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Not Quite The Final Nail in The Unstamped Arbitration Clause Saga?

Updated: Sep 26, 2023

By Aryan Pandey, Jindal Global Law School, Sonipat.


Introduction

The admissibility of documents in arbitration differs from court proceedings as it is not governed by the Indian Evidence Act, 1872 or the Code of Civil Procedure, 1908. The arbitral tribunal has the discretion, based on the principle of Kompetenz-Kompetenz, to determine the rules of admissibility for any material presented before it. On 11th January 2021, the Supreme Court encountered a case, N.N. Global Mercantile Pvt. Ltd. v. Indo Unique Flame Ltd., where a three-judge bench had to determine the validity of arbitration agreements in unstamped instruments subject to stamp duty. The 3-judge bench referred the case to a constitutional bench because its findings departed from the court’s earlier verdict in M/s SMS Tea Estates Ltd. v. M/S Chandmari Tea Co., followed by a division bench in Garware Wall Ropes Limited v. Coastal Marine Construction and Engineering Limited. On 25th April 2023, the constitutional bench settled the debate with a split majority of 3:2, ruling that an arbitration agreement under Section 7 of the Act is exigible to stamp duty, and inadequate payment of stamp duty would invalidate the agreement. This judgment is surprising in light of the 2015 amendment to the Act, which restricted the court's power to only examine the existence of an arbitration agreement in Section 11 applications. The article examines the legal position before the 2015 amendment, subsequent verdicts, the scope of the doctrine of separability, the cross-jurisdictional approach taken by countries like the UK and the USA and concludes with suggestions.


Position of Law until N.N. Global

In the early years after independence and then for a long time thereafter, it was the Supreme Court’s judgement in Kishorilal which laid down the standards for the applicability of the doctrine of separability. Kishorilal laid down a differential standard for the applicability of the doctrine of separability basically divided into two-components:

a) In case of a breach, repudiation or frustration of contract, the arbitration agreement survives.

b) The arbitration agreement is not saved by the doctrine of separability when a contract is substituted, altered or rescinded by mutual agreement under section 62 of the Indian Contract Act, or if it is void ab initio[1].

Hence, before the enactment of the Arbitration Act, 1996 it was this differential standard that was employed by the Supreme court of India to determine the validity of an arbitration agreement.

ii) The Trends in SMS Tea-Garware and Vidya Drolia Judgements:

SMS Tea Estates v. Chandmari Tea Company was the first case where the SC faced the issue of stamping, a division bench held that if a document in which the arbitration agreement is contained is not properly stamped then the court will impound the document in the manner specified under section 38 of The Indian Stamp Act, 1899 (the Stamp Act). However, the nature of bar imposed by section 35 of the Stamp Act is not an absolute bar i.e., the bar is removed as soon as the deficit in stamp duty is discharged and thus, it is a curable defect. After the decision in SMS Tea, there were amendments made to the Arbitration Act done on the recommendations made by the 246th Law Commission Report. The amendment led to the addition of Section 11 (6A) which limited the scope of judicial interference at the stage of appointment of arbitrators to examination of the existence of an arbitration agreement. Post the 2015 Amendment to the Act, the issue resurfaced before the court in Garware Wall Ropes Ltd. v. Coastal Marine Construction & Engineering Ltd. where the court considered the question whether after the introduction of Section 11 (6A) is it the judge who will impound the impugned document or whether the judicial scrutiny is limited to the examination of a valid arbitration agreement and any impounding that needs to be done will be done by the arbitrator. Justice Nariman agreeing with the earlier view adopted by the court held that the Stamp Act applies to the agreement as a whole and that it is not possible to bifurcate the arbitration clause contained in such instrument to give it an independent existence. In February 2020, the view taken by the court in SMS Tea and Garware was affirmed by a three-judge bench in M/S Dharmaratnakara Rai Bahadur Arcot Narainswamy Mudaliar Chattram and other charities and ors. v. M/S Bhaskar Raju & Brothers and Vidya Drolia v Durga Trading Corporation. It was after this in 2021 that a 3-judge bench in NN Global took an opposite view but referred to a five-judge bench to resolve the ambiguity.


