Supreme Court of India: Whether The Arbitration Agreement Incorporated In An Unstamped Work Order Is Legally Enforceable And Whether A Fraudulent Invocation Of A Bank Guarantee Is An Arbitrable Dispute?

Consider a situation where a party is granted some work under a work order which in turn obligates such party to furnish a Bank Guarantee for securing the performance of work. However, what will happen in a situation where no work is assigned to such party? Whether such Bank Guarantee can then be encashed even if no work is assigned and if so, will such invocation be termed as fraudulent? Also, whether such a dispute of fraudulent invocation of a Bank Guarantee is an arbitrable dispute? Does the doctrine of kompetenz – kompetenz confer jurisdiction on the arbitral tribunal to decide such a dispute?

Under the statutory scheme of certain State specific legislations in India (like Maharashtra Stamp Act, 1958) certain instruments are barred from being received in evidence, or to be relied on for any purpose whatsoever, or being acted upon, or registered, or authenticated, by any person or public officer, unless such instrument is duly stamped. Does that mean that if a work order is not stamped, the arbitration agreement embedded in such work order will also become unenforceable for the reason that the underlying work order is unstamped? In such a scenario, will the doctrine of separability come to rescue the arbitration agreement?

The Supreme Court of India answered all these questions in the case of M/s. N.N. Global Mercantile Pvt. Ltd. v. M/s. Indo Unique Flame Ltd. & Others. Civil Appeal Nos. 3802 – 3803 / 2020 decided on 11 January 2021.

Arbitration Agreement In An Unstamped Agreement

The arbitration agreement contained in a commercial agreement is a distinct and separate agreement for two reasons:-

  • The underlying commercial agreement governs the rights and obligations of the parties qua the commercial transactions whereas,
  • The arbitration agreement is the agreement of the parties to arbitrate the dispute.

This is envisaged under the doctrine of separability as prevalent in the arbitration world which connotes that invalidity, ineffectiveness, or termination of the substantive commercial contract, would not affect the validity of the arbitration agreement, except if the arbitration agreement itself is directly impeached on the ground that the arbitration agreement is void ab initio.[1] It is further engraved in Article 16(1) of the Model Law.[2]

Another concept which is intertwined with the doctrine of separability is the doctrine of kompetenz kompetenz which implies that the arbitral tribunal has the competence to determine and rule on its own jurisdiction, including objections with respect to the existence, validity, and scope of the arbitration agreement, in the first instance, which is subject to judicial scrutiny by the courts at a later stage of the proceedings.[3]

The Statutory Scheme under the Indian Arbitration & Conciliation Act, 1996 (A&C Act)

Section 16 of the Indian A&C gives statutory recognition to the doctrine of separability and kompetenz – kompetenz which mirrors Article 16(1) of the Model Law.[4] This is further supplemented by Section 5 which is a non-obstante clause and prohibits judicial intervention except as specified in Part I of the A&C Act (Domestic Arbitrations). Thus, on a co-joint reading of Sections 16 & 5, the Supreme Court observed that all civil commercial matters, including the issue as to whether the substantive contract was voidable can be resolved through arbitration.

Rival Contentions

The party assailing the arbitration agreement contended that since, the work order being an unstamped document could not be received in evidence for any purpose, or acted upon, unless it is duly stamped, consequently, the arbitration clause in such work order also could not be acted upon or enforced since the arbitration clause would have no existence in law, unless the applicable stamp duty (and penalty, if any) is paid on the work order.

Per contra, the opposite party averred that even though the work order is an unstamped agreement, it would be enforceable after it is duly stamped, for which an opportunity must be given to the parties to make up the deficient stamp duty and penalty as may be assessed by the Collector. Non-payment of stamp duty would not render the agreement unenforceable but was a curable defect.

Decision on the Issues at hand

After analysing the statutory scheme of the State legislation on Stamp Duty in question (i.e. Maharashtra Stamp Act, 1958), the Court held as under:-

The Stamp Act is a fiscal measure enacted to secure the revenue of the State on certain classes of instruments. It operates as a statutory bar to an unstamped instrument being admitted in evidence, or being acted upon, for any purpose, by any authority having by law or consent of parties (the expression which includes Arbitrator/Arbitral Tribunal), the power to receive evidence, unless such instrument is duly stamped. However, it also provides that upon payment of the requisite stamp duty, the instrument may be admitted in evidence. Thus, upon payment of Stamp Duty and endorsement by the concerned Collector, the defect of admissibility and legality of such instrument would stand cured.

The Stamp Act does not subject an arbitration agreement to payment of Stamp Duty, unlike various other agreements enlisted in the Schedule to the said Act. On the basis of the doctrine of separability, the arbitration agreement being a separate and distinct agreement from the underlying commercial contract, would survive independent of the substantive contract. The arbitration agreement would not be rendered invalid, un-enforceable or non-existent, even if the substantive contract is not admissible in evidence or cannot be acted upon on account of non-payment of Stamp Duty.

