Recently, a three-judge bench of the Supreme Court in M/s N.N. Global Mercantile Pvt. Ltd. v. M/s Indo Unique Flame Ltd. & Others has reiterated and clarified the law on the (i) doctrine of separability of arbitration agreements from the underlying contract; (ii) arbitrability of disputes involving fraud; and (iii) maintainability of a writ petition against orders passed under the Arbitration and Conciliation Act, 1996 (“Arbitration Act”).
The Court also revisited the law on the issue of validity, existence and enforceability of an arbitration agreement in an unstamped document, and in doing so, has over-ruled certain findings of a two-judge bench in SMS Tea Estates Pvt. Ltd. v. M/s. Chandmari Tea Co. Pvt. Ltd. (which has been followed by a two-judge bench in Garware Wall Ropes Limited v. Coastal Marine Constructions and Engineering Limited). However, since a co-ordinate bench of the Court in Vidya Drolia & Ors. v. Durga Trading Corporation has, in paragraph 92, affirmed the findings in paragraphs 22 to 29 of Garware (supra), the said issue has been referred to be authoritatively settled by a five-judge constitution bench of the Supreme Court.
In Part I of this post, we discuss the findings of the Court on the issue of separability of arbitration agreements from the underlying contract and the corresponding validity of arbitration agreements in unstamped agreements.
Indo Unique Flame Ltd. (“Indo/ Respondent No. 1”) was awarded a work order dated 18th September 2015 (“Work Order 1”) by the Karnataka Power Corporation Ltd. (“KPCL”). In pursuance of the same, Respondent No. 1 furnished a bank guarantee (“BG 1”) through its banker, State Bank of India (“SBI/ Respondent No. 2”). Thereafter, Indo entered into a sub-contract (“Work Order 2”) with N.N. Global Mercantile Private Limited (“Global Mercantile/ Appellant”) and in pursuance of the same, a bank guarantee (“BG 2”) was furnished in favour of SBI. Subsequently, certain disputes arose between KPCL and Indo under the unstamped Work Order 1, which led to the invocation of BG 1 by KPCL. As a result, BG 2 furnished by Global Mercantile under the Work Order 2 was also invoked.
Being aggrieved by the invocation of BG 2, Global Mercantile filed a suit (“Suit”) against Indo, SBI and the Union Bank of India (the Appellant’s banker) before the commercial court at Nagpur (“Commercial Court”) praying inter-alia for a declaration that Indo was not entitled to encash BG 2. The Appellant alleged that the invocation of BG 2 was fraudulent since it was not in terms of Work Order 2, being a conditional guarantee linked to the performance of work. The Commercial Court vide an ex-parte interim order directed status quo to be maintained as regards encashment of BG 2 (“Interim Order”). Thereafter, Indo filed an application under Section 8 of the Arbitration Act (“Section 8 Application”) seeking reference of disputes to arbitration. The Commercial Court rejected the Section 8 Application on the ground that the arbitration clause contained in Work Order 2 was not a general arbitration clause which would cover BG 2 and that the BG 2 was an independent contract. The Court noted that neither of the parties had performed any part of the Work Orders and consequently held that the jurisdiction of the Commercial Court was not ousted by the arbitration agreement.
Subsequently, Indo filed a writ petition before the Hon’ble Bombay High Court (“Bombay High Court”) to quash and set aside the aforesaid order. The Bombay High Court vide its judgment dated 30th September 2020 (“Impugned Judgment”) held that as both parties had admitted the existence of the arbitration agreement between them, the application under Section 8 was maintainable. With respect to the contention that the invocation of BG 2 was fraudulent, it was held that the such allegations could be resolved through arbitration, and the filing of the Suit before the Commercial Court was not justified. On the issue of the arbitration agreement being unenforceable since the Work Order was unstamped, it was held that the Appellant herein could raise the issue either under Section 11 of the Arbitration Act, or before the arbitral tribunal at an appropriate stage. The writ petition was held to be maintainable on the basis that there was no absolute bar to entertain a writ petition even if an alternate remedy was available.
Aggrieved by the Impugned Judgment, the Appellant filed a special leave petition before the Supreme Court.
Arguments advanced by the parties
The Appellant inter-alia submitted that (i) the Section 8 Application was not maintainable under the Maharashtra Stamp Act, 1958 (“Stamp Act”) as the Work Order being an unstamped document could not be received in evidence for any purpose, or acted upon, unless it was duly stamped; (ii) the arbitration clause in the unstamped agreement 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; (iii) the invocation of BG 2 was fraudulent since it was not in terms of Work Order 2, being a conditional guarantee linked to the performance of work. The Respondent inter-alia submitted that even though Work Order 1 was an unstamped agreement, non-payment of stamp duty would not render the agreement unenforceable and that the same was a curable defect.
