RETHINKING THE VALIDITY OF ARBITRATION CLAUSES WITHIN UNSTAMPED AGREEMENTS

The author is Dhruv Singhal, a second year student at National Law University Jodhpur.

Centuries ago, Francis Bacon had warned of individuals who “engage courts in quarrels of jurisdiction, and are not truly amici curiae but parasiti curiae [not friends but parasites of the court].” One oft-used recourse of parties intending to prolong litigation and delay the dispensation of justice is to stall the procedure of appointment of arbitrators and contest the validity of the mutually agreed-upon arbitration agreement, if it is contained in an unstamped instrument.

This goes against the core idea of arbitration which is supposed to be an alternative dispute resolution mechanism and an antidote to unnecessary delays and costs which characterize litigation. Unfortunately, a 5-judge bench of the Supreme Court in its recent judgement in N.N. Global Mercantile (P) Ltd. v. Indo Unique Flame Ltd. (“N.N. Global-2”) has reaffirmed this position of law and has backtracked from the earlier progressive verdict delivered by the 3-judge bench (“N.N. Global-1” or “2021 judgement”) in the case.

To summarize, the Supreme Court has held, by a 3:2 majority, that arbitral clauses within unstamped instruments are unenforceable, and it has also expanded the scope of enquiry of a Court under Section 11 of the Arbitration and Conciliation Act, 1996 (“ACA, 1996”), to enquire into both the factual and legal existence of an arbitration agreement before referring the parties to arbitration.

This article seeks to firstly explain the background of this decision, secondly critically analyze the majority and the minority verdicts given by the Supreme Court in the 2023 judgement and thirdly, discuss the possibilities of removing the roadblocks to a hassle-free framework for the appointment of arbitrators in India.

The Background: A Saga of Arbitration and Arbitrariness

Section 11 of the ACA, 1996 envisages the appointment of arbitrators by the Supreme Court, or the High Court (or any other person or institution designated by such a Court) in cases of failure of the contracting parties to either reach a consensus regarding the appointment procedure or the failure to comply with any such agreement reached.

The consistent position of the Supreme Court with regard to this provision had been to enlarge the jurisdiction of such a Court under Section 11 to consider both the existence and the (legal) validity of the agreement before referring the parties to arbitration. This question again came in SMS Tea Estates (P) Ltd. v. Chandmari Tea Co. (P) Ltd. (2011) (“SMS Tea”) where a Constitution Bench of the Supreme Court went on to hold that the Court under Section 11 could not act upon an arbitration clause in an instrument before the requisite stamp duty on it has been paid, as required under the Indian Stamp Act, 1899 (“Stamp Act”).

The 246th Law Commission Report which intended to “redress the institutional and systematic malaise” affecting the growth of arbitration in India, recommended the introduction of Section 11(6A) in the Act to limit pre-arbitral judicial intervention to a prima facie analysis of the “existence and the validity” of the arbitration agreement. The report cited judicial delays in the appointment of arbitrators as the reason for this amendment. As noted by the minority verdict in N.N. Global-2 (¶ 247, ¶ 347), even the legislature’s version of Section 11(6A), introduced by the Arbitration and Conciliation (Amendment) Act, 2015, confined the scope of inquiry only to the existence of the arbitration agreement.

While the Report addressed the overall jurisprudence on this issue, it did not specifically make any references to the decision in SMS Tea, leading to the Supreme Court in Garware Wall Ropes Ltd v. Coastal Marine Construction & Engg. (2019) reaching the conclusion that the amendment did not hit at the reasoning of the Court, and that arbitral clauses in unstamped instruments were still unenforceable. This was further reaffirmed in Vidya Drolia v. Durga Trading Corporation (2021) (“Vidya Drolia”) which was held by a 3-judge bench of the Supreme Court.

The issue again came before the Supreme Court in the case of N.N. Global-1 where another 3-judge bench disagreed with the coordinate bench’s decision in Vidya Drolia and referred the question to the 5-judge bench.

“Mistaking the Forest for the Trees”: Analysis of the Court’s Verdict

Notably, the 2021 judgement gave recognition to the legislative intent in incorporating the doctrine of kompetenz-kompetenz in Indian arbitration law, allowing arbitrators to determine their own jurisdiction and limiting pre-arbitral intervention by the judiciary. The Supreme Court further read the amendment in line with contemporary developments in international arbitration and read into Indian law the doctrine of severability of the arbitration agreement from the principal unstamped agreement, such that the ‘severed’ agreement could be acted upon by a Court under Section 11. The implicit rationale on which N.N. Global-1 stood that an arbitration agreement when separated, would not need to be stamped, because though the Stamp Act mandates the stamping of ‘arbitral awards’ (Item 12 of the Act’s Schedule), it did not make an express reference to arbitration agreements.

