How Much is Too Much - Supreme Court on Scope of Examination of Arbitration Agreement at Pre-Arbitral Stage

When faced with a suit or proceeding in any court or tribunal when there is an arbitration clause in the agreement, Section 8 of the Arbitration and Conciliation Act, 1996 (“Act”), empowers a judicial authority to refer parties to arbitration, thereby honouring the parties’ (pre-dispute) bargain. The Law Commission of India, in its 246th report, recommended amendments to Sections 8 and 11(6A)[1] of the Arbitration Act, with the intent to restrict the scope of judicial intervention at the pre-arbitral stage only to prima facie determine whether an arbitration agreement exists, thereby making it imperative for such judicial authority to refer the parties to arbitration, leaving the final determination of the existence and validity of an arbitration agreement to the arbitral tribunal under Section 16. Conversely, the judicial authority could arrive at a conclusion that the arbitration agreement does not exist. The prima facie test was brought into force through the 2015 Amendments, which were also aimed at avoiding the effect of Booz Allen[2] and Ayyasamy[3], which stated that a Court at the Section 8 stage itself should determine not only the existence, but also the validity of the arbitration agreement (including arbitrability of the dispute), thereby disregarding the principle of kompetenz-kompetenz. The 2015 Amendments also made an order under Section 8, refusing to refer parties to arbitration appealable under Section 37. However, the word “prima facie” was not introduced into Section 11 (6A) as per the Law Commission’s recommendation.

Given the difference in the approach between Section 8 and 11, unsurprisingly, the 2015 Amendments created ambiguity, in relation to the scope of judicial examination and intervention, under Sections 8 and 11, both provisions, in their essence, providing for judicial intervention at a pre-arbitral stage. A three judge bench of the Supreme Court in Vidya Drolia & Ors v. Durga Trading Corporation[4] recognised the need for this parity between the two provisions, where it noted that the ‘prima facie’ standard applied equally to the power of judicial review under Section 11, thereby reading the ‘mandate of a valid arbitration agreement in Section 8 into mandate of Section 11, that is, “existence of an arbitration agreement”[5]. The Supreme Court in Vidya Drolia, noted that the existence and validity of an arbitration agreement are essentially intertwined with an invalid arbitration agreement not being capable of existing, so that the exercise of a ‘prima facie’ judicial review of existence would therefore necessarily entail a determination of its validity.[6] Justice Ramana, in a separate, but concurring opinion, laid down the scope of a prima facie examination of the validity of an arbitration agreement to include an examination into: (a) whether the arbitration agreement was in writing; (b) was it contained in an exchange of letters; (c) whether the arbitration agreement fulfilled the core ingredients of a contract and (d) whether the subject matter of a dispute was arbitrable (although, the Court caveated this by noting that this examination was to be limited to “rare occasions[7]

Just three months after the Vidya Drolia decision, the Supreme Court was again faced with  examining the scope of a “prima facie” review under Section 11 of the Arbitration Act in the case of Pravin Electricals v. Galaxy Infra and Engineering Private Limited[8], where Pravin Electricals appealed before the Supreme Court against an order of the Delhi High Court under Section 11(6) of the Arbitration Act, appointing a sole arbitrator in a dispute. The existence of the arbitration agreement contained in a consultancy agreement was disputed between the parties. The Court in this case examined the contours of Sections 8 and 11 in great detail and noted that while these provisions have been brought at par in so far as the scope of judicial review is concerned, there continued to be an anomaly in respect of appealability. In so far as orders under Section 8, refusing to refer parties to arbitration are appealable under Section 37(1)(a),  a similar refusal to refer parties to arbitration under Section 11(6) read with Sections 6(A) and 7 is not appealable. The Supreme Court therefore recommended a re-look by the Parliament at Sections 11(7) and 37, so as to bring orders under Sections 8 and 11 on par in respect of appealability as well. In Pravin Electricals, the Court grappled with another interesting question. There were a lot of factual and evidentiary issues that it needed to consider, such as signatures, notarisation, dates, etc., of the arbitration agreement and this would require a deeper examination, which the arbitral tribunal would be fit to make rather than the Court at a prima facie stage. For this reason (setting aside the Delhi High Court decision, stating that an arbitration agreement exists), the Supreme left the decision on determination on whether the arbitration agreement exists to the arbitrator itself, while confirming the appointment of the arbitrator in terms of the Delhi High Court’s decision.

The observations of the Supreme Court in the Vidya Drolia case, albeit in a different context of arbitrability of a dispute, have been referred to and relied upon in another recent decision of the Supreme Court in Indus Biotech Private Limited v. Kotak India Venture (Offshore) Fund[9], where the question before the Court was whether a mere filing of a petition by a financial creditor against a corporate debtor under Section 7 of the IBC, 2016, obviated the requirement of the NCLT examining whether a reference to arbitration was required under Section 8 of the Act. The Court, in effect, was tasked with identifying the trigger point at which a proceeding became non-arbitrable, consequent upon the determination of admissibility of a Section 7 IBC application.

