Recently a three-Judge Bench of the Supreme Court in N.N. Global Mercantile (P) Ltd. v. Indo Unique Flame Ltd. decided on the effect of an arbitration clause contained in a contract which requires to be stamped and clarified the law grounding on doctrine of separability of arbitration agreements from the underlying contract and also decided upon arbitrability of disputes involving fraud. The Supreme Court held:
“the allegations of fraudulent invocation of bank guarantee furnished under a substantive contract would be an arbitrable dispute, irrespective of whether the underlying contract regarding the arbitration was stamped or not.”
In addition to this, the Court further observed that any allegations of fraud being on non-arbitrable grounds is an entirely archaic view and has grown obsolete, and must be discarded.
Therefore, in this article the authors endeavour to examine the implication on arbitration agreement embedded in an unstamped contract as propounded in the present case and will also analyse the paradigm shift in the judicial pronouncements over the years making its way towards pro-arbitration proceedings.
II. Factual matrix
Indo Unique Flame Ltd. (hereinafter referred as “the respondent”) was awarded a work order dated 18-9-2015 by Karnataka Power Corporation Ltd. (hereinafter referred as “KPCL”) and in pursuance to the same a bank guarantee was furnished for Rs 29.29 crores in favour of KPCL through State Bank of India. Subsequently, the respondent entered into a sub-contract with N.N. Global Mercantile Pvt. Ltd. (hereinafter referred as “the appellant”) which contained an arbitration clause in respect of transportation of coal from its washery to the stockyard, siding, coal handling and loading into the wagons. As per Clause 9 of the sub-contract, the appellant furnished a bank guarantee in favour of the respondent.
Under the principal contract, certain dispute arose between the respondent and KPCL which led to the invocation of bank guarantee by KPCL and as a result, the bank guarantee furnished by the appellant was also invoked. Being aggrieved by such invocation, the appellant filed a suit against the respondent and State Bank of India before the Commercial Court at Nagpur praying for a pronouncement that the respondent was not entitled to encash the bank guarantee furnished under the sub-contract as it was a conditional guarantee. The Commercial Court hereinafter directed status quo to be maintained with respect to the enforcement of the bank guarantee.
The respondent filed an application under Section 8 of the Arbitration and Conciliation Act, 1996 (hereinafter referred as the “the Act, 1996”) seeking reference of disputes to arbitration. The Commercial Court rejected the application holding that the bank guarantee was an independent contract. The order of the Commercial Court was challenged by the respondent by filing a writ petition in the Bombay High Court. The High Court held that it was the admitted position that there was an arbitration agreement between the parties and therefore the application under Section 8 of the Act, 1996 was maintainable.
The decision of the High Court allowing the application for seeking arbitration was appealed against before the Supreme Court. The issue dealt by the Supreme Court was:
a) Whether an arbitration agreement would be enforceable and acted upon, even if the work order is unstamped and unenforceable under the Stamp Act?
b) Whether allegation of the fraudulent invocation of the bank guarantee is an arbitrable dispute?
c) Whether a writ petition under Articles 226 and 227 of the Constitution would be maintainable to challenge an order rejecting an application for reference to arbitration under Section 8 of the Act, 1996.
III. Law prior to N. Global
The Stamp Act, 1899 (hereinafter referred as “the Stamp Act”) requires stamp duty to be collected on the execution of specific documents. Section 33 of the Stamp Act imposes a duty on the courts to examine an instrument on whether it is duly stamped or not.
33. Examination and impounding of instruments.—
(1) Every person having by law or consent of parties, authority to receive evidence, and every person in charge of a public office, except an officer of police, before whom any instrument, chargeable, in his opinion, with duty, is produced or comes in the performance of his functions, shall, if it appears to him that such instrument is not duly stamped, impound the same.
(2) For that purpose every such person shall examine every instrument so chargeable and so produced or coming before him, in order to ascertain whether it is stamped with a stamp of value and description required by the law in force in India when such instrument was executed or first executed.
Further Section 35 of the Stamp Act envisages that any contract not duly stamped is not admissible as evidence in the court of law. The relevant portion of Section 35 is mentioned herein below:
Instruments not duly stamped inadmissible in evidence, etc.—No instrument chargeable with duty shall be admitted in evidence for any purpose by any person having by law or consent of parties authority to receive evidence, or shall be acted upon, registered or authenticated by any such person or by any public officer, unless such instrument is duly stamped:
(a) any such instrument shall, be admitted in evidence on payment of the duty with which the same is chargeable, or, in the case of an instrument insufficiently stamped, of the amount required to make up such duty, together with a penalty of five rupees, or, when ten times the amount of the proper duty or deficient portion thereof exceeds five rupees, of a sum equal to ten times such duty or portion;
Therefore, in view of the provisions of Section 35 of the Stamp Act, unless the stamp duty and penalty due in respect of the instrument is paid, the court cannot act upon the said instrument.