There is no legal impediment to the enforceability of the arbitration agreement, pending payment of Stamp Duty on the substantive contract. The adjudication of the rights and obligations under the work order or the substantive commercial contract would however not proceed before complying with the mandatory provisions of the Stamp Act.

Where the appointment of the arbitrator takes place by the parties consensually in accordance with the terms of the arbitration agreement, or by a designated arbitral institution, without the intervention of the court, the arbitrator / tribunal is obligated  to impound the instrument and direct the parties to pay the requisite Stamp Duty (and penalty, if any), and obtain an endorsement from the concerned Collector.

Where the parties fail to make the appointment in accordance with the arbitration agreement, and an application is filed under Section 11 before the Court to invoke the default power for making the appointment. In such a case, the High Court, or the Supreme Court, as the case may be, while exercising jurisdiction under Section 11, would impound the substantive contract which is either unstamped or inadequately stamped, and direct the parties to cure the defect before the arbitrator / tribunal can adjudicate upon the contract.

When an application is filed under Section 8 before a judicial authority for reference of disputes to arbitration, since the subject matter of the contract is covered by an arbitration agreement. In such a case, the judicial authority will make the reference to arbitration. However, in the meanwhile, the parties would be directed to have the substantive contract stamped in accordance with the provisions of the relevant Stamp Act, so that the rights and obligations emanating from the substantive contract can be adjudicated upon.

Note: Interestingly, the Court while reaching to its conclusion has overruled SMS Tea Estates Pvt. Ltd. v. M/s. Chandmari Tea Co. Pvt. Ltd[5] (Division Bench) wherein the Supreme Court inter alia held that an arbitration agreement in an unstamped commercial contract cannot be acted upon, or is rendered un-enforceable in law; and an arbitration agreement would be invalid where the contract or instrument is voidable at the option of a party, such as under Section 19 of the Indian Contract Act, 1872 (‘Voidability of agreements without free consent’). In addition, the decision in Garware Wall Ropes Limited v. Coastal Marine Constructions and Engineering Limited.[6] (Division Bench) wherein it was inter alia held  that an arbitration clause in an agreement would not exist when it is not enforceable by law and which was followed in SMS Tea Estates and recently in Vidya Drolia & Ors. v. Durga Trading Corporation.[7] (Three-Judge Bench) has been referred to a Constitution Bench of five judges.

Arbitrability Of A Dispute Involving Fraudulent Invocation Of A Bank Guarantee

On this issue, the Court held as under:-The view that since fraud disputes involve detailed investigation into the allegations and production of elaborate evidence, it could not be properly dealt by an arbitrator, and ought to be settled by a court of law, is based on the English decision of Russel v. Russel[8] which in itself is an outdated view which ante-dates even the first English Arbitration Act of 1899.

Arbitrability of fraud is no longer an issue relating to the competence of the arbitrator or dealing with voluminous evidence. Arbitrators are competent to deal with allegations of civil fraud.

Mere allegations of fraud simplicitor are not a sufficient ground to decline reference to arbitration. Parties may be referred to arbitration where allegations of fraud pertain to disputes between parties inter se, and have no implication for third parties. The courts may, however, refuse to make a reference to arbitration only in those cases where there are very serious allegations of fraud, which make a virtual case of criminal offence of fraud, or where allegations of fraud are so complicated, that it becomes absolutely essential that such complex issues be decided only by the civil courts on appreciation of voluminous evidence. This would also include those cases where there are serious allegations of forgery or fabrication of documents, or where fraud is alleged with respect to the arbitration clause itself, or where the fraud alleged is of such a nature that it permeates the entire contract, including the agreement to arbitrate.[9]

The twin test to decide whether fraud is arbitrable or not is as follows:-

  • Does the plea of fraud permeate the entire contract and above all, the agreement of arbitration, rendering it void, or
  • Whether the allegations of fraud touch upon the internal affairs of the parties inter se having no implication in the public domain.

Only where the court is satisfied that the allegations of fraud are serious and complicated in nature, would it be more appropriate for the court to deal with the subject matter of the disputes, rather than relegate the parties to arbitration. It is the duty of the court to impart a sense of business efficacy to commercial transactions, and mere allegations of fraud would not be sufficient to decline reference of disputes to arbitration.[10]

The same set of facts may have civil as well criminal consequences. If it is clear that a civil dispute involves questions of fraud, misrepresentation, etc. which can be the subject matter of a proceeding under Section 17 of the Indian Contract, 1872, (‘Fraud’) and/or the tort of deceit, the mere fact that criminal proceedings can or have been instituted in respect of the same subject matter, would not lead to the conclusion that a dispute which is otherwise arbitrable, ceases to be so.[11]

Thus, all civil or commercial disputes, either contractual or non-contractual, which can be adjudicated upon by a civil court, in principle, can be adjudicated and resolved through arbitration, unless it is excluded either expressly by statute, or by necessary implication. The A&C Act does not exclude any category of disputes as being non arbitrable. Section 2(3) of A&C Act however recognizes that certain categories of disputes by law may not be submitted to arbitration.