To explain this further – Section 7 of the IBC requires the NCLT to objectively determine whether the corporate debtor is in default with the IBC, entitling the corporate debtor to show that no default has occurred and no debt is due. If the NCLT is of the view that a default has occurred and proceeds to admit the Section 7 application, then the corporate insolvency resolution process begins with CIRP and the proceedings take on the colour of a proceeding in rem as on the date of admission of the Section 7 application, and from that point on, the matter would not be arbitrable[10]. The trigger point, therefore, according to the Court, ‘was not the filing of the application under Section 7 of the IBC but the admission of the same on determining default’ where then the admission creates third party rights in all creditors of the debtor and will have an “erga omnes effect”.[11] The Court was of the view that the provisions of the IBC override all other laws and therefore the Section 8 application under the Act could not be decided, divorced from the Section 7 determination under the IBC and a party could not be allowed to use the “bogey” of arbitration to avoid admission. The decision in respect of the Section 7 application would in and of itself decide whether the Section 8 application may be even considered or otherwise. 

Analysis and Conclusion

The recent trend of Section 8 decisions has been well thought out and encouraging. With the fast and very many changes in both the arbitration and IBC regimes, the interplay of these issues along with questions of what and how much can be considered at the threshold stage by a Court are bound to come up. Generally, the trend has been to treat Section 8 applications as peremptory and sacrosanct, leaving it to the arbitral tribunal to decide the bulk of the issues, including (applying Pravin Electricals) the existence of the arbitration agreement. This approach is in line with global standards since matters of jurisdiction and arbitrability ought to be left to the Tribunals. Other than reducing backlog, this approach has another benefit. If a Tribunal decides that an arbitration agreement does not exist upon examination of all evidence, that would be the end of the matter – therefore no prejudice is caused to the party denying the existence of the arbitration agreement. Such an inquiry would need consideration of (often complex) factual issues and a Court at a threshold stage is just not the right forum for it. Such an approach is therefore fair even to the party that claims the existence of an arbitration agreement.

That said, under Indian law not all matters can be decided by arbitration – particularly those that are in rem. The Supreme Court, in Vidya Drolia, recognised that certain subject matter may be ex facie non-arbitrable, so that the Court may, even at the Section 8 stage, refuse to refer the parties to arbitration, so as to ‘check and protect parties from being forced to arbitrate when the matter is demonstrably ‘non-arbitrable’ and to cut off the deadwood[12]. It is therefore prudent for decisions on default in IBC to be taken before any questions of arbitration as the mechanism of dispute resolution is raised. But this then leads to a hybrid approach. The minute the Court decides a Section 7 application – it is, in effect, making a decision on arbitrability (and is in line with the Booz Allen approach of deciding this matter at the threshold). But this would be contrary to the now amended language of Section 8, which seeks to dilute the effect of the Booz Allen approach of deciding even arbitrability at the threshold. Some would argue that the Indus Biotech decision is, in effect, the revival of the Booz Allen ratio on deciding arbitrability at the threshold. However, the Vidya Drolia reading of this, to only exclude demonstrably non-arbitrable matters at a prima facie stage would come into play – in fact this reading is already being applied by courts – the Delhi High Court in a decision pronounced on June 4, 2021[13], applied the Vidya Drolia construction in a case involving a trademark assignment agreement to hold that the dispute between the parties emanated from the assignment agreement and not from the Trademark Act, the latter making it an action in rem and thereby non-arbitrable. This test of determining demonstrable non-arbitrability is obviously a subjective test and one susceptible to expansion. One way or another, Courts walk a tight rope in Section 8 decision making. A one size fits all approach is neither sensible nor possible. Perhaps, therefore, the current approach of our Courts, on a case by case basis, is a wise one.

[1] When the 2019 Amendments to the Act are brought into force, Section 11 (6A) which introduced this prima facie test under Section 11 through the 2015 Amendments was to be deleted since the power of appointment is to be delegated to arbitral institutions. Section 11 (7) which states that no appeal would lie from the order of the High Court or the Supreme Court and that it would be final under Section 11 (5) and (6). Section 11 (7) has also been deleted by way of the 2019 Amendments. However, presently, these change has not been notified. 

[2] Booz Allen & Hamilton Inc. v. SBI Home Finance Ltd. (2011) 5 SCC 532

[3] A. Ayyasamy v. A. Paramasivam and Others (2016) 10 SCC 386

[4] 2021 2 SCC 1.

[5] Vidya Drolia, paragraph 147.5

[6] Vidya Drolia, paragraph 147.1

[7] Vidya Drolia, paragraph 237

[8] 2021 SCC OnLine SC 190

[9] 2021 SCC OnLine SC 268

[10] Indus Biotech, paragraph 17.

[11]Indus Biotech, paragraphs 17 and 26

[12] Vidya Drolia, paragraph 154.

[13] M/s Golden Tobie Private Limited v. M/s Golden Tobacco Limited, Delhi High Court, CS(COMM) 178/2021, on 04.06.2021.