The Indian Supreme Court in Ellora Paper Mills: Hindsight is 20/15?

The Supreme Court of India has retrospectively applied a prohibition inserted by a 2015 amendment, where employees of a party cannot be appointed as arbitrators, to arbitrations commenced even before the amendment.

In Ellora Paper Mills v. State of M.P.,[1] the Supreme Court (Court) held that a tribunal comprised entirely of officers of the State had “lost its mandate” by virtue of the 2015 amendment (2015 amendment) to the Arbitration and Conciliation Act, 1996 (Act), which inter alia prevents appointing arbitrators who are the employees, consultants, or advisors, or persons that have any other past or present business relationship with a party to the dispute.

A reading of the judgment suggests that the Court premised its ruling on the fact that the underlying arbitration did not technically commence because the State had obtained a stay on proceedings from the Madhya Pradesh High Court. Therefore, the arbitration was deemed to have commenced after the 2015 amendment, due to which the judgment does not strictly apply the 2015 amendment retrospectively. However, as we explain below, obtaining a stay on proceedings presupposes that those proceedings have commenced. On that basis, this decision could serve as precedent for extending the 2015 amendment retrospectively.

The 2015 amendment inserted Section 12(5) and the Fifth, Sixth, and Seventh Schedules to the Act. Under Section 12(5), persons who fall within the Seventh Schedule are ineligible to act as arbitrators, unless the parties by way of express agreement waive the disqualification after the dispute arises. Besides the appointment of employees or consultants, other examples of such ineligibilities include having a significant financial interest in the outcome of the case, or being a lawyer in the same law firm which is representing one of the parties.

Under Section 12 of the Act, an arbitrator must disclose grounds that may give rise to “justifiable doubts” about his impartiality and independence. The grounds for this purpose are mentioned in the Fifth Schedule. Some of these grounds (namely, Entries 1-19) also appear in the Seventh Schedule, which governs when an arbitrator becomes ineligible for appointment. There is a commonality of grounds in the Fifth and Seventh Schedules for the sole purpose of ensuring that the grounds in the Seventh Schedule are made aware to the parties by the arbitrator due to her obligations in the Fifth Schedule. In this sense, the 2015 amendment creates a dichotomy between grounds that may give rise to justifiable doubts, which become the subject of a challenge to the arbitrator, and grounds in the Seventh Schedule that automatically render an arbitrator ineligible and terminate her mandate.

The Fifth and Seventh Schedules are inspired by the IBA Guidelines on the Conflicts of Interest in International Arbitration (IBA Guidelines), issued by the International Bar Association (IBA). However, they depart from the IBA Guidelines on the point of waiver. Unlike the IBA Guidelines, the proviso to Section 12(5) allows parties to waive the ineligibility in the Seventh Schedule after a dispute arises by way of an express agreement in writing.

In its judgment in Ellora Paper Mills[2], the Court ruled that because the Arbitral Tribunal constituted to hear the underlying dispute was composed of employees of the State, they became ineligible after the 2015 amendment, thereby terminating their mandate. Therefore, the Court ruled that the Tribunal could not continue, and a fresh arbitrator had to be appointed as per the Act.

The Court’s decision is a useful consolidation of the various rulings on Section 12(5) of the Act, and serves as a reminder for parties to assess whether arbitration agreements concluded before the various amendments to the Act need a rethink in light of the changing legal landscape. However, the decision’s impact on arbitrations commenced before the 2015 amendment is worrisome, as it has the potential effect of: (1) applying this substantive retrospectively (although, as discussed below this is based on the court’s interpretation that the arbitration did not “commence” before 2015 – which we argue is not accurate); and (2) compelling pre-amendment arbitrations to start afresh by reconstituting the Tribunal—to the extent the Tribunal has become ineligible and loses its mandate to act—even if the arbitration is at an advanced stage.

Facts

At the heart of controversy is a government tender issued by the State of Madhya Pradesh for the supply of specialised paper for the year 1993-1994. Ellora Paper Mills (Ellora) bid successfully and was awarded a contract through a supply order.

