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Arbitration Act and FEMA


India is one of the few countries that still has exchange controls and does not have full capital account convertibility.

The Foreign Exchange Management Act, 1999 (“FEMA”), empowers the Reserve Bank of India (“RBI”) to frame regulations, master directions and issue circulars for the enforcement of the FEMA (“FEMA Regulatory Regime”). The FEMA Regulatory Regime contemplates prior RBI approval for certain categories of capital account transactions between residents and non-residents.

The enforcement of international arbitration awards in India, where there is going to be a remittance of foreign exchange from a resident to a non-resident, would invariably have FEMA implications. FEMA implications may also arise in situations where the foreign award provides for transfer of shares between residents and non-residents. If the foreign award is not in conformity with the FEMA Regulatory Regime, in such a situation, can the court, where the enforcement action is filed, decline enforcement on the ground that the foreign award would be contrary to the country’s ‘public policy’.

Relevant Legal Provisions

Section 48 of the Arbitration and Conciliation Act, 1996 (“Arbitration Act”), lays down conditions for the enforcement of a foreign arbitral award. Under section 48(2), “Enforcement of an arbitral award may also be refused if the court finds that (a) The subject-matter of the difference is not capable of settlement by arbitration under the law of India; or (b) The enforcement of the award would be contrary to the public policy of India.”

Two explanations are provided to Section 48(2). First, it is clarified that an award is in conflict with the public policy of India, only if: “(i) The making of the award was induced or affected by fraud or corruption or was in violation of Section 75 or Section 81; or (ii) It is in contravention with the fundamental policy of Indian law; or (iii) It is in conflict with the basic notions of morality or justice.”

Second, it has also been provided that “The test as to whether there is a contravention with the fundamental policy of Indian law shall not entail a review on the merits of the dispute … If an application for the setting aside or suspension of the award has been made to a competent authority … the court may, if it considers it proper, adjourn the decision on the enforcement of the award and may also, on the application of the party claiming enforcement of the award, order the other party to give suitable security.” Section 48 adopts Article V of the New York Convention on Recognition and Enforcement of Foreign Arbitral Awards, 1958, to which India is a signatory.

Scope of Public Policy

The scope of enquiry for the court before which the application for enforcement of a foreign award is pending is circumscribed by the conditions for refusal set out in Sections 48(1) and 48(2) of the Arbitration Act. It is not open to a party seeking to resist a foreign award to assail the award on merits as the enforcing court is not the appellate court.

Further, even if the award debtor has not challenged the award or resisted its enforcement under Section 48, the court enforcing the award is duty bound to make an independent enquiry to satisfy itself that: (a) the subject matter of the difference is capable of settlement by arbitration under the law of India; and (b) the enforcement of the award will not be contrary to the public policy of India.

The amendments made to Section 48 by the Arbitration and Conciliation (Amendment) Act, 2015 (“2015 Amendment”), has significantly restricted the ground of “public policy” by overruling many previous judgments of the Supreme Court of India (“SC”). The amendment was based on the 246th Report of the Law Commission of India (“LCI Report”), which had recommended various amendments to the Arbitration Act. The LCI Report had recommended restricting the scope of “public policy” under both Section 34 and Section 48 of the Arbitration Act.

This was to bring the definition in line with the definition propounded by the SC in the case of Renusagar Power Co. Ltd. v. General Electric Co.[1] (“Renusagar”), where the SC, while construing the term “public policy” in Section 7 of the Foreign Awards (Recognition and Enforcement) Act, 1961, held that an award would be contrary to public policy if such enforcement would be contrary to: (1) the fundamental policy of Indian law; (2) interests of India; or (3) justice or morality.

The amendment made to the definition of ‘public policy’, vide the 2015 Amendment, is stricter and does not include reference to “interests of India”, which is vague and capable of interpretational misuse, especially in the context of challenging awards in international commercial arbitrations.

Judicial Pronouncements

The effect of the 2015 Amendments to the Arbitration Act has been well explained by the SC in its judgment, dated August 31, 2017, in HRD Corpn. v. GAIL (India) Ltd.[2] (“HRD Corporation”). In HRD Corporation, it was held that both Sections 34 and 48 have been brought back to the position of law contained in the Renusagar case, “where ‘public policy’ will now include only two of the three things set out therein, viz., ‘fundamental policy of Indian law’ and ‘justice or morality’”. The ground relating to ‘the interest of India’ no longer remains. The ‘fundamental policy of Indian law’ is now understood to be as laid down in Renusagar. ‘Justice or morality’ has been tightened and is now understood to be referring to only the basic notions of justice and morality i.e. such notions as would shock the conscience of the court as understood in Associate Builders v Delhi Development Authority[3] (“Associate Builders”).

In this regard, it is pertinent to note that in Union of India v. Vedanta Ltd[4], the SC held that the grounds for refusing enforcement of foreign awards contained in Section 48 are exhaustive, which is evident from the language of the provision, which provides that enforcement may be refused “only if” the applicant furnishes proof of any of the conditions contained in that provision.

FEMA a Fundamental Policy?

It may be helpful to first look at the SC’s landmark decision in Renusagar on the scope of “public policy” in relation to enforcement of foreign awards. The SC considered whether an award would fall foul of public policy if its enforcement would involve a contravention of the Foreign Exchange Regulation Act, 1973 (“FERA”). The court held that FERA was enacted to safeguard the country’s economic interests and any violation of its provisions would be contrary to India’s public policy. In Associate Builders, the SC, while interpreting the term “fundamental policy of Indian law”, relied on Renusagar to observe that a violation of the foreign exchange act would be contrary to the fundamental policy of Indian law. However, it must be noted that in Renusagar, the SC held that FERA was enacted to protect the nation’s economic interests and that if enforcement of an award violated FERA it would be contrary to the “interest of India” and not the “fundamental policy of Indian law” (as observed by the Supreme Court in Associate Builders).

The Delhi High Court (“Delhi HC”) in its judgment dated April 11, 2017, in Cruz City v Unitech Ltd[5], considered whether a violation of FEMA would be contrary to the public policy of India under section 48(2)(b) of the Arbitration Act. The court considered the decisions of the Supreme Court in Renusagar and in Shri Lal Mahal v Progetto Grano Spa[6], regarding the scope of “public policy” and concluded that enforcement of a foreign award could be refused on the grounds of public policy of India, only if it were contrary to: (1) the fundamental policy of Indian law; (2) the interests of India; or (3) justice or morality. The court further held that a contravention of a provision of law was not sufficient to invoke the defence of “public policy” and the expression “fundamental policy of India” referred to the basic rationale, values and principles, which form the bedrock of laws in the country.

The Delhi HC distinguished Renusagar on the grounds that it dealt with a FERA violation and held that FERA and FEMA were based on materially different considerations and took completely different approaches to economic policy. While FERA sought to protect India’s economic interests, FEMA only sought to manage foreign exchange transactions and did not share the same protectionist rationale as its predecessor.

The court noted that the nature of public policy in question also had to be considered. The permissive nature of FEMA and the overarching public policy consideration in favour of enforcing foreign awards based on India’s international obligations also had to be considered when weighing whether enforcement of the award would contravene public policy. The court further held that no provision of FEMA had been violated and even if this were the case, Unitech could not escape liability on this ground under the arbitral award, and would be separately liable for any consequences that would follow from FEMA violation.

The Cruz City judgment follows the earlier decision of a division bench of Delhi HC in the 2012 case of SRM Exploration Pvt Ltd v N&S&N Consultants[7] (“SRM Exploration”), where the court had held that the deletion of Section 47 of FERA from FEMA shows a legislative intent to not make a transaction void even if it is in violation of FEMA.

[In Part II of this article, the authors shall discuss certain recent judicial pronouncements which throw light on the legislative gap between the Arbitration Act and FEMA]

Section 47(3) of the FERA

Section 47(3) of FERA, relating to “contracts in evasion of the act” stated that: “Neither the provisions of this act nor any term (whether express or implied) contained in any contract that anything for which the permission of the central government or the Reserve Bank is required by the said provisions shall not be done without that permission, shall prevent legal proceedings being brought in India to recover any sum which, apart from the said provisions and any such term, would be due, whether as debt, damages or otherwise, but (a) the said provisions shall apply to sums required to be paid by any judgment or order of any court as they apply in relation to other sums; (b) no steps shall be taken for the purpose of enforcing any judgment or order for the payment of any sum to which the said provisions apply except as respects so much thereof as the central government or the Reserve Bank, as the case may be, may permit to be paid …”

The approach suggested by the Delhi HC in SRM Exploration arguably posed a danger since it may encourage unscrupulous parties to enter into transactions that effectively circumvent FEMA regulations. It could never be the legislative intent to allow an arbitration award to be used as a device to circumvent a statutory provision and in any event, circumvention of law is certainly against the fundamental policy of Indian law.

It needs to be noted that in the Cruz City judgment, Delhi HC has taken a view that “having held that a simpliciter violation of any particular provision of FEMA cannot be considered synonymous to offending the fundamental policy of Indian law, it would also be apposite to mention that enforcement of a foreign award will invariably involve considerations relating to exchange control. The remittance of foreign exchange in favour of a foreign party seeking enforcement of a foreign award may require permissions from the Reserve Bank of India. There may also be a question whether the initial agreement pursuant to which a foreign award has been rendered required any express permission from RBI. However, as indicated earlier, the policy under FEMA is to permit all transactions albeit subject to reasonable restrictions in the interest of conserving and managing foreign exchange. India has not accepted full capital account convertibility as yet. Thus, there are transactions for which permission may not be forthcoming. Whereas certain transactions are permitted under FEMA and regulations made thereunder without any further permissions; other transactions may require express permission from the RBI. However, these considerations can be addressed by ensuring that no funds are remitted outside the country in enforcement of a foreign award, without the necessary permissions from the Reserve Bank of India. This would adequately address the issues of public interest and the concerns relating to foreign exchange management, which FEMA seeks to address.”

[1] 1994 Supp (1) SCC 644.

[2] (2018) 12 SCC 471.

[3]  (2015) 3 SCC 49.

[4] (2020) 10 SCC 1.

[5] 2017 SCC OnLine Del 7810.

[6] (2014) 2 SCC 433.

[7] 2012 SCC OnLine Del 1714.