The Pendulum Swings Again — Supreme Court Circumscribes the Referral Court’s Powers Under Arbitration Law

Introduction

One of the key concerns that global businesses have while dealing with Indian counterparts is the time taken in enforcing contracts in India. Far too often, any discussion between Indian practitioners and their counterparts in developed economies veer towards the time taken for a dispute to be adjudicated once it enters the Indian legal system. Far often than not, arbitration is an important talking point in such discussions.

For some time now, there has been a significant push to promote arbitration as a dispute resolution mechanism. Understandably, a key motivator for promoting arbitration is to reduce the infamous backlog of Indian courts while improving the country’s standing with respect to enforcement of contracts. Given these key factors, one would presume that Indian courts are unlikely to intervene in matters where an adjudication through arbitration is appropriate. Unfortunately, India has a chequered history when it comes to the role of courts vis-à-vis arbitral process.

In India, a significant majority of arbitrations are conducted by way of an adhoc mechanism. This is in stark contrast to several other jurisdictions such as the United Kingdom and Singapore where institutional arbitration rules the roost. In ad hoc arbitrations, courts have a relatively active role to play at a pre-arbitral stage such as appointing arbitrators where the parties are unable to reach a mutual consensus. The present article discusses the scope of inquiry that may be undertaken by a court while faced with appointing an arbitrator to adjudicate a dispute.

Power of courts to appoint arbitrators

Section 11 of the Arbitration and Conciliation Act, 1996 (Act), deals with the appointment of arbitrators including the power of courts to appoint arbitrators. The judgment of the Supreme Court in SBP & Co. v. Patel Engg. Ltd.¹ (Patel Engg.) enabled a court which was called upon to appoint arbitrators under Section 11 of the Act (referral court) to look into questions of arbitrability of the claim, validity of arbitration agreement and other jurisdictional issues before deciding on appointment of arbitrators. However, in later years, this led to significant delay in appointment of arbitrators by courts and consequently, delay the arbitral process inordinately and frustrating the very purpose of arbitration.

The 246th Report of the Law Commission of India (Report), which was issued in August 2014, listed out judicial backlog and a relatively low threshold for judicial intervention as significant reasons for delay in arbitral process. The Report recommended circumscribing the powers of the referral court to avoid delays and to ensure that there was no interference with the powers of the Arbitral Tribunal to determine its own jurisdiction.

A number of recommendations in the Report were given statutory recognition by way of the Arbitration and Conciliation (Amendment) Act, 2015 (2015 Amendment). The 2015 Amendment inserted an important provision in the form of Section 11(6-A) which provides that while considering an application for appointment of arbitrator, the referral court must confine itself to the examination of the existence of an arbitration agreement.

Scope of inquiry by referral courts — Key judicial pronouncements

One of the earliest judgments to follow Patel Engg.² was National Insurance Co. Ltd. v. Boghara Polyfab (P) Ltd.³ (Boghara Polyfab). In Boghara Polyfab⁴, the Supreme Court delineated three categories of issues which would arise before the referral court, namely, (i) issues which will have to be decided by the referral court (jurisdiction of referral court to consider the matter, existence of arbitration agreement, locus of the applicant); (ii) issues which the referral court may consider or defer to the Arbitral Tribunal (whether the claim is time-barred, whether the parties have concluded the transaction without objection); and (iii) issues which the referral court must compulsorily defer to the Arbitral Tribunal (whether the claim falls within the arbitration clause, merits of the claim, etc.). Thus, Boghara Polyfab⁵ essentially allowed referral courts to deal with a number of issues prior to deciding on the appointment of an arbitrator to adjudicate the claims.

The decision of the Supreme Court in Duro Felguera, SA v. Gangavaram Port Ltd.⁶ (Duro Felguera) was one of the first instances where the implication of Section 11(6-A) of the Act was considered post the 2015 Amendment. The Court observed that the findings in Bohara Polyfab⁷ ceased to hold the field in light of the Section 11(6-A) which curtailed the scope of power of referral courts to merely enquiring about the existence of an arbitration agreement.