Subsequently, Ellora remonstrated that the State did not honour its payment obligations under the contract and had also rejected some consignments without justification. The State informed Ellora that the paper supplied did not conform to its specifications and could not be utilised.

From 1994 onwards, Ellora filed a variety of civil actions against the State. One of these was a civil suit for the recovery of money. The State approached the civil court under Section 8 of the Act, seeking a stay of the civil proceeding and requesting that the parties be referred to arbitration. The civil court rejected this application. On appeal, the Madhya Pradesh High Court in 2000 referred the parties to arbitration. A tribunal called the “Stationery Purchase Committee” was then constituted in the same year. It comprised of five officers of the State, including Deputy Secretary, Department of Revenue, Deputy Secretary, General Administration Department, and Deputy Secretary, Department of Finance.

Between 2000 and 2019, the arbitration did not progress in view of Ellora’s numerous objections to the Tribunal’s jurisdiction and consequent litigation on the matter. Ultimately, in 2019 Ellora filed an application before the Madhya Pradesh High Court under Section 14 (failure or impossibility to act) read with Sections 11 (appointment of arbitrators) and 15 (termination of mandate and substitution of arbitrator) of the Act. It requested that a new tribunal be constituted, as the Stationery Purchase Committee had become ineligible pursuant to the 2015 amendment inserting Section 12(5) in the Act.

Before the High Court, Ellora argued that because the nominated arbitrators were all employees of the State, they were hit by the ineligibility in Entry 1 of the Seventh Schedule of the Act, which bars an arbitrator from being an employee, consultant, advisor or having any other past or present business relationship with a party. By reason of their ineligibility, Ellora asserted that the ineligible arbitrators could not appoint their replacement arbitrators either.

The High Court rejected Ellora’s application. It relied on the Supreme Court’s decisions in BCCI v. Kochi Cricket (P) Ltd.[3] and Union of India v. Parmar Construction Co.,[4] where the Court had ruled that provisions of the 2015 amendment will not apply to arbitral proceedings commenced before the 2015 amendment unless the parties otherwise agreed. In this case, the High Court ruled that the prohibition in Section 12(5) read with the Seventh Schedule­—inserted by the 2015 amendment—preventing a party from appointing its own employees to an Arbitral Tribunal did not apply to the arbitration, as it had commenced before the 2015 amendment. Ellora appealed this decision to the Court.

Arguments by the parties

Before the court, Ellora argued that in the absence of an express agreement in writing to continue with the arbitration proceedings, the mandate of the Stationery Purchase Committee had terminated after the insertion of Section 12(5) of the Act.

In response, the State argued that since the Arbitral Tribunal was constituted in 2000, Section 12(5) would not apply. The State asserted that the 2015 amendment, which was brought into effect from 23-10-2015 did not have retrospective application.

The Court’s decision

The Court observed that though the Tribunal was formed in 2000, there was no real progress in the arbitration due to the various litigations initiated by Ellora, which culminated in a stay granted by the Madhya Pradesh High Court from 2001 to 2017. “[T]he fact remains”, the Court said, that “no further steps whatsoever have been taken in the arbitration proceedings and therefore technically it cannot be said that the arbitration proceedings by (the Stationery Purchase Committee) has commenced”.

Accepting that the Arbitral Tribunal—comprising officers of the State—were hit by the disqualification in Section 12(5) read with Entry 1 in the Seventh Schedule of the Act, the Court ruled that all the members had become ineligible to continue as arbitrators. When the arbitration clause is found to be foul with the amended provision, the appointment of arbitrators would be “beyond the pale of the arbitration agreement”, empowering a court to appoint an arbitrator as may be permissible, the Court ruled.

 

As a result, the Court ruled that a fresh arbitrator had to be appointed under the provisions of the Act. It set aside the decision of the High Court. Interestingly, instead of remanding the matter to the High Court for appointing a fresh arbitrator, the Court went ahead and appointed its own choice of an arbitrator (retired Justice Abhay Manohar Sapre). It did so because the dispute was pending for over 21 years.

