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Timestamp: 2020-07-09 09:13:28
Document Index: 299120796

Matched Legal Cases: ['UKHL ', 'art. 23', 'art. 6', 'art. 21', 'art. 178', 'art. 19', 'art. 23', 'art. 6']

Separability of Arbitration Agreement in Mutual Termination of Contracts in India
A Legislative Guide
Gautam Mohanty[1] & Raghav Bhargava[2]
[Originally published in the Journal of International Arbitration. The details of the original publication are as hereunder:
Mohanty, Gautam & Bhargava, Raghav. ‘Separability of Arbitration Agreement in Mutual Termination of Contracts in India: A Legislative Guideline’. Journal of International Arbitration 36, no. 6 (2019): 727–738.
This article is being republished here under the rights of the Author (Gautam Mohanty) to republish on personal website with permission of Kluwer Law International for a non-commercial purpose and with permission of the Co-author Raghav Bhargava. Gautam Mohanty is an Editor of The Arbitration Workshop.
An arbitration agreement is treated independent of the contract that contains the agreement. Section 16(1)(b) of the Indian Arbitration and Conciliation Act, 1996 expressly states that the invalidity of a contract shall not affect the validity of an arbitration agreement, even in cases of the contract being void ab initio. This provision is modelled on the UNCITRAL Model Law. This settled position of law has also been reflected through the Honoura’ble Supreme Court of India’s judgment in the case of A. Ayyasamy v. A. Paramasivam,[3] wherein the Apex Court has given due recognition to the principle of severability in contracts stipulating a separate arbitration clause. However, such rulings are restricted to cases whether either the contract is void ab initio or has been terminated, inter alia, due to reasons such as fraud, impossibility to perform, non-performance of the contract etc. Pertinently, the question of whether, as a consequence of mutual bilateral termination of a contract, an arbitration clause is terminated or not, still remains and is res integra.
The purpose behind the doctrine of severability in a contract containing an arbitration agreement is to ensure the effective resolution of disputes arising between the parties to a contract via arbitration. It is intended for an effective adjudicatory mechanism to exist even in situations where the contract becomes non-executable due to reasons beyond the control of the contracting parties. While the arbitral process is contingent on mutual consent of the parties to refer the matter to arbitration, a peculiar scenario arises in situations where the contract containing the arbitral agreement is mutually terminated. This results in a dichotomy: the parties’ clear intention to terminate the arbitration agreement for resolution of disputes between the parties, on the one hand, contradicts a pre-decided mechanism of dispute resolution on the other hand.
In light of the above, it is pertinent to consider the judicial dicta relating to this issue. The Honourable High Court of Bombay has sought to clarify such bilateral terminations in the cases of Ashok Thapar v. Tarang Exports[4] and Mulheim Pipecoatings GmbH v. Welspun Fintrade Ltd. & anor.[5]But in the absence of any legislative action or a categorical decision by the Honourable Supreme Court of India clarifying the legal position regarding the same and conflicting jurisprudence of the Honourable Bombay High Court, this issue remains unclear. This article aims to analyze views taken by the Honourable Bombay High Court against the current position of law, analyze the position in foreign jurisdictions, and suggest legislative reforms with regard to the issue of existence of an arbitration agreement in cases of bilateral termination of contracts.
2. EXISTING JURISPRUDENCE
2.1 Ashok Thapar v. Tarang Exports
2.1.1 Background Facts
The plaintiff and the respondent entered into a Leave and License Agreement, pursuant to which the respondent (Tarang Exports) was permitted to occupy the property. Subsequently, both parties mutually ended the Agreement. Disputes arose with respect to recovery of security deposit and other monies. The plaintiff filed a suit with the City Civil Judge for recovery of the security deposit and other claims based on the Leave and License Agreement. Thereafter, the defendant argued that the Civil Court did not possess requisite jurisdiction to entertain the suit in light of the arbitration clause contained in the Leave and License Agreement. The Civil Court dismissed the defendant’s application and held that it had jurisdiction in the matter. The defendant appealed before the Bombay High Court.
