Indian Supreme Court: Can arbitral award be enforced against a non-signatory third party? interpreted ‘persons claiming under’ the parties; adopted the English Doctrine of ‘group of companies’

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Background

Yesterday, (24th April, 2018), the Supreme Court of India, in Cheran Properties Limited v. Kasturi and Sons Limited and Ors (Civil Appeal no.s 10025-10026 of 2017) while dealing with an issue of whether or not an arbitration award can be enforced against a non-signatory third party inter alia held that in terms of Section 35 of the Indian Arbitration and Conciliation Act, 1996 (the Act), a person who claims under a party is bound by the arbitral award. Besides the parties, an arbitral award binds every person whose capacity or position is derived from and is the same as a party to the proceedings. To determine whether the award binds the third party, the Court adopted the English doctrine of ‘group of companies’ which uses the intentions of parties as a parameter in this regard. The group of companies doctrine has been applied to pierce the corporate veil to locate the “true” party in interest, and more significantly, to target the creditworthy member of a group of companies. Detailed analysis is given below

Factual Matrix

Sporting Pastime India Limited (SPIL) entered in to a Share Transfer Agreement (the agreement) with Kasturi & Sons Limited (KSL), KC Palanisamy (KCP) and a company by the name of Hindcorp Resorts Pvt (Hindcorp). The intention of the parties, was that KCP would take over the business, shares and liabilities of SPIL and would discharge the liabilities of the agreement which were outstanding on the date of the agreement. KCP agreed to discharge the liabilities within 180 days from the date on which he took over management of SPIL. As per the agreement 95 % of the shares were transferred by KSL to Cheran Properties Limited (CPL) which is the nominee of KCP. Pursuant to this agreement the documents of title and share certificates relating to 2,43,00,000 shares of the SPIL were transferred to KCP. The transaction as agreed in the agreement was not completed by KCP, which resulted in arbitration proceedings. The dispute resolution clause of this agreement was as follows:

“In the unlikely case of dispute arising out of this agreement relating to claims and counter claims, the parties hereto agree that the same shall be referred to Arbitration under the Indian Arbitration Law. The arbitration shall be by three arbitrators. KCP shall be entitled to appoint one arbitrator. KSL shall be entitled to appoint one arbitrator. The two arbitrators so appointed shall elect the third arbitrator.”

An award was passed according to which KCP and SPIL were directed to return KSL and Hindcorp the documents of title and share certificates relating to 2,43,00,000 shares of the SPIL, which were handed over earlier to the KCP pursuant to the agreement.

Challenge against the Award in High Court

KCP challenged the award of the arbitral tribunal under Section 34 of the Act. The challenge was dismissed first by single judge and on appeal by division bench of Madras High Court (the High Court). Even the appeal against the said order of Division Bench of Madras High Court was dismissed by the Supreme Court of India. In its proceedings, the High Court had made an observation that the shares had not been purchased by the CPL as a matter of an independent right but as a nominee of KCP.

Proceedings before the National Company Law Tribunal (the NCLT) and the National Company Law Appellate Tribunal (the NCLAT) of India

As the award directed the transfer of shares, it was executed through NCLT by KSL. Among other things, KSL initiated proceedings for rectification of the register of SPIL as it was required to return documents of title and share certificates relating to the agreement. The NCLT and the NCLAT both held that CPL is a nominee of KCP and holds the shares in question on his behalf.

Contentions of the appellant (CPL)

  1. CPL is not a party to the arbitration agreement contained in the Agreement. This agreement was entered into between KCP, KSL, SPIL and Hindcorp. CPL is not a party to the arbitration agreement even though it had paid the consideration for its purchase of shares.
  2. It is settled position of law that an arbitration agreement will, under Section 7 of the Act, binds only parties and not a third party.
  3. An arbitral award has to be enforced as a decree of a civil court in view of the provisions of Section 36 of the Act. The arbitral award could not have been enforced by pursuing proceedings before the NCLT.
  4. CPL ought to have been, but was not impleaded as a party to the arbitral proceedings (obviously because it was not a party to the arbitration agreement). CPL has paid valuable consideration for the shares purchased by it. KSL proceeded on a wrong legal basis in the first place and has compounded its legally untenable approach by selecting a wrong remedy by moving the NCLT. Proceedings before NCLT would be barred by Section 42 of the Act.

Contentions of the Respondents KSL, SPIL and KCP

  1. The agreement specifically provides that the nominees of KCP would be bound by the agreement.
  2. CPL is merely a nominee and is not entitled to raise the present dispute.
  3. The High Court had specifically held CPL as the nominee of KCP. KCP was party to those proceedings before High Court and yet not challenged the findings.
  4. The arbitral award has the status of a decree under Section 36 and can be enforced “as if” it is a decree of the court. Under the Indian Companies Act, 2013 no matter relating to the transfer of shares can be decided except by the NCLT.
  5. Section 35 of the Act, indicates that an arbitral award binds parties to arbitration and persons claiming under them. CPL, at all material times, been aware of the fact that it was claiming under KCP in pursuance of the agreement.

Law in Question

Section 7 of the Act

7 Arbitration agreement. —

(1) In this Part, “arbitration agreement” means an agreement by the parties to submit to arbitration all or certain disputes which have arisen or which may arise between them in respect of a defined legal relationship, whether contractual or not.

(2) An arbitration agreement may be in the form of an arbitration clause in a contract or in the form of a separate agreement.

(3) An arbitration agreement shall be in writing.

