Supreme Court of India: Whether The Arbitration Clause Survives The Subsequent Compromise/Settlement Arrived Between The Parties

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In Zenith Drugs & Allied Agencies Pvt. Ltd. v. Nicholas Piramal India Ltd. 2019 SCC OnLine SC 946, the Supreme Court was called upon to decide whether the parties can be referred to arbitration relying on an arbitration clause in an agreement which itself is followed by a compromise deed between the parties. In other words, the issue was whether the arbitration clause survives the subsequent compromise/settlement arrived between the parties.

While answering in negative, the Supreme Court held that when the parties have settled their differences and compromised the matter, in a dispute subsequently arising between the parties, arbitration clause in the prior agreement cannot be invoked. Detailed case analysis given below:

Factual Matrix

The Appellant was appointed as clearing and freight forwarding agent by one RPIL vide an agency agreement for three years. The agency agreement contained an arbitration clause. Thereafter, RPIL got merged with the Respondent and ceased to exist. As a sequitur, the Respondent terminated the agency agreement which was objected by the Appellant who filed a suit in court seeking declaration that the agency agreement was illegally terminated by the Respondent.

Albeit the suit ended up being compromised, the Respondent refused to honour the terms of the compromise which led the Appellant to file money suit against the Respondent claiming compensation. In the said suit, the Respondent sought stay of court proceedings in favour of arbitration under Section 8 of the Arbitration & Conciliation Act, 1996 (‘Act’) citing the arbitration clause under the terminated agency agreement. The trial court refused to stay court proceedings in view of the compromise entered into between the parties earlier.

The Respondent filed a review petition before the High Court against this order of trial court which was allowed, and the dispute was referred for arbitration. The High Court observed that the existence of arbitration clause has been admitted by the Appellant when it filed the suit for declaration on the ground of illegal termination of the agency agreement by the Respondent.

Further, applying the doctrine of Kompetenz Kompetenz (as recognised under Section 16 of the Act), the High Court also observed that whether arbitration clause applied to the subject matter of money suit in itself is an issue to be decided by the arbitrator. This decision of High Court is assailed by the Appellant before the Supreme Court in the present proceedings.

Parties Contentions

Appellant contended as under:

  • That a substantial and bona fide part of the claim in its suit for declaration was outside the ambit of arbitration clause;
  • That the lis under the subsequent money suit is ‘exclusively determinable’ by the trial court and therefore, High Court erred in referring the parties for arbitration;
  • That the Appellant had challenged the compromise on the ground of inducement and fraud by filing a separate petition and same is pending. Therefore, High Court erred in holding that Appellant had admitted the existence of arbitration clause by filing the suit for declaration.

Per contra, the Respondent argued as under:

  • That the existence of arbitration clause under the agency agreement is admitted by the Appellant when it filed the suit for declaration. Therefore, the lis is still arbitrable;
  • That the Appellant secured compromise through false inducement and practising fraud upon the Respondent. Therefore, the said compromise is a nullity and void ab-initio;
  • That the lis between the parties is ‘touching upon the presents’ of the agency agreement and hence it is arbitrable. The word ‘touching upon’ has wide meaning which not only relates to the dispute arising out of the agency agreement but any other dispute arising out of the same would necessarily fall within its ambit.

Judgement

The Court observed as under:

  • That the agency agreement was substituted by compromise deed. Therefore, when the parties have settled their differences and compromised the matter, in the dispute subsequently arising between the parties, arbitration clause in the prior agreement cannot be invoked.
  • Under Section 8 of the Act, only those disputes which are specifically agreed to be resolved through arbitration can be the subject matter of arbitration and upon satisfaction of the same, the Court can refer the parties to arbitration. Whereas in the present case, the compromise decree does not contain any arbitration clause.
  • Therefore, the money suit filed by the Appellant claiming compensation was not covered by the arbitration clause of the agency agreement.
  • Though some of the claims in money suit related to the loss sustained by the Appellant due to termination of agency agreement but other claims relate to the loss said to have been caused to the Appellant subsequent to compromise between the parties. Therefore, such claims do not ‘touch upon’ the agency agreement.
  • Since the Respondent has raised the plea that the compromise decree is vitiated by fraud, the merits of such a plea could be decided by the Civil Court upon consideration of the evidence adduced by the parties.