2.1.2 Judgment
The Bombay High Court opined that the issue in dispute was “whether an Arbitration Clause survives even after bilateral termination of the Agreement” and that the above issue was res integra in nature. Further, the Bombay High Court, while relying on the judgments of the Supreme Court in the cases of SMS Tea Estate Pvt. Ltd. v. Chandmari Tea Co. Pvt. Ltd.,[6] Branch Manager, Magma Leasing & Finance Ltd. v. Potluri Madhavilata,[7] and Ford Credit Kota Mahindra Ltd. v. M. Swaminathan,[8] held that the doctrine of separability applies even in cases of mutual termination of a contract containing the arbitration agreement and thus, the matter should be referred to arbitration. In its judgment, the Bombay High Court did not address the application of the doctrine of severability in the context of unilateral termination of agreements or in the context of an impossible agreement.
2.2 Mulheim Pipecoatings Gmbh v. Welspun Fintrade Ltd. & Anor.
The appellant and respondent had entered into a Share Purchase Agreement (SPA) which contained an arbitration clause covering all disputes related to it. The agreement included a transfer of shares by the respondent to the appellant. The appellant company was not allowed to transfer the shares to a third party within two years. If after the expiry of two years, they wished to transfer the same, the first preference should be given to the respondent at the same price. A subsequent Memorandum of Understanding (MOU) entered between the two did not contain any mention of arbitration as a method of dispute resolution, but had provisions contradictory to the SPA. Disputes arose regarding the validity of the notice and the transfer of the shares. The matter was brought before the Bombay High Court.
2.2.2 Judgment
The Court, while opining that arbitral proceedings must continue in this matter, made interesting observations. Justice Chandrachud distinguished between two situations: first, when the performance of the contract containing the arbitration agreement is brought to an end; second, when the existence of the contract is brought to an end. In the former, the arbitral agreement will survive, while it will not survive in the latter.
As a result of Ashok Thapar and Mulheim, a confusion has arisen, as the same court in two different judgments has interpreted severability during mutual termination of an agreement in two opposite ways: in one of which the arbitration agreement will be valid, while in the other it will not be. This contradictory interpretation by the same court requires much needed clarity.
3. INTERPRETING THE JUDGMENT IN ASHOK THAPAR
The controversial ruling of the Honourable Bombay High Court in Ashok Thapar has unsettled the position with respect to severability. Frustratingly, while it interprets the law in an unconventional manner, this ruling does not adequately explain its reasons for reaching this conclusion. However, various arguments can be made in support of the Ashok Thapar decision.
First, arbitration agreements have autonomy. Legislations in India are often modelled according to legislations in England. The Arbitration and Conciliation Act of 1996 (“Indian Act”) is a proof of the same with respect to the Arbitration Act of 1996 (“English Act”). Pertinently, a similar question as to the status of an arbitration agreement pursuant to mutual bilateral termination of a contract has been dealt with in the landmark English case of England Harbour Assurance Case.[9] In this case, an action was brought by re-insurers on the grounds of illegality of reinsurance policies, as a result of which the plaintiff should not be held liable. The illegality was denied by the defendants who sought a stay and reference to arbitration. The court held that while the purposes of the contract may fail, resulting in termination of a contract, the arbitration clause may not be automatically extinguished for the purpose of the agreement. More recently, in 2007, the English Court of Appeal and House of Lords in Fiona Trusts & Holding Corp. v. Privalov,[10]which involved claims of fraudulent inducement of a party’s agent, observed that such a claim levelled at the sanctity of the underlying contract does not adversely affect the arbitration clause within the contract. The court, while relying upon several authoritative academic works,[11]declared that:
It is not enough to say that the bribery impeaches the whole contract unless there is some special reason for saying that the bribery impeaches the arbitration clause in particular … It is only if the arbitration agreement is itself directly impeached for some specific reason that the tribunal will be prevented from deciding the disputes that relate to the main contract.