(4) An arbitration agreement is in writing if it is contained in—

(a) a document signed by the parties;

(b) an exchange of letters, telex, telegrams or other means of telecommunication which provide a record of the agreement; or

(c) an exchange of statements of claim and defence in which the existence of the agreement is alleged by one party and not denied by the other.

(5) The reference in a contract to a document containing an arbitration clause constitutes an arbitration agreement if the contract is in writing and the reference is such as to make that arbitration clause part of the contract.

Indowind Energy Limited v Wescare (India) Limited (2010) 5 SCC 306

“It is fundamental that a provision for arbitration to constitute an arbitration agreement for the purpose of Section 7 should satisfy two conditions: (i) it should be between the parties to the dispute; and (ii) it should relate to or be applicable to the dispute.”

S.N.Prasad, Hitek Industries (Bihar) Limited v Monnet Finance Limited (2011) 1 SCC 320

Indown (Supra) was followed in this case. The issue in this case was whether a guarantor to a loan who is not a party to also an agreement between the lender and borrower could be made a party to a reference to arbitration in regard to a dispute governing the repayment of the loan and be subjected to the arbitral award.

The loan agreement contained an arbitration clause. In the view of the Supreme Court of India:

“An arbitration agreement between the lender on the one hand and the borrower and one of the guarantors on the other, cannot be deemed or construed to be an arbitration agreement in respect of another guarantor who was not a party to the arbitration agreement. Therefore, there was no arbitration agreement as defined under Sections 7(4)(a) or (b) of the Act, insofar as the appellant was concerned, though there was an arbitration agreement as defined under Section 7(4)(a) of the Act in regard to the second and third respondents..”

Consequently, the impleadment of the appellant as party to the arbitration proceedings and the award were held to be unsustainable. The principle which was adapted by the Supreme Court of India is as follows:

“..The Act makes it clear that an arbitrator can be appointed under the Act at the instance of a party to an arbitration agreement only in respect of disputes with another party to the arbitration agreement. If there is a dispute between a party to an arbitration agreement, with other parties to the arbitration agreement as also non-parties to the arbitration agreement, reference to arbitration or appointment of arbitrator can be only with respect to the parties to the arbitration agreement and not the non-parties.”

Group of companies doctrine

Chloro Controls India Private Limited v Severn Trent Water Purification Inc (2013) 1 SCC 641

In this case, the Supreme Court of India had observed that ordinarily, an arbitration takes place between persons who have been parties to both the arbitration agreement and the substantive contract underlying it.

English Law has evolved the “group of companies doctrine” under which an arbitration agreement entered into by a company within a group of corporate entities can in certain circumstances bind non-signatory affiliates. The test as formulated by the Supreme Court of India, noticing the position in English law, is as follows:

“Though the scope of an arbitration agreement is limited to the parties who entered into it and those claiming under or through them, the courts under the English law have, in certain cases, also applied the “group of companies doctrine”. This doctrine has developed in the international context, whereby an arbitration agreement entered into by a company, being one within a group of companies, can bind its non-signatory affiliates or sister or parent concerns, if the circumstances demonstrate that the mutual intention of all the parties was to bind both the signatories and the non-signatory affiliates. This theory has been applied in a number of arbitrations so as to justify a tribunal taking jurisdiction over a party who is not a signatory to the contract containing the arbitration agreement.

[Russell on Arbitration(23rd Edn.)]

This evolves the principle that a non-signatory party could be subjected to arbitration provided these transactions were with group of companies and there was a clear intention of the parties to bind both, the signatory as well as the non-signatory parties. In other words, “intention of the parties” is a very significant feature which must be established before the scope of arbitration can be said to include the signatory as well as the non-signatory parties.”

Conclusion

In this case, the Supreme Court of India held as under:

  1. In certain situations, an arbitration agreement between two or more parties may operate to bind other parties as well.
  2. The group of companies doctrine has been applied to pierce the corporate veil to locate the “true” party in interest, and more significantly, to target the creditworthy member of a group of companies.
  3. Though the extension of this doctrine is met with resistance on the basis of the legal imputation of corporate personality, the application of the doctrine turns on a construction of the arbitration agreement and the circumstances relating to the entry into and performance of the underlying contract.
  4. While the alter ego principle is a rule of law which disregards the effects of incorporation or separate legal personality, in contrast the group of companies doctrine is a means of identifying the intentions of parties and does not disturb the legal personality of the entities in question. In other words :

“the group of companies doctrine is akin to principles of agency or implied consent, whereby the corporate affiliations among distinct legal entities provide the foundation for concluding that they were intended to be parties to an agreement, notwithstanding their formal status as non-signatories.”

  1. This case relates to a post award situation. The enforcement of the arbitral award has been sought against the PCL on the basis that it claims under KCP and is bound by the award.
  2. Section 35 of the Act, postulates that an arbitral award “shall be final and binding on the parties and persons claiming under them respectively”. The expression ‘claiming under’, in its ordinary meaning, directs attention to the source of the right. The expression includes cases of devolution and assignment of interest.
  3. The expression “persons claiming under them” in Section 35 widens the net of those whom the arbitral award binds. It does so by reaching out not only to the parties but to those who claim under them, as well. The expression “persons claiming under them “is a legislative recognition of the doctrine that besides the parties, an arbitral award binds every person whose capacity or position is derived from and is the same as a party to the proceedings. Having derived its capacity from a party and being in the same position as a party to the proceedings binds a person who claims under it. The issue in every such a case is whether the person against whom the arbitral award is sought to be enforced is one who claims under a party to the agreement.

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