SC clarifies scope of judicial scrutiny under Section 11 of Arbitration Act: Sets aside Bombay HC ruling on appointment of arbitrator

Supreme Court: In an appeal against the judgment and order passed by the Bombay High Court, wherein the High Court dismissed the application preferred by the appellant under Section 11 of the Arbitration and Conciliation Act, 1996 (‘Act, 1996’) seeking appointment of an arbitrator to adjudicate disputes and claims in terms of Clause 18.12 of the Master Services Agreement (‘MSA’) executed between the appellant and the respondent, the three judge bench of Dr. Dhananjaya Y. Chandrachud, CJI, J.B. Pardiwala* and Manoj Misra, JJ. while setting aside the impugned judgment, said that the High Court exceeded the limited scope of judicial scrutiny at the stage of Section 11 by undertaking a detailed examination of the factual matrix. The High Court erroneously proceeded to assess the auditor’s report in detail and dismissed the arbitration application.

Background:

The appellant, a technology-based wellness venture inter alia providing lifestyle consultancy services, executed the MSA with the respondent, an entity engaged in digital marketing services, to manage its digital advertising campaigns. The MSA was subsequently extended on 29-04-2022 for a period of three years, with certain amendments.

Between August 2021 and April 2022, the appellant paid some amount to the respondent for the services rendered by it. It is the case of the appellant that for the subsequent 10 invoices raised between 12-05-2022 and 07-10-2022, the appellant was in the process of initiating and making payments when, in September 2022, certain media reports alleged malpractices in the advertising industry implicating major players. It was later discovered by the appellant that the Economic Offences Wing, Mumbai had lodged a complaint against Dentsu International Limited, the parent company of the respondent, and its senior officials alleging serious irregularities and malpractices in their service.

Considering the aforesaid developments, the appellant engaged an independent auditor in November 2022 to prepare a report on the activities of the respondent from April 2021 to 31-12-2022. The auditor submitted its report in February 2023. Thereafter, the respondent served a demand notice on the appellant under Section 8 of the Insolvency and Bankruptcy Code, 2016 (‘IBC’) seeking some amount towards the outstanding invoices. In response, the appellant rejected the demand, citing the audit findings, and invoked arbitration under Clause 18.12 of the MSA. The appellant also filed a counter claim, demanding a refund with 18% interest per annum and an additional Rs 6 crore by way of damages for the alleged misrepresentations by the respondent. Subsequently, upon failure of the respondent to comply with the arbitration notice, the appellant filed a Commercial Arbitration Application before the High Court, seeking appointment of a sole arbitrator to adjudicate the disputes between the parties. However, the respondent filed the Company Petition under Section 9 of the IBC before the National Company Law Tribunal for initiating the corporate insolvency resolution process of the appellant.

The High Court vide the impugned judgment, dismissed the application seeking the appointment of an arbitrator, while obserbing that although the report highlighted poor returns on investment and inconsistent metrics, yet it did not support the assertions made by the appellant regarding fraudulent practices of the respondent. Further, the High Court observed that the appellant failed to demonstrate any substantial discrepancies in the report that would justify withholding payment for the invoices raised. Aggrieved, the appellant filed the present appeal.

Issue: Whether the High Court committed any error in dismissing the appellant’s application under Section 11 of the Act, 1996?

Analysis and Decision:

After taking note of SBI General Insurance Co. Ltd. v. Krish Spinning, 2024 SCC OnLine SC 1754 the Court said that the scope of inquiry under Section 11 of the Act, 1996 is limited to ascertaining the prima facie existence of an arbitration agreement. In the present case, the High Court exceeded this limited scope by undertaking a detailed examination of the factual matrix. The High Court erroneously proceeded to assess the auditor’s report in detail and dismissed the arbitration application.

Thus, the Court viewed that such an approach does not give effect to the legislative intent behind the 2015 amendment to the Act, 1996 which limited the judicial scrutiny at the stage of Section 11 solely to the prima facie determination of the existence of an arbitration agreement.

The Court reiterated that “frivolity in litigation too is an aspect which the referral court should not decide at the stage of Section 11 as the arbitrator is equally, if not more, competent to adjudicate the same”.¹

The Court clarified that the limited jurisdiction of the referral Courts under Section 11 must not be misused by parties in order to force other parties to the arbitration agreement to participate in a time-consuming and costly arbitration process. Further, it suggested that, with a view to balance the limited scope of judicial interference of the referral Courts with the interests of the parties who might be constrained to participate in the arbitration proceedings, the Arbitral Tribunal may direct that the costs of the arbitration shall be borne by the party which the Tribunal ultimately finds to have abused the process of law and caused unnecessary harassment to the other party to the arbitration.

The Court concluded that the existence of the arbitration agreement in Clause 18.12 of the MSA has not been disputed by the respondent. Thus, the question whether there exists a valid dispute to be referred to arbitration can be addressed by the Arbitral Tribunal as a preliminary issue.

Thus, the Court set aside the impugned judgment and appointed S.J. Vazifdar, former Chief Justice of the Punjab & Haryana High Court, as the sole arbitrator to adjudicate the disputes between the parties.

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