Therefore, the arbitration agreement is treated as a self-contained contract ancillary to the principal contract.[12] This is popularly referred to as the principle of autonomy, wherein the arbitration agreement remains unaffected by the fate of the main contract, that is, the latter’s nullity, resolution, termination, or even its non-existence.[13]
Accordingly, the arbitrator/judiciary possesses the ability to determine the existence of an arbitration agreement. This interpretation does find support in section 11(6A)[14] of the Indian Act pursuant to which the courts have the power to determine the existence of an arbitration agreement. The principle of autonomy also finds acceptance in rules of various international arbitration centres and institutions, such as the London Court of International Arbitration (LCIA) Rules,[15] wherein an arbitration agreement is treated as a distinct agreement. Similarly, the International Chamber of Commerce (ICC) Rules,[16] as well as the UNCITRAL[17] Rules, also reflect the independent nature of the arbitration agreement vis-à-vis the principal agreement. Thus, the autonomy of the arbitration agreement has now become a general principle of arbitration on which arbitrators across the globe rely to solve disputes.[18]
Secondly, arbitration agreements are not compulsorily governed by the laws governing the contract containing the arbitration agreement. A contract is to be governed by national laws under which it is made, whereas, an arbitration agreement is governed by the laws chosen by the parties. As a result, situations might exist wherein the principal contract is governed by laws separate from that of the arbitration agreement. Thus, laws which govern the principal contract cannot be enforced upon the arbitration agreement. In such situations, an arbitration agreement would stand independent of the principal contract. The arbitration agreement would not be scrutinized based on national law rules regarding the validity of other contracts. The reverse also holds true. National law rules which render an agreement invalid would not be made applicable to the arbitration agreement. Thus, the validity or invalidity of the arbitration agreement would be separate and independent to that of the main contract. Though not explicitly stated, the aforesaid view could also form the basis to come to similar conclusions as that of the court in Ashok Thapar.
Redfern and Hunter provide further support to the aforesaid argumentation. In their view, there are two separate contracts.[19] The first contract is the primary contract which contains commercial obligations and transactions with respect to the parties to the contract. This is the contract that governs all transactions between the parties. The second contract is the arbitration clause. This contract deals with all disputes relating to the primary contract which may arise between the parties. The second contract remains dormant and only becomes active when there is a dispute between the parties regarding the first contract. As a result, the autonomy of the arbitration agreement results in two independent contracts, which even though contingent on each other to a certain extent remain independent as well.
4. BOGHARA POLYFAB AND KISHORILAL GUPTA: SEPARABILITY PRINCIPLE ENGULFED IN OBITER
For the purposes of this article, the authors believe that the case of Union of India (UOI) v. Kishorilal Gupta & Bros.[20] and National Insurance Co. Ltd. v. Boghara Polyfab Pvt. Ltd.[21] assume pivotal importance, as the Honourable Supreme Court has in the aforesaid cases made observations with regard to the applicability of the separability principle to bilateral termination of contracts. However, as the observations are obiter dicta in nature and not ratio decidendi, they are barred from legal recognition under judicial dictum as laid elaborately laid down by the Apex Court of India.[22]
In Union of India v. Kishorilal Gupta & Bros.,[23] the Honourable Supreme Court, while deciding a Special Leave Petition (SLP), was principally adjudicating upon the legal question of survival of an arbitration clause in a contract when the contract was superseded by a new contract. In that case, certain disputes arose under three contracts in relation to the supply of raw materials and for compensation for breach of contract. The Supreme Court of India, after application of its judicial mind uninfluenced by authorities or case-law, observed that:
the logical outcome of the earlier discussion would be that the arbitration clause perished with the original contract. Whether the said clause was a substantive term or a collateral one, it was none the less an integral part of the contract, which had no existence de hors the contract … Though the phraseology was of the widest amplitude, it is inconceivable that the parties intended its survival even after the contract was mutually rescinded and substituted by a new agreement.[24]
However, after incisively analysing the relevant judicial opinion and principles regarding the doctrine of separability, the Honourable Supreme Court enunciated the necessary principles for judicial determination of separability as below:[25]
(1) An arbitration clause is a collateral term of a contract as distinguished from its substantive terms; but none the less it is an integral part of it;
(2) however comprehensive the terms of an arbitration clause may be, the existence of the contract is a necessary condition for its operation; it perishes with the contract; [emphasis added]
(5) in the former case, if the original contract has no legal existence, the arbitration clause also cannot operate, for along with the original contract, it is also void; in the latter case, as the original contract is extinguished by the substituted one, the arbitration clause of the original contract perishes with it; and
(6) between the two falls many categories of disputes in connection with a contract, such as the question of repudiation, frustration, breach, etc. In those cases, it is the performance of the contract that has come to an end, but the contract is still in existence for certain purposes in respect of disputes arising under it or in connection with it. As the contract subsists for certain purposes, the arbitration clause operates in respect of these purposes.