In view of the above findings, the Supreme Court set aside the order of the High Court holding that the lis between the parties do not fall within the ambit of arbitration clause contained in the agency agreement and the Appellant had not admitted the existence of arbitration clause by filing the suit for declaration.

My Comments

I would like to apprise my readers with another earlier dicta of the Supreme Court which had already settled the position of law on this issue but has not been dealt with in the instant case. In Union of India v. Kishorilal Gupta & Bros. AIR 1959 SC 1362, the Supreme Court considered the question whether the arbitration clause in the contract will cease to have effect, when the contract stood discharged as a result of settlement.

While answering the question in the affirmative, a three-Judge Bench of the Supreme Court culled out the following general principles as to when arbitration agreements operate and when they do not operate:

  1. An arbitration clause is a collateral term of a contract distinguished from its substantive terms; but none the less it is an integral part of it.
  2. Howsoever comprehensive the terms of an arbitration clause may be, the existence of the contract is a necessary condition for its operation; and the arbitration clause perishes with the contract.
  3. A contract may be non est in the sense that it never came legally into existence or it was void ab initio. In that event, as the original contract has no legal existence, the arbitration clause also cannot operate, for along with the original contract, it is also void.
  4. Though the contract was validly executed, the parties may put an end to it as if it had never existed and substitute a new contract for it, solely governing their rights and liabilities. In such an event, as the original contract is extinguished by the substituted one, the arbitration clause of the original contract perishes with it.
  5. Between the two extremes referred to in paras (3) and (4), are the cases where the contract may come to an end, on account of repudiation, frustration, breach, etc. In these cases, it is the performance of the contract that has come to an end, but the contract is still in existence for certain limited purposes, in respect of disputes arising under it or in connection with it. When the contracts subsist for certain purposes, the arbitration clauses in those contracts operate in respect of those purposes.

The principle stated in para (1) is now given statutory recognition in Section 16(1)(a) of the Act. The principle in para (3) has to be now read subject to Section 16(1)(b) of the Act. The principles in paras (4) and (5) are clear and continue to be applicable. The principle stated in para (2) requires further elucidation with reference to contracts discharged by performance or accord and satisfaction.

In the instant case, the parties have substituted a new agreement by way of compromise and by doing so they brought about a novation of the agency agreement. As per the agency agreement, the Appellant was the clearing and forwarding agent for north-eastern region whereas under the terms of the compromise, the appellant has been appointed as stockist of the company only for Guwahati and Agartala. The clauses in the compromise also stated that the Appellant handed over all the stocks of goods, entire documents in their possession both used and unused as well as sales tax documents, road permit, and other documents to the Respondent. All these term goes to show that the agency agreement was substituted by the compromise agreement and thus, arbitration clause in the agency agreement cannot be invoked.

According to Section 62 of the Contract Act, 1872 of India, if the parties to a contract agree to substitute a new contract for it, or to rescind it or alter it, the original contract need not be performed. The agency agreement, therefore, necessarily became inoperative, unenforceable and ceased to exist and as a corollary, the arbitration clause in the agency agreement also perished with the substitution of agency agreement.

However, I wish to highlight that the above judgement is in no way going against the doctrine of separability. The principle stated in para (5) is the situation which is covered by the doctrine of separability. Meaning thereby, had the agency agreement been repudiated, frustrated, breached etc., then the arbitration clause would have survived such repudiation, frustration, breach.

Another way of considering the matter from standpoint of the doctrine of separability is whether it is the further performance of the agency agreement that is brought to an end or it is the existence of the agency agreement which is brought to an end. In the former case, where the further performance of the agency agreement has been brought to an end, the arbitration clause would survive whereas when the existence of the agency agreement is itself brought to an end, the arbitration clause would not survive. [ Principle enunciated by Bombay High Court in Mulheim Pipecoatings GmbH. vs. Welspun Fintrade Limited & Anr. 2014 (2) ABR 196]

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