Comment

The Court in Ellora Paper Mills[5] engaged on the limited legal question (for the first time) of whether an ineligibility, when it exists, applies to arbitration proceedings initiated before the 2015 amendment. Previous decisions, though sharing the commonality of a contract concluded before the 2015 amendment, were nevertheless in respect of arbitration proceedings commenced after the 2015 amendment. The implications of the judgment in Ellora Paper Mills[6] on arbitral proceedings before the 2015 amendment are worrisome and against business prudence.

(1) 2015 amendment given retrospective applicability without legal basis

Firstly, the Court said because the arbitration did not progress since 2000, the arbitration proceedings did not “technically” commence.[7] This finding, it may be argued, can be looked at differently since Ellora could have never obtained a stay on proceedings that did not commence at all. Therefore, the Court’s observation that the arbitration did not “technically” commence is contrary to the stay having been granted.

At any rate, the court seems to have relied on the nascent stage of the underlying arbitration to make the ineligibility in Section 12(5) read with the Seventh Schedule applicable to members of the Arbitral Tribunal, by virtue of their relationship with the State. While this ruling is correct in attempting to remedy the wrongs that the Fifth and Seventh Schedules to the Act aim to redress, it allows a subsequent judicial forum to halt arbitral proceedings at an advanced stage and appoint a new arbitrator if a party petitions to have the Tribunal’s mandate terminated retrospectively on applying the standards of the 2015. This would seriously hamper the efficacy of the previous proceedings and would require the whole dispute to be heard afresh. One way to distinguish this case is the Court ruled as it did since it found that the arbitral proceedings had not commenced and therefore that they are deemed to have been commenced after 2015. However, as described above, this finding is also open to other interpretations.

The Court’s reliance on previous decisions on Section 12(5) to arrive at its ruling deserves some inspection.

By way of background, the genesis of the legal discussion surrounding Section 12(5) is in two decisions of the Court in Voestalpine Schienen GmbH v. Delhi Metro Rail Corpn. Ltd.[8] and HRD Corpn. v. GAIL (India) Ltd.[9] In these cases, the Court characterised an arbitrator’s ineligibility in the Seventh Schedule as one which goes to the “root of the appointment”. This is because the arbitrator’s ineligibility is by operation of law, and renders her without any inherent jurisdiction to continue. In such cases, the Court ruled that a challenge to the arbitrator (or the Tribunal) is not needed. An aggrieved party needs to instead file an application under Section 14(2) of the Act, which deals with an application to a court for terminating an arbitrator’s mandate.

In TRF Ltd. v. Energo Engg. Projects Ltd.[10] (TRF) the Court considered whether the Managing Director of a party designated as an appointing authority, and subsequently rendered ineligible under Section 12(5) read with the Seventh Schedule could then nominate an arbitrator as his/her replacement. The Court invoked the maxim qui facit per alium facit per se (what one does through another is done by oneself), and ruled that the nomination of an arbitrator by an ineligible arbitrator would be tantamount to the ineligible arbitrator carrying on the arbitration herself. This was not allowed.

Subsequently, in Bharat Broadband Network Ltd. v. United Telecoms Ltd.,[11] (BBNL) the Court ruled that the decision in TRF[12] does not save appointments by ineligible managing directors even if such appointments were made before the judgment in TRF.[13] Both TRF[14] and BBNL[15] are decisions where the contract was concluded before the 2015 amendment but the dispute itself arose after the 2015 amendment.

At this juncture, it is noteworthy to mention that the proviso to Section 12(5) allows parties to waive an arbitrator’s ineligibility once the dispute arises “by an express agreement in writing”. Interpreting these words, the Court in BBNL[16] said the requirement under Section 12(5) is to have an express agreement in writing, which disallows implied agreements (or conduct) such as filing a statement of claim in the arbitration. In any case, the Court added, party autonomy in waiving the ineligibility under Section 12(5) by express agreement “is to be respected only in certain exceptional situations” such as family arbitrations or situations where the ineligible person commands blind faith by both parties to the dispute.