Findings of the supreme court
Validity of an arbitration agreement in an unstamped agreement
The Court reiterated the well-settled position that an arbitration agreement is a distinct and separate agreement, independent from the underlying substantive commercial contract. The Court stated that this is based on the premise that when parties enter into a commercial contract containing an arbitration clause, they enter into two separate agreements viz. (i) the substantive contract which contains the rights and obligations of the parties arising from the commercial transaction; and (ii) the arbitration agreement which contains the binding obligation of the parties to resolve their disputes through the mode of arbitration. The Court noted that the concepts of separability (i.e. the invalidity, ineffectiveness or termination of the substantive contract would not affect the arbitration agreement, unless the same is directly impeached as being void ab initio) and kompetenz -kompetenze (i.e. the arbitral tribunal has the competence to determine and rule on its own jurisdiction, including in relation to the existence, validity and scope of the arbitration agreement) are the foundation of the autonomy of an arbitration agreement.
Analysing the statutory scheme of the Stamp Act, the Court emphasised that the Stamp Act is a fiscal measure enacted to secure the revenue of the State on certain classes of instruments (specified in Schedule I thereto). It observed that under the Stamp Act, the substantive contract would not be admissible in evidence, and could not be acted upon, for any purpose, in the event of non-payment of stamp duty. However, this was a deficiency curable on the payment of the requisite stamp duty and endorsement by the concerned Collector and would not invalidate the main contract.
The Court further observed that the arbitration agreement, being separate and distinct from the underlying commercial contract, would survive independent of the substantive contract. Further, the Stamp Act did not categorise an arbitration agreement as an instrument chargeable to stamp-duty. Accordingly, the Court held that there would be no legal impediment to the enforceability of the arbitration agreement, pending payment of stamp duty on the substantive contract. It, however, cautioned that the adjudication of the rights and obligations under the Work Order or the substantive commercial contract would not proceed before the parties complied with the mandatory provisions of the Stamp Act.
In particular, the Court over-ruled the finding of a two-judge bench in SMS Tea Estates Pvt. Ltd. v. M/s. Chandmari Tea Co. Pvt. Ltd. to the extent it ruled (i) that an arbitration agreement in an unstamped commercial contract cannot be acted upon, or is rendered un-enforceable in law; and (ii) that an arbitration agreement would be invalid where the contract or instrument is voidable at the option of a party, such as u/S. 19 of the Indian Contract Act, 1872 (“Contract Act”)
Additionally, the Court analysed the findings in Garware (supra) and found that the same had erroneously followed the judgment in SMS Tea Estates (supra). It, however, noted that since the judgment in Garware (supra) has been cited with approval by a co-ordinate bench of the Court in Vidya Drolia (supra), it would be appropriate to refer the findings in paragraphs 22 and 29 of Garware (supra) affirmed in paragraph 92 of Vidya Drolia (supra) to a Constitutional Bench of the Supreme Court.
Further, the Court also made observations regarding the authority, which would exercise the power of impounding an instrument under the relevant stamp act in cases where the substantive contract contained an arbitration. Considering the three different modes of reference of disputes to arbitration, the Court iterated that:
- in cases where the parties appoint the arbitrator consensually in accordance with the terms of the arbitration agreement, or by an arbitral institution, without the intervention of the Court, then, the arbitrator / tribunal is obligated by Section 33 of the Indian Stamp Act, 1899 (or the applicable State act) 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;
- In cases where the parties fail to make the appointment in accordance with the arbitration agreement and an application is filed under Section 11 of the Arbitration Act before the Court to invoke the default power for making the appointment, the High Court, or the Supreme Court, as the case may be, while exercising its jurisdiction, would impound the substantive contract which is either unstamped or inadequately stamped, and direct the parties to cure the defect before the arbitrator / tribunal adjudicates upon the contract;
- In cases where an application is filed under Section 8 of the Arbitration Act before a judicial authority for reference of disputes to arbitration, the judicial authority would make the reference to arbitration (since the subject matter of the contract is covered by an arbitration agreement). 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.
The Court further observed in cases where an application is filed under Section 9 of the Arbitration Act for an urgent interim relief, the situation is slightly different. In such cases, even if the Court is informed that the substantive contract is not duly stamped, it would grant ad-interim relief to safeguard the subject-matter of the arbitration. However, the substantive contract would then be impounded, and the concerned party would be directed to take the necessary steps for payment of the requisite stamp duty in accordance with the provisions of the relevant stamp act, within a time-bound period. The Court further clarified that the payment of stamp duty on the substantive contract, as assessed by the Collector, would be subject to the right of revision / appeal available under the relevant stamp act.
Accordingly, with regards to the unstamped Work Order, the Court directed the same to be impounded and forwarded to the concerned Collector in Maharashtra for payment of the requisite stamp duty by the parties.
In Part II of this post, we analyse the findings of the Court with respect to arbitrability of disputes involving fraud; and issue of maintainability of a writ petition against orders passed under the Arbitration Act and provide our views on the Judgment.
 Civil Appeal Nos. 3802 – 3803/ 2020 arising out of SLP (Civil) Nos. 13132 – 13133 of 2020)
 (2011) 14 SCC 66.
 (2019) 9 SCC 209
 Delivered on 14.12.2020 in C.A. No. 2402 / 2019.
 (2011) 14 SCC 66.