if an insurer admits or accepts liability. Since on facts it was found that the insurer repudiated the claim, though an arbitration clause did “exist”, so to speak, in the policy, it would not exist in law, as was held in that judgment, when one important fact is introduced, namely, that the insurer has not admitted or accepted liability. Likewise, in the facts of the present case, it is clear that the arbitration clause that is contained in the subcontract would not “exist” as a matter of law until the sub-contract is duly stamped, as has been held by us above. The argument that Section 11(6A) deals with “existence”, as opposed to Section 8, Section 16 and Section 45, which deal with “validity” of an arbitration agreement is answered by this Court’s understanding of the expression “existence” in Hyundai Engg. case, as followed by us.”
Existence and validity are intertwined, and arbitration agreement does not exist if it is illegal or does not satisfy mandatory legal requirements. Invalid agreement is no agreement.”
The Court relying upon the aforesaid observations, reiterated that an arbitration agreement is distinct and independent from the underlying substantive commercial contract and can be acted upon, irrespective of the alleged invalidity of the commercial contract.
In view of the aforesaid finding, the Court considered it appropriate to refer the findings in paragraphs 22 and 29 of Garware Ropes, which were affirmed in paragraph 92 of Vidya Drolia, to a Constitution Bench of five judges for an authoritative determination. The issue to be referred has been reproduced below:
“Whether the statutory bar contained in Section 35 of the Indian Stamp Act, 1899 applicable to instruments chargeable to Stamp Duty under Section 3 read with the Schedule to the Act, would also render the arbitration agreement contained in such an instrument, which is not chargeable to payment of stamp duty, as being non-existent, unenforceable, or invalid, pending payment of stamp duty on the substantive contract / instrument ?”
Further on the issue of arbitrability of fraudulent invocation of the bank guarantee, the Court answered in affirmative and held that such issue would be arbitrable, since it arises out of disputes between parties inter se, and is not in the realm of public law. The Court upheld the view taken in the case of Avitel Post Studioz v HSBC PI Holdings5 and held the ground on which fraud was held to be non-arbitrable earlier was that it would entail voluminous and extensive evidence, and would be too complicated to be decided in arbitration.
In contemporary arbitration practice, arbitral tribunals are required to traverse through volumes of material in various kinds of disputes such as oil, natural gas, construction industry, etc. The ground that allegations of fraud are not arbitrable is a wholly archaic view, which has become obsolete, and deserves to be discarded. The Court further clarified that the criminal aspect of fraud, forgery, or fabrication, which would be visited with penal consequences and criminal sanctions can be adjudicated only by a court of law, since it may result in a conviction, which is in the realm of public law.
This judgment reaffirms the position given in section 7 of the Arbitration and Conciliation Act, 1996 that requires an arbitration agreement to be in black and white in order for it to be enforceable and the judiciary has repeatedly held arbitration agreements forming part of documents, emails etc., which are signed and exchanged between the parties as enforceable in the eyes of law.
The judgment is a welcome decision by the apex court as it reasserts the principle of severability and Kompetence-Kompetence. It further signifies that the arbitration agreement forming part of any unstamped agreement which should have been compulsorily stamped, cannot defeat the intent of the parties to seek their resolution of disputes by way of arbitration.
Lastly and more importantly, a requirement of stamping or registration of an arbitration agreement would have aided in delay in the dispute resolution mechanism in India and hence we look forward to the Constitution Bench reaffirming this decision as such decisions are being lauded in the arbitration fraternity.