N.N. Global and the Scope of Application of Doctrine of Separability:

The majority view in N.N. Global Mercantile Pvt. Ltd. v. Indo Unique Flame was based on technical grounds while completely ignoring the party’s consensus to hold arbitration as a dispute resolution mechanism. Justice K.M. Joseph’s following observation elucidates the hyper-technical view adopted by the court:

“…an agreement, which is unenforceable on account of a substantive law, which would include the Stamp Act, would not be a contract, applying Section 2(h) of the Contract Act. It is only if an agreement is enforceable, that it would become a contract. It is only a ‘contract’, which would be the ‘Arbitration Agreement’, which is contemplated in Section 11(6A) of the Act. It may not be apposite to merely describe an unstamped Arbitration Agreement as a ‘curable defect’. As long it remains an unstamped instrument, it cannot be taken notice of for any purpose, as contemplated in Section 35 of the Stamp Act.”

A conjoint reading of Section 33 and 35 of the Indian Stamp Act conveys that an instrument not duly stamp will be impounded and that it would be inadmissible in evidence. However, what the court failed to consider in SMS Tea was that the law never required an arbitration agreement to be stamped. Section 3 read with Schedule 1(12) of the Stamp Act makes it clear that it is only the final arbitration award that needs to be stamped and not the arbitration agreement. Thus, the provisions of the arbitration act and the application of the doctrine of separability make it abundantly clear that an arbitration agreement is an independent document free from the fiscal claws of the stamp act and needs to be read independently of the main agreement.

The doctrine of separability was enunciated by the House of Lords in Heyman v Darwins Ltd., and a primary glance at Lord Macmillan’s opinion which the Supreme Court also highlighted in Kishorilal makes it very clear that the nature of an arbitration agreement is such that it ought to be severed and read independently of the main agreement in case of any difficulty. He opined that “The other clauses set out the obligations which the parties undertake towards each other hinc inde, but the arbitration clause does not impose on one of the parties an obligation in favour of the other. It embodies the agreement of both parties that, if any dispute arises with regard to the obligations which the one party has undertaken to the other, such dispute shall be settled by a tribunal of their own constitution.”


Cross-Jurisdictional Analysis

The Indian courts has avoided the implementation of the doctrine of separability in arbitration agreements while globally the doctrine of separability has been employed by many nations to create a pro-arbitration environment. Globally, courts have taken a very liberal approach in interpreting the arbitration agreement, adopting the blue pencil rule and striking off the invalid part to give the arbitration agreement a valid meaning. Thus, it is fair to conclude that the threshold for invalidating the arbitration agreement is set at a strikingly higher level globally when compared to Indian Jurisprudence, where a mere technical insufficiency can invalidate the same.

The independent or the autonomous nature of the doctrine of separability is one of the cornerstones of arbitration domestically and globally. The UNCITRAL Arbitration Rules was among the first few to recognise this principle. India adopted Article 16(1) of the UNCITRAL Model law as Section 16(1) of the Arbitration and Conciliation Act, 1996.

In UK, Section 7 of the Arbitration Act itself provides for separability. The leading authority cited for enunciating the same is Harbour Assurance Co. (UK) Ltd. v Kansa General International Insurance Co. Ltd.which gives further prominence to this theory by holding that the invalidity of the substantive part of the agreement does not necessarily affect the validity of the arbitration agreement. Since then, the UK jurisprudence has evolved along those lines.

The US Jurisprudence has also evolved similarly. In Buckeye Check Cashing Inc. v Cardegna, Justice Scalia while delivering the opinion of the court and further upholding the Kompetenz-Kompetenz doctrine held that “…a challenge to the validity of a contract as a whole, and not specifically to the arbitration clause within it, must go to the arbitrator, not the court… Because this challenges the Agreement, and not specifically its arbitration provisions, the latter are enforceable apart from the remainder of the contract, and the challenge should be considered by an arbitrator, not a court.”


Conclusion:

The verdict of the initial 3-judge bench in N.N. Global was pro-arbitration and was widely accepted. However, the recent ruling in N.N. Global by the Constitutional Bench, moves the Indian Jurisprudence on Arbitration opposite to the global standards as envisaged by UNCITRAL Model Law and the New York Arbitration Convention. The doctrine of separability is a globally accepted practice which makes the court encourage arbitration, however the reluctancy of the Indian courts to adopt this will further create impediments on India’s vision of becoming an arbitration hub. Perhaps the spirit of the law taking precedence over the letter of the law would resolve the issue, one which has paved the way for an unnecessary hindrance to the object of the law.



[1]Aditya Prasanna Bhattacharya and others, Indian Golf Union and the Lingering Ghost of common law severability in India, Arbitration International, Volume 37, Issue 1, March 2021, Pages 153–166, https://doi.org/10.1093/arbint/aiaa038

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