The civil aspect of fraud is considered to be arbitrable in contemporary arbitration jurisprudence, with the only exception being where the allegation is that the arbitration agreement itself is vitiated by fraud or fraudulent inducement, or the fraud goes to the validity of the underlying contract, and impeaches the arbitration clause itself. Another category of cases is where the substantive contract is “expressly declared to be void” under Section 10 of the Indian Contract Act, 1872 (‘What agreements are contracts’) where the agreement is entered into by a minor (without following the procedure prescribed under the Guardian and Wards Act, 1890) or a lunatic, which would be with a party incompetent to enter into a contract. Thus, the civil aspect of fraud can be adjudicated by an arbitral tribunal.

In the case of voidable agreements, such disputes would be arbitrable, since the issue whether the consent was procured by coercion, fraud, or misrepresentation requires to be adjudicated upon by leading cogent evidence, which can very well be decided through arbitration. Until it so proved and upheld as per Sections 2(i) and (j) of the Indian Contract Act, 1872 such an agreement would remain enforceable, and is not void.

When a plea is taken to avoid arbitration on the ground of the underlying contract being void, the court is required to ascertain the true nature of the defence. Often, the terms ‘void’ and ‘voidable’ are used loosely and interchangeably. The court ought to examine the plea by keeping in mind the provisions of the Indian Contract Act, 1872. In cases where the court comes to a conclusion that the contract is void without receiving any evidence, it may be justified in declining the reference to arbitration in a few isolated cases. These would be cases where the court can readily conclude that the contract is void upon a meaningful reading of the contract document itself. However, it would not be permissible to circumvent arbitration where the defence taken is that the contract is voidable, which are cases covered under circumstances mentioned inter alia in Sections 12, 14, 15, 16, 17, 18 of the Indian Contract Act, 1872.[12]

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. However, 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.[13]

In the present case, 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.

Further Reading

In this judgment, Justice Indu Malhotra had discussed some of the most celebrated judicial precedents which forms genesis of the doctrines of separability and kompetenz – kompetenz in the international commercial arbitration. The same are briefly mentioned below:-

Doctrine of Separability

  • Arbitration clause is a separate contract which survives the termination of the main contract. It is merely procedural, ancillary, and collateral to the substantial stipulations of the contract. [14]
  • The arbitration clause constitutes a self-contained contract collateral or ancillary to the underlying agreement.[15]
  • If the arbitration clause is not directly impeached, an arbitration agreement is capable of surviving the invalidity of the contract, so that the arbitrator has the jurisdiction to determine the initial validity of the contract.[16]
  • An arbitration agreement is a distinct and separable agreement from the underlying or principal contract.[17]
  • The agreement to arbitrate, whether concluded separately or included in the contract to which it relates, is always save in exceptional circumstances, completely autonomous in law which excludes the possibility of it being affected by the possible invalidity of the main contract.[18]

Fraud in the inducement of the arbitration clause

  • If the claim is fraud in the inducement of the arbitration clause itself an issue which goes to the ‘making’ of the agreement to arbitrate—the court may proceed to adjudicate it. But the statutory language (of the Federal Arbitration statute of the US) does not permit the court to consider claims of fraud in the inducement of the contract generally.[19]

Doctrine of kompetenz – kompetenz

  • Allegation of invalidity of the underlying contract, would not preclude the arbitral tribunal from determining the said issue in the first instance, even though the alleged illegality would render the contract void from inception. Only if the arbitration agreement is itself directly impeached, and rendered void or unenforceable on grounds which relate to the arbitration agreement itself, and not merely as a consequence of the invalidity of the underlying contract, that the courts may refuse reference to arbitration. [20]
  • The main agreement and the arbitration agreement must be treated as having been separately concluded and the arbitration agreement can be invalidated only on a ground which relates to the arbitration agreement and is not merely a consequence of the invalidity of the main agreement. The doctrine of separability requires direct impeachment of the arbitration agreement before it can be set aside. Therefore, the allegations that the arbitration agreement is parasitical to a challenge to the validity to the main agreement will not do. [21]
  • The doctrine of “kompetenz-kompetenz”, also referred to as “compétence-compétence”, or “compétence de la recognized”, implies that the Arbitral Tribunal is empowered and has the competence to rule on its own jurisdiction, including determining all jurisdictional issues, and the existence or validity of the arbitration agreement.[22]

The English Law on doctrines of separability and kompetenz – kompetenz

The Hon’ble Supreme Court noticed that the law as it stands in U.K. today is that if the court while entertaining a plea to refer the parties to arbitration, is satisfied of the existence of the arbitration agreement, it is incumbent to refer the parties to arbitration, even if objections to the validity of the substantive contract are raised. Where the arbitration agreement is embedded in an underlying contract, the court would not entertain the dispute on the issue of jurisdiction until the arbitral tribunal has ruled on this issue.[23]

[1] Para 3.3.