The majority judgement in N.N. Global-2, authored by Justice Joseph Kurian and Justice Aniruddha Bose and a concurring opinion written by Justice CT Ravikumar, nullify the basis for the reasoning propounded in the 3-judge bench verdict by holding that an arbitration agreement, whether severable or not, is itself an agreement that would need to be stamped, under Section 3 of the Stamp Act, read with Article 5(c) of the Act’s schedule, which mandates the stamping of all agreements, even “if not otherwise provided for.”

Having held that stamping the arbitration agreement is a legal necessity, the majority went on to hold that a Court under Section 11 of the ACA, 1996 is capable of looking into both the existence and the (legal) validity of the arbitration agreement before the appointment of arbitrators. Since Section 35 of the Indian Stamp Act puts a bar on unstamped instruments being taken into evidence, this reasoning renders an unstamped arbitration agreement unenforceable.

Despite the technically sound analysis of the statutes, the majority verdict may be criticized on two counts. First, it essentially permits the litigating parties to effectively stall proceedings and is deleterious to the efficiency of the arbitration regime as the fulfilment of this fiscal obligation may often be time-consuming. In states where the stamp duty is levied on an ad-valorem basis, the parties may be discouraged from filing for arbitration, as they would have to weigh the comparative costs and benefits of covering the stamp deficiency and the outcome of the proceedings.

Second, it ignores the difference between Section 11 and Section 2(1)(e) of the ACA, 1996. Whereas the former provision – as inferable from the language of the statute – only permits a prima facie enquiry into the existence of the agreement, the latter provision envisages that there may be a principal Civil Court of the ordinary jurisdiction or the High Courts that have the “jurisdiction to decide the questions forming the subject-matter of the arbitration if the same had been the subject-matter of a suit.” Under Section 2(1)(e) thus, the Court can look into the evidence and determine the substantive issues a tribunal will be dealing with, and its jurisdiction thus, is broader.

The Need to Harmonize the Law in Favour of Arbitration

The dissenting opinions, authored separately by Justice Ajay Rastogi and Justice Hrishikesh Roy reiterate the rationale of the 2021 judgement wherein a contrast was drawn between enquiry into the ‘existence’ of the arbitration agreement by a Court at the pre-arbitral stage – as in Section 11(6A) – and into the ‘validity’ of the same as in Section 16 by an arbitration tribunal. As highlighted in United India Insurance Company Limited v. Hyundai Engineering & Construction Company Limited, stamping is a curable defect that can be later enquired into by the arbitration tribunal as well.

Such an interpretation would be in consonance with international standards. A quick sojourn through different jurisdictions demonstrates that the principle of kompetenz-kompetenz has become well-entrenched and a popular doctrine to minimise judicial intervention. The UK Court of Appeal in Harbour Assurance v. Kansa General International Insurance, held that unless the challenge is to the arbitration agreement itself, the invalidity of the main contract does not materially affect the enforceability of the former. The arbitration agreement is not viewed as a “component of a material-legal contract” when the validity of the contract is contested, but rather as a separate “procedural contract,” that has been combined into one for convenience's sake. These two contracts stand independent of each other and even if the former is legally unenforceable at a point of time, the latter may be enforced.

Further, the UNCITRAL Model Law on International Commercial Arbitration itself, through its Article 16(1) enshrines the doctrine of severability to state that an arbitral tribunal's finding that a contract is void will not automatically invalidate the arbitration provision contained in such a contract. Section 16(1) of ACA, 1996 has codified this idea of separability, and it needs to be respected.

The dissenting opinion by Justice Hrishikesh Roy appeals to the legislature for a constructive interpretation of the legislative intent that can foster speedy referral to arbitration (¶ 403). It is recommended by this writer that arbitration agreements be added among the exceptions to the Stamp Act (under Article 5 of the Statute’s Schedule) to avoid dilatory litigation over the stamp duty. Forgoing such duty may also save the unnecessary costs that the State incurs out of its exchequer in such frivolous cases.

Concluding Remarks

To conclude, the Supreme Court’s decision in N.N. Global-2 comes as a setback for efficiency in the arbitration regime in India as the necessity of paying the stamp duty on the arbitration agreement itself and the pre-arbitral enquiry into both the existence and the legality of the agreement adds several procedural hurdles in the enforcement of the intent of the parties. It is imperative that such inconsistencies between the Stamp Act and the ACA 1996 be removed through legislative intervention to foster the growth of India’s image as the destination choice for commercial arbitration.