However, in United India Insurance Co. Ltd. v. Antique Art Exports (P) Ltd.⁸ (Antique Art) the Supreme Court took a divergent view in a matter where the appointment of arbitrator was objected to on the ground that there was a “full and final” discharge of the contract. The Supreme Court essentially went into the merits of the matter to hold that there was prima facie evidence to show that the discharge agreement or no claim certificate was obtained through fraud/coercion/undue influence. The Court also observed that referral courts may look into the prima facie evidence to find out whether the dispute is bona fide genuine before appointing an arbitrator. The Court distinguished Duro Felguera⁹ stating that the exposition therein was a general observation about the effect of the amended provisions. It was further held that appointment of an arbitrator is a judicial exercise and it is necessary to ensure that the dispute resolution process does not become unnecessarily protracted.

The findings in Antique Art¹⁰ were overruled in Mayavati Trading (P) Ltd. v. Pradyuat Deb Burman¹¹. The Supreme Court observed that post 2015 Amendment, referral courts are mandated to abstain from enquiring on whether accord and satisfaction had taken place in a dispute.

In Uttarakhand Purv Sainik Kalyan Nigam Ltd. v. Northern Coal Field Ltd.¹², the Supreme Court was dealing with an objection that the claims which were sought to be referred to an arbitrator for adjudication were time-barred. The Court held that since the issue of limitation was a mixed question of law and fact, the issue ought to be decided by the Arbitral Tribunal and the referral court should restrict itself to the examination of existence of arbitration agreement between the parties and went on to appoint an arbitrator for adjudication of the dispute.

In Garware Wall Ropes Ltd. v. Coastal Marine Constructions & Engg. Ltd.¹³ (Garware) the Supreme Court was deciding on enforceability of an arbitration clause of an unstamped contract. The Court held that referral courts are bound by the mandatory provisions of the Stamp Act to impound an unstamped instrument despite the 2015 Amendment. The Court held that an unstamped agreement cannot be said to be a contract since it is not enforceable in law and consequently, arbitration clause of an unstamped agreement would be unenforceable in law.

Thereafter, in Vidya Drolia v. Durga Trading Corpn.¹⁴ (Vidya Drolia), the Supreme Court held that prima facie review by a referral court at the referral stage does not interfere with the “competence-competence” principle and ensures that vexatious and frivolous matters are not referred to arbitration. It further observed that referral courts can interfere when it is manifest that the claims are ex facie time-barred and dead, there is no subsisting dispute or the disputes are non-arbitrable in nature.

In Indian Oil Corpn. Ltd. v. NCC Ltd.¹⁵ (Indian Oil) the Supreme Court relied upon Vidya Drolia¹⁶ to hold that although referral courts may look into the aspect of “accord and satisfaction”, it is advisable that the determination of accord and satisfaction should be left to the Arbitral Tribunal in cases where facts are disputed.

The Supreme Court in NTPC v. SPML Infra Ltd.¹⁷ (NTPC) laid down the “eye of the needle” test by relying on Vidya Drolia¹⁸ to delineate the scope of power that may be exercised by a referral court. The Court held there are two issues that are to be considered by a referral court. The first issue is the existence and validity of the arbitration agreement and the second issue is with respect to the arbitrability of the dispute. The Court held that where the claims are manifestly and ex facie non-arbitrable, the referral court may reject the claim without referring the same to arbitration.

The issue of validity of arbitration agreements in unstamped documents was reconsidered by a 7-Judge Bench of the Supreme Court in In Re: Interplay Between Arbitration Agreements under the Arbitration and Conciliation Act 1966 and the Stamp Act 1899¹⁹ (Interplay, In re). The Court overruled Garware²⁰ and held that the standard of scrutiny under Section 11 of the Act was confined to prima facie examination of the existence of the arbitration agreement. The Court further held that there is no fetter upon referral courts to refer parties to arbitration where the arbitration agreement is a part of an unstamped agreement.