[2]Article 16. The arbitral tribunal may rule on its own jurisdiction, including any objections with respect to the existence or validity of the arbitration agreement. For that purpose, an arbitration clause which forms a part of a contract shall be treated as an agreement independent of the other terms of the contract. A decision by the arbitral tribunal that the contract is null and void shall not entail ipso jure the invalidity of the arbitration clause.”

[3] Para 3.4. Different jurisdictions provide different stages where the Court can scrutinize the decision of the arbitration tribunal qua its jurisdiction. Under the Indian Arbitration & Conciliation Act, 1996, such challenge before the Court is maintainable only after the final award is passed as provided by Section 16(6) of the said Act  

[4] “16. Competence of arbitral tribunal to rule on its jurisdiction:

(1) The arbitral tribunal may rule on its own jurisdiction, including ruling on any objections with respect to the existence or validity of the arbitration agreement, and for that purpose, —

(b) a decision by the arbitral tribunal that the contract is null and void shall not entail ipso jure the invalidity of the arbitration clause.”

[5] (2011) 14 SCC 66 followed in Naina Thakkar v. Annapurna Builders, (2013) 14 SCC 354.

[6] (2019) 9 SCC 209.

[7] Delivered on 14.12.2020 in C.A. No. 2402 / 2019.

[8] [1880] 14 Ch. D 471 relied upon by the Indian Courts in N. Radhakrishnan v. Maestro Engineers (2010) 1 SCC 72 and Abdul Kadir v. Madhav Prabhakar AIR 1962 SC 406: [1962] 3 SCR 702.

[9] A. Ayyasamy v. A. Paramasivam & Ors (2016) 10 SCC 386 followed in Rashid Raza v. Sadaf Akhtar (2019) 8 SCC 710.

[10] Ameet Lalchand Shah & Ors. v. Rishabh Enterprises & Anr (2018) 15 SCC 678.

[11] Avitel Post Studioz Ltd. & Ors. v. HSBC PI Holdings (Mauritius Limited), (2020) SCCOnLine SC 656 affirmed in Deccan Paper Mills v. Regency Mahavir (2020) SCCOnLine SC 655 and Vidya Drolia & Others v. Durga Trading Corporation Civil Appeal No.2402 of 2019 decided vide Judgment dated 14.12.2020.

[12] Swiss Timing Ltd. v. Commonwealth Games 2010 Organising Committee, (2014) 6 SCC 677 cited with approval by this Court in Avitel Post Studioz Ltd. & Ors. v. HSBC PI Holdings (Mauritius Limited) (supra)

[13] Malhotra’s Commentary on the Law of Arbitration, [4th ed., Wolters Kluwer (2020)], p.339, Volume I.

[14] Heyman v. Darwins Ltd [1942] AC 356.

[15] Bremer Vulkan Schiffbau und Maschinefabrik v. South India Shipping Corporation [1981] AC 909.

[16] Harbour Assurance v. Kansa General International Insurance, [1993] 1 Lloyd’s Rep. 455 (CA).

[17] Lesotho Highlands Development Authority v. Impregilo SpA and others, [2005] UKHL 43 : [2006] 1 A.C. 221 at [21].

[18] Gosset v. Caparelli Cass. Civ. Lere, 7 May 1963 (Dalloz, 1963), 545.

[19] Prima Paint Corporation v. Flood & Conklin MFG. CO 388 US 395 (1967) followed in Buckeye Check Cashing, Inc v. Cardegna et. al US SC 440 (2006) and Rent-A- Center, West, Inc. v. Jackon 561 US 63 (2010).

[20] Fiona Trust & Holding Corporation v. Privalov [2007] EWCA Civ 20.

[21] Fili Shipping Co Ltd and others v. Premium Nafta Products Ltd and others [2007] UKHL 40.

[22] Uttarakhand Purv Sainik Kalyan Nigam Ltd. v. Northern Coal Field Ltd (2020) 2 SCC 455.

[23] As noted by Lord Hoffman in [2007] 4 ALL ER 951 at 960, at paragraph 19.

Disclaimer: The views expressed in this post are mine and do not reflect the views of the organisation(s) I am engaged with

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