In Jaipur Zila Dugdh Utpadak Sahkari Sangh Ltd. v. Ajay Sales & Suppliers[17] the Court considered whether the chairman of one of the parties could act as a sole arbitrator in the dispute. The contract in this case was also before the 2015 amendment, but disputes arose after the 2015 amendment. Observing that since an arbitrator derives her power of appointment from the arbitration agreement, if the arbitration agreement itself becomes contrary to law, the Court said the ineligible arbitrator can no longer continue to act. In such cases, it would be appropriate for a party to approach a court and have a replacement arbitrator appointed.

On facts, the Court in Jaipur Zila Dugdh[18] ruled that a chairman would be ineligible under the Seventh Schedule since he (i) has a business relationship with one of the parties to the dispute; (ii) has a controlling influence over one of the parties; and (iii) represents or advises one of the parties or their affiliates.

 

In Ellora Paper Mills[19], the contract and arbitration were both before the 2015 amendment—a unique factual matrix not seen in TRF[20], BBNL[21], or Jaipur Zila Dugdh[22]. Yet the Court relied on these three decisions and extended the 2015 amendment to an arbitration proceeding commenced before the 2015 amendment. While it is true that an arbitrator becomes ineligible by virtue of the 2015 amendment, the question before the Court was whether that ineligibility would operate in the arbitration in question, commenced several years prior in time. The Court ruled that it did on the basis that the underlying arbitration never commenced because of the stay order. However, the Court did not engage any further on whether its ruling meant all pre-2015 amendment arbitrations would now expose themselves to the 2015 amendment.

The applicability of the 2015 amendment to arbitral proceedings, while the subject of some initial controversy, is now a settled question in view of the judgment in BCCI v. Kochi Cricket (P) Ltd.[23] where the Court ruled that the 2015 amendment applies prospectively to arbitral proceedings i.e. to arbitrations commencing after 23-10-2015, which is the date when the 2015 amendment came into effect. As for court proceedings relating to arbitration proceedings, the Court ruled that the 2015 amendment would apply to all court proceedings even if initiated before the 2015 amendment.

The Government sought to nullify this ruling through the Arbitration and Conciliation (Amendment) Act, 2019, which inserted a new Section 87 that provided that (unless the parties agreed otherwise) the 2015 amendments would apply prospectively to all arbitral and court proceedings commenced after 23-10-2015 and not otherwise. The Court struck this down as unconstitutional in Hindustan Construction Co. Ltd. v. Union of India.[24] As a result, the position in BCCI[25] is the law today.

Therefore, the judgment in Ellora Paper Mills[26] read in the context of these cases seems to be a deviation from the effect of the ruling in BCCI[27]. Both BCCI[28] and Ellora Paper Mills[29] were rendered by two-Judge Benches. Section 26 of the 2015 amendment is also designed to apply prospectively since it states, “Nothing contained in the (2015 amendment) shall apply to the arbitral proceedings commenced, in accordance with the provisions of Section 21 of (the Act) unless the parties otherwise agree….”

The only remaining issue on the retrospective applicability of the 2015 amendment to arbitral proceedings is when can parties said to have agreed to make the amendment applicable to their arbitration. Case law suggests that the standard of proof for such an agreement is high. For example, S.P. Singla Constructions (P) Ltd. v. State of H.P.[30] ruled that a contractual clause that said any statutory modifications or re-enactments to the Arbitration Act, 1940 shall also apply to the arbitration proceedings under that clause were itself not sufficient to make the 2015 amendment to Section 12(5) applicable to arbitral proceedings commenced in 2013. The Court in Ellora Paper Mills[31] did not consider that commencing an arbitration before the 2015 amendment was itself evidence that the parties did not intend to make the 2015 amendment apply to their arbitration.

(2) Amending existing arbitration agreements and powers of the court as an appellate forum

Nevertheless, Ellora Paper Mills[32] and the judgments it relies on has an important commercial implication. Arbitration agreements, particularly in government contracts, concluded before 2015 may still stipulate the appointment of an arbitrator in contravention of the Seventh Schedule.

Where a party believes it would not prefer to waive this disqualification in future, it must initiate negotiations to amend the arbitration clause and bring it in line with the Act. This would save a lot of legal costs and precious time after a dispute arises.

Section 14 of the Act inter alia says an arbitrator’s mandate terminates if he becomes de jure unable to perform his functions. The effect of case law on Section 