The Supreme Court ultimately held that the new contract entered into between the parties had superseded the earlier contracts entered into between the parties and as a result the arbitration clause postulated in the earlier contracts perished automatically. Even though, the ratio decidendi of the Court in the aforesaid case was limited to the validity of an arbitration agreement in a contract which was superseded by a new contract, the Court has clearly opined as obiter dicta that the existence of an arbitration clause is entirely dependent upon the existence of the contract, which can be argued as necessarily implying that an arbitration clause does not survive pursuant to bilateral termination of the contract.
In National Insurance Co. Ltd. v. Boghara Polyfab Pvt. Ltd.,[26]the Supreme Court, while deciding an insurance matter, framed the moot legal question as whether a dispute raised by an insured, after giving a full and final discharge voucher to the insurer, could be referred to arbitration. The disputes in the case arose around the discharge voucher issued by the National Insurance Co. Ltd. (appellant in this case) in favour of Boghara Polyfab whereby the appellant argued that Boghara Polyfab had accepted the payment offered in full and final settlement and therefore arbitration for any disputes arising thereafter was not arbitrable on account of discharge of the contract. In response, Boghara Polyfab argued that the discharge voucher was obtained by fraud and coercion.
A perusal of the judgment delivered by the Apex Court categorically highlights that the ratio decidendi of the case is in relation to the ambit of powers vested with the Chief Justice/his designate under section 11 of the Indian Arbitration and Conciliation Act, 1996. Nonetheless, the Supreme Court of India has in its obiter dicta opined about the consequences emanating from bilateral termination of contract as stated below:
We may next examine some related and incidental issues. Firstly, we may refer to the consequences of discharge of a contract. When a contract has been fully performed, there is a discharge of the contract by performance, and the contract comes to an end. In regard to such a discharged contract, nothing remains – neither any right to seek performance nor any obligation to perform. In short, there cannot be any dispute. Consequently, there cannot obviously be reference to arbitration of any dispute arising from a discharged contract. …
It is thus clear that the arbitration agreement contained in a contract cannot be invoked to seek reference of any dispute to arbitration, in the following circumstances, when the contract is discharged on account of performance, or accord and satisfaction, or mutual agreement, and the same is reduced to writing (and signed by both parties or by the party seeking arbitration): (a) Where the obligations under a contract are fully performed and discharge of the contract by performance is acknowledged by a full and final discharge voucher/receipt. Nothing survives in regard to such discharged contract. (b) Where the parties to the contract, by mutual agreement, accept performance of altered, modified and substituted obligations and confirm in writing the discharge of contract by performance of the altered, modified or substituted obligations. (c) Where the parties to a contract, by mutual agreement, absolve each other from performance of their respective obligations (either on account of frustration or otherwise) and consequently cancel the agreement and confirm that there is no outstanding claims or disputes.
5. THE NOTION OF SEVERABILITY ACROSS INTERNATIONAL JURISDICTIONS
The Austrian Arbitration Law Reform Act, 2006 is based on the UNCITRAL Model Law and follows the principles enshrined therein. However, during the course of adoption, Article 16 of the UNCITRAL Model Law, which lays down the theory of separability, was excluded from inclusion in the national legislation.[27]A perusal of the legislative history behind the enactment of the Austrian Arbitration Law indicates that the drafters of the statute took an extreme yet interesting view regarding the doctrine of separability and believed this doctrine to be “misleading, overly simplifying and alien to the general principles of Austrian law,”[28]thus, making Austria one of the only countries which does not have a provision in their national legislation with respect to separability of an arbitration agreement from the main contract. In the absence of an express provision and lack of reasoning provided by the Commission that drafted the Austrian Arbitration Act, the Austrian judiciary has played an important role in clarifying the law regarding separability.The Supreme Court of Austria, in its decision of 2015, gave a landmark judgment wherein it rejected the doctrine of separability by holding that the arbitration agreement is only ancillary to the main agreement.[29] As a consequence, an arbitration agreement is considered akin to any other clause in the underlying contract and therefore does not hold any special place in the contract. It is not the case that the existence of the arbitration agreement is contingent on the existence or fate of the main contract. The rationale behind the judgment of the Austrian Supreme Court as understood is centered around the intention of the parties with respect to the arbitration agreement. The Supreme Court of Austria, in its decision of 5 February 2008,[30] held that while an arbitration agreement may be treated as any other clause in the contract, its survival is contingent on the intention of the parties with respect to the arbitration agreement. Thus, the arbitration agreement will survive if the intention of the parties was to ensure it survives, and alternatively, the arbitration agreement will not survive if the parties did not intend for it to survive.The position of law in Austria, thus, reflects a unique position in international arbitration, wherein the fate of the underlying contract does not drive the fate of the arbitration agreement, but rather it is driven by the intention of the parties. Accordingly, where the parties intended for the arbitration agreement to survive the termination of the contract, it will survive the termination.