The issue whether a contract containing an arbitration clause which is not duly stamped as per the provisions of Sections 33 and 35 of the Stamp Act be enforceable and can be acted upon by the parties has been widely debated in recent years. The Supreme Court in its various judicial pronouncements over the years have discussed the concept of non-stamping of an agreement containing an arbitration clause and thereby its effect on the validity of the said arbitration clause.
The Supreme Court in SMS Tea Estates (P) Ltd. v. Chandmari Tea Co. (P) Ltd. inter alia addressed the applicability of the provisions of the Stamp Act and considered the issue whether an arbitration agreement in an unregistered and unstamped lease deed, which required compulsory registration under Sections 17 and 19 of the Registration Act, 1908, was valid and enforceable. While considering the issue the Court held that:
When a contract contains an arbitration agreement, it is a collateral term relating to the resolution of disputes, unrelated to the performance of the contract. It is as if two contracts—one in regard to the substantive terms of the main contract and the other relating to resolution of disputes—had been rolled into one, for purposes of convenience….
- Having regard to Section 35 of the Stamp Act, unless the stamp duty and penalty due in respect of the instrument paid, the court cannot act upon the instrument, which means that it cannot act upon the arbitration agreement which is part of the instrument.
Thereafter, in Garware Wall Ropes Ltd v. Coastal Marine Constructions and Engg. Ltd. the Supreme Court dealt with the question whether the courts can appoint an arbitrator under Section 11 of the Act, 1996 when the underlying agreement containing the arbitration clause is insufficiently stamped. While reiterating the ruling of SMS Tea Estates, the Court in Garware Wall Ropes Ltd., rejected the argument that an arbitration clause in an agreement ought to be considered an agreement independent of the agreement of which such arbitration clause is a part and held that:
… It is important to remember that the Stamp Act applies to the agreement or conveyance as a whole. Therefore, it is not possible to bifurcate the arbitration clause contained in such agreement or conveyance so as to give it an independent existence, as has been contended by the respondent.
The Court further held that a harmonious reading of the provisions of the Stamp Act and the Contract Act, 1872 would suggest that in the event an agreement is not duly stamped, then it cannot be said to be a valid agreement.
Recently, the Supreme Court in Dharmaratnakara Rai Bahadur Arcot Narainswamy Mudaliar Chattram and other Charities v. Bhaskar Raju and Bros. again reiterated the settled law of SMS Tea Estates and held:
… if the court comes to a conclusion that the instrument is not properly stamped, it should be impounded and dealt with, in the manner specified in Section 38 of the Stamp Act, 1899. Further, the Court stated that the court cannot act upon such a document or the arbitration clause therein.
Therefore, the Supreme Court in the aforesaid precedents laid down the principle that if a contract containing an arbitration clause is not duly stamped as per the provisions of Sections 33 and 35 of the Stamp Act, then such contract shall be unenforceable till the payment of the requisite stamp duty and the arbitration clause contained in the said contract cannot be invoked by the parties.
However, the Supreme Court in the present case revisited the law on the issue of validity, existence and enforceability of an arbitration agreement in an unstamped document and overruled two major judgments i.e. SMS Tea Estates (P) Ltd. and Garware Wall Ropes Ltd.
IV. The paradigm shift in the judicial pronouncements
The Supreme Court in the earlier two judgments erred while deciding the implication of arbitration agreements in unstamped documents by positioning the law that an arbitration clause contained in a contract would exist as a matter of law only if the underlying contract is duly stamped. However, in the present case, the Court had gone a step further and delved into the shift of the approach of the Court from increased judicial intervention to pro-arbitration. The Court primarily focused in the following issues:
A. Arbitration agreement as an independent agreement
The Supreme Court in the present case held that it is well settled in arbitration jurisprudence that an arbitration agreement is a separate and distinct agreement, which is independent from the substantive commercial contract in which it is imbedded. This is based on the premise that when parties enter into a commercial contract containing arbitration clause, they are entering into two separate agreements viz. the substantive contract which contains the rights and obligations of the parties arising from the commercial transaction and secondly, the arbitration agreement which contains the binding obligation of the parties to resolve their disputes through mode of arbitration.
The Supreme Court further held that the autonomy of arbitration agreement is based on the twin concept of separability and kompetenz-kompetenz.
(i) The doctrine of separability
The doctrine of separability of the arbitration agreement connotes that the invalidity, ineffectiveness or termination of the substantive commercial contract would not affect the validity of the arbitration agreement, except if the arbitration agreement itself is directly impeached on the ground that the arbitration agreement is void ab initio. It embraces that the arbitration clause is separable from the rest of the contract and an assertion that the latter is invalid does not prevent the arbitrators from ruling on the validity of the former. Article 16(1) of the UNCITRAL Model Law on International Commercial Arbitration incorporates the doctrine of separability which positions that:
…an arbitration clause which forms part of a contract shall be treated as an agreement independent of the other terms of the contract. A decision by the arbitral tribunal that the contract is null and void shall not entail ipso jure the invalidity of the arbitration clause.