In Arif Azim Co. Ltd. v. Aptech Ltd.²¹ (Arif Azim), the Supreme Court was considering whether the referral court may decline to make a reference under Section 11 of the Act where the claims are ex facie and hopelessly time-barred. The Court held that referral courts were under a duty to “prima facie examine and reject non-arbitrable or dead claims, so as to protect the other party from being drawn into a time-consuming and costly arbitration process”.

Findings in SBI General Insurance Co. Ltd. v. Krish Spg.

In SBI General Insurance Co. Ltd. v. Krish Spg.²² (Krish Spinning), a three-Judge Bench reconsidered the scope of power of referral courts in light of Section 11(6-A) of the Act and the numerous judgments passed by the Supreme Court. The Supreme Court, while deciding whether “full and final settlement” of claims arising under a contract bars initiation of arbitration in respect of settled claims, held that once a contract has been fully performed, it can be said to have been discharged by performance. However, whether there has been a discharge of contract is a mixed question of law and fact which is arbitrable under the arbitration agreement contained in the underlying contract. The Court also referred to numerous judgments to hold that ordinarily, referral courts ought to restrict itself into examining the existence of the arbitration agreement.

The Court also relied upon Interplay, In re²³ judgment to hold that the scope of examination under Section 11(6-A) of the Act is confined to the existence of an arbitration agreement on the basis of Section 7 of the Act and does not include a contested or laborious enquiry which falls within the jurisdiction of the Arbitral Tribunal. Accordingly, the Court held that tests such as “eye of the needle” and “ex facie meritless” which require the referral court to examine contested facts and appreciate prima facie evidence are not in conformity with principles of arbitral autonomy and judicial non-interference.

The Court also clarified its dictum in Arif Azim²⁴ and held that the referral court should limit its enquiry to examining whether the Section 11(6) application has been filed within the limitation period of three years from the date of notice of arbitration. However, referral courts cannot enquire whether the claims raised by the claimant are time-barred and should leave such issues for determination by the Arbitral Tribunal.

Conclusion

As can be seen from above, there has been a lot of divergence regarding the scope of inquiry that a referral court may undertake while deciding whether to appoint an arbitrator for adjudication of contractual disputes. The Krish Spg. judgment²⁵ seems to have, for once and for all, laid the controversy to rest by deciding that the power of referral courts is limited to enquiring about the existence of an arbitration agreement between the parties. This includes matters related to “accord and satisfaction” as well as time-barred claims.

It is noteworthy that in 2019, the Arbitration and Conciliation (Amendment) Act, 2019 (2019 Amendment) was passed by Parliament which omitted Section 11(6-A) of the Act. However, the relevant provision of 2019 Amendment viz. Section 3(v) of the 2019 Amendment, is yet to be brought into force. Thus, despite the passage of 2019 Amendment, Section 11(6-A) continues to be in force as of now. Ergo, it remains to be seen whether Krish Spg.²⁶ will hold the field if and when the omission of Section 11(6-A) of Act is given effect as per the 2019 Amendment.

On a plain reading of Krish Spg. judgment²⁷ it seems that referral courts will now be constrained to appoint an arbitrator and refer the dispute to arbitration even if the claim is ex facie frivolous. This may be an issue in cases where an application under Section 11 of the Act is filed on the basis of a claim which is barred by res judicata or is sub judice in nature. Perhaps, it could be argued that where there are no questions of fact which need to be determined by an Arbitral Tribunal, the referral court may consider the matter and decide the fate of such a claim at the stage of a Section 11 application.

It is noteworthy that as a matter of practice, both parties are required to incur substantial costs at a preliminary stage while engaging in arbitration. This includes sharing the costs of the arbitration as well as other legal costs such as attorneys’ fees. Essentially, a party will now be required to take out jurisdictional objection when faced with a frivolous claim.

In order to ensure that parties desist from filing frivolous claims, it is essential to strengthen the costs regime in the domestic arbitration landscape. Arbitral Tribunals must ensure that adequate costs are awarded while dismissing frivolous claims. Thus, while the findings of the Supreme Court are in line with well-established principles of arbitration law, Arbitral Tribunals must now ensure that the judgment does not encourage a party to file frivolous claims through arbitration and thereby harass the counterparty or force its hand into a settlement.