The law in Switzerland with regard to treatment of arbitration agreements after termination of the contract containing the agreement therein follows in the footsteps of Austria. Austria and Switzerland both believe that the termination of the contract containing the arbitration agreement shall not affect the arbitration agreement except in cases where an express intention to the effect can be shown.
The Swiss Code on Private International Law, 1987[31] lays the foundation for independence of the arbitration agreement from the underlying contract. Article 178[32] states that “the validity of an arbitration agreement may not be contested on the ground that the principal contract is invalid or that the arbitration agreement concerns a dispute not yet existing.” The provision indicates that the courts shall not entertain any challenge to the arbitration agreement stemming from the validity or invalidity. While the provision does not make any express mention of the status of an arbitration agreement during mutual termination of contract, however, it sets the basis for further expansion of the theory of separability to mutual termination of contracts. This is evinced by Judgment 4A_438/2013 of February 27, 2014, First Civil Law Court, wherein the court held that “the severability of the arbitration clause is a cornerstone of arbitration and if a contract provides that the rights and obligations of the parties cease at termination, this will not extend to the arbitration clause unless very specifically stated in the contract.” Similar observations were made by the Association Suisse de l’Arbitrage, who stated that the arbitration clause is independent of the underlying contract and in particular will survive the termination of the contract. [33]
Thus, it is clear that Switzerland also believes in the independence of the arbitration clause from the contract containing the clause.
The law governing arbitral proceedings in China is the Arbitration Law of China, 1994. The legislation is by far the most explicit amongst domestic legislations across the globe with respect to separability of arbitration agreements. Article 19 of the Act[34] states that “an arbitration agreement shall exist independently. The amendment, rescission, termination or invalidity of a contract shall not affect the validity of the arbitration agreement. The arbitration tribunal shall have the power to affirm the validity of a contract.”
Even in China, an arbitration agreement can exist independently of the underlying contract and shall continue to be valid even in cases wherein the underlying contract containing the arbitration agreement is mutually terminated.
5.4 Institutional and International Rules
The 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (“New York Convention”), the key document with respect to arbitral awards, does not provide any direct reference to the principle of autonomy of the arbitration agreement or its separability from the main contract. However, Article V of the New York Convention lays down grounds on which enforcement of awards may be refused. These grounds include invalidity of the arbitration agreement as per laws under which it was made, incapacity of the parties to arbitrate the matter, amongst others. This reflects the belief that it is indeed within the powers of the national legal system to determine whether the arbitration agreement is valid for enforcement or not.
Support with regard to autonomy of arbitration agreements can also be found in the UNCITRAL Arbitration Rules,[35] London Court of International Arbitration Rules,[36] as well as the International Chamber of Commerce Rules of Arbitration.[37]
In the authors’ view, it would be preferable in light of the detailed discussions above, that the Indian Legislature amends the law and expressly incorporates a provision similar to article 19 of the Arbitration Law of China, 1994, explicitly giving legal recognition to the obiter dicta of the Supreme Court as enunciated in the preceding paragraphs. However, one must remain sceptical as to whether the Indian Legislature will take the abovementioned suggested steps, as it rarely amends the Indian Arbitration and Conciliation Act, 1996 in view of purely legal conceptual concerns. Thus, for the time being, it would be apt for parties and practitioners to explicitly incorporate the theory of separability into their arbitration agreement. Any express intention of the parties with regard to the survivability of the arbitration agreement as a separate agreement irrespective of the existence of the main contract will in all likelihood be given due recognition by the courts of India.
[1] Gautam Mohanty is a registered Advocate in India and is currently working as an Arbitration Associate with Justice Deepak Verma, Former Judge of Supreme Court of India. [2] Raghav Bhargava has a keen interest in commercial arbitration and international humanitarian law. He has previously worked under Justice Deepak Verma, Former Judge of Supreme Court of India and has written for the Cambridge International Law Journal. [3] A. Ayyasamy v. A. Paramasivam, AIR 2016 SC 4675 (India). [4] Ashok Thapar v. Tarang Exports Pvt. Ltd., 2018 SCC OnLine Bom 1489 (India). [5]Mulheim Pipercoatings GmbH v. Welspun Fintrade Ltd. & Anr., (2014) 2 AIR Bom R 196 (India). [6] SMS Tea Estate (P) Ltd. v. Chandmari Tea Co. (P) Ltd. (2011) 14 SCC 66 (India). [7] Branch Manager, Magma Leasing & Finance Ltd. v. Potluri Madhavillata, (2009) 10 SCC 103 (India). [8] Ford Credit Kota Mahindra Ltd. v. M. Swaminathan, AIR 2005 Mad. 18 (India). [9] Harbour Assurance Co. (UK) Ltd. v. Kansa General Int’l Insurance Co. Ltd. [1993] 1 Lloyds Rep. 81 (QB). [10] Fiona Trust & Holding Corp. v. Privalov, [2007] 1 All E.R. (Comm.) 891 (English Ct. App.), aff’d [2007] UKHL 40 (HL). [11] The Court of Appeal relied in particular on L. Collins (ed.), Dicey, Morris and Collins on The Conflict of Laws ¶12-099 (14th ed. 2006), which approved the analysis in Prima Paint and subsequent U.S. decisions. [12] Hayman v. Darwins Ltd. [1942] A.C. 356 (HL). [13] Aiste Skylent, International Arbitration: The Doctrine of Separability and the Competence-competence Principle (Aarhus School of Business, May 2003) <http://pure.au.dk/portal/files/2372/000126197-126197.pdf> accessed 12 February 2019. [14] Arbitration and Conciliation Act 1996, s. 11(6A) (India). [15] LCIA Arbitration Rules, art. 23(1). [16] ICC Arbitration Rules, art. 6(4). [17] LCIA Arbitration Rules, art. 21(2). [18] Supra n. 11. [19] Alan Redfern and Martin Hunter, Redfern and Hunter on International Arbitration, 5th edn, OUP 2009) 117. [20] Union of India v. Kishorilal Gupta & Bros., AIR 1959 SC 1362 (India). [21] National Insurance Co. Ltd. v. Boghara Polyfab Pvt. Ltd., (2009) 1 SCC 267 (India). [22] State of Haryana v. Ranbir, AIR 2006 SC 1796 (India), para. 10. [23] Supra n. 18. [24] Ibid. para. 8. [25] Ibid. para. 10. [26] Supra n. 19. [27] M Nueber and G Zeiler, ‘Austria’ in S Balthasar (ed), International Commercial Arbitration 194 (C.H. Beck 2016). [28] Dietmar Czernich, Theory of Separability in Austrian Arbitration law: Is it on safe pillars?, 32 Arbitration International 463 (2018). [29] Supreme Court, 23 June 2015, 18 Cg1/15v, RdW 2016 (Austria). [30] Supreme Court, 5 February 2008, 10 Ob 120/07f (Austria). [31] Swiss Federal Code on Private International Law, 1987. [32] Ibid. art. 178. [33] Association Suisse de l’Arbitrage, Arbitration Clauses in Switzlerand (2016) <www.arbitration-ch.org/asset/.../arbitration-clauses-in-switzerland.pdf> accessed 14 March 2019. [34] Arbitration Law of China, 1994, art. 19. [35] 2010 UNCITRAL Arbitration Rules, arts. 16(1) and 21(2). [36] LCIA Arbitration Rules, art. 23(2). [37] Ibid. art. 6(9).