Similarly, the Act, 1996 is based on the Model Law and also recognises the principle of separability of arbitration clause and consequently, allows parties to elect the substantive law of the entire contract as different from the law governing the arbitration agreement. The Bombay High Court in Mulheim Pipecoatings GmbH v. Welspun Fintrade Ltd. formulated the principles of the doctrine of separability and held that “for an arbitration agreement to be null and void, requires a direct impeachment of the arbitration agreement and not simply a parasitical impeachment based on a challenge to the validity or enforceability of the main agreement”.
The Supreme Court in National Agriculture Coop. Mktg. Federation (India) Ltd. v. Gains Trading Ltd., while observing the doctrine of separability held:
“the validity of contract and the arbitration clause should be treated independently from the main contract. Moreover, if a contract becomes null and void, the arbitration clause shall not be understood in the same context as void.”
(ii) The doctrine of kompetenz-kompetenz
This principle states that the Arbitral Tribunal has the competence to determine and rule on its own jurisdiction, including issues of existence, validity and scope of arbitration agreement in the first instance which is subject to judicial scrutiny by the courts at a larger stage of the proceedings. The principle of kompetenz-kompetenz has two aspects i.e. firstly an authentication to the arbitrators to decide the jurisdiction without the help of the court and secondly, the Arbitral Tribunal gets an upper hand to decide the issue first before the Court interferes. It has been noted over the years that the doctrine of kompetenz-kompetenz has evolved to minimise judicial intervention at the pre-reference stage and reduce challenges raised on the issue of jurisdiction of the Arbitral Tribunal. The said doctrine has also been recognised under Section 16(1)(a) of the Act, 1996 which categorically states that an arbitration clause which forms part of a contract shall be treated as an agreement independent of the other terms of the contract.
In Olympus Superstructures (P) Ltd. v. Meena Vijay Khetan, it was observed that under the Act, 1996 the Arbitral Tribunal is vested with powers under Section 16(1) to rule on its own jurisdiction including ruling on any objection with respect to its existence or validity of arbitration agreement and for that purpose the arbitration clause which forms part of the contract shall be treated as an agreement independent of any terms of the contract and any decision of the Arbitral Tribunal that the contract is null and void shall not entail ipso jure the invalidity of the arbitration clause.
The Supreme Court while continuing to accept the principle of kompetenz-kompetenz, in Uttarakhand Purv Sainik Kalyan Nigam Ltd. v. Northern Coal Field Ltd., held that the scope of jurisdiction under Section 11(6-A) was confined to the examination of the existence of the arbitration agreement at the preference stage. In view of the legislative mandate contained in Section 11(6-A), the Court is now required only to examine the existence of the arbitration agreement. All other preliminary or threshold issues are left to be decided by the arbitrator under Section 16 which enshrines the kompetenz-kompetenz principle.
B. Non-payment of stamp duty does not invalidate the main contract
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. 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, the Supreme Court in the present case held that the non-payment or deficiency of stamp duty on the work order does not invalidate the main contract. It further held that Section 34 provides that an unstamped instrument would not be admissible in evidence, or be acted upon till the requisite stamp duty is paid. This would amount only to a deficiency curable on the payment of the requisite stamp duty and would not invalidate the main contract. 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.
The Court clarified that where an application is filed under Section 8 of the Act, 1996 before judicial authority for reference of disputes to arbitration, the judicial authority would make the reference to arbitration. 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 in the present judgment has thus clarified the prerequisites for referring a case to arbitration on disputes involving unstamped contracts. The Court while expanding the scope of doctrine of separability emphasises that the arbitration agreement is an independent contract and non-compliance of the provisions of Sections 33 and 35 of the Stamp Act does not invalidate arbitration agreement and the non-stamping of the same will amount only to a deficiency curable on the payment of the requisite stamp duty at a later stage. The Court also pointed out that an arbitration agreement is not included in the Schedule as an instrument chargeable to stamp duty under the Maharashtra Stamp Act, 1958. It can be inferred from the judgment that the intention of the Court to expand the scope of the utilisation of the principle of separability was to minimise judicial intervention at the pre-reference stage and reduce challenges raised on the issue of invocation of arbitration agreement. Hence, it can be concluded that the Court have taken a pro-arbitration stance to not impede the arbitral process and benefit parties who intent to settle the matter through arbitration.
* Principal Associate, Hammurabi and Solomon Partners.
** Associate, Hammurabi and Solomon Partners.
 Supra Note 4, pp. 72-73.
 Supra Note 4.
Supra Note 7, p. 232.
 Supra Note 4.
 Supra Note 4, p. 74.
 Supra Note 4.
 Supra Note 7.
 United Nations Commission on International Trade Law, UNCITRAL Model Law on International Commercial Arbitration. http://www.scconline.com/DocumentLink/q0V16q1A, <https://www.uncitral.org/pdf/english/texts/arbitration/ml-arb/07-86998_Ebook.pdf>, 1985.
Dr Mukesh Kumar Malviya, Jurisdictional Issues in International Arbitration with Special Reference to India, Bharati Law Review, Jan-March 2017, <http://docs.manupatra.in/newsline/articles/Upload/03D471A1-CEC8-46DC-8E27-A42DC5D09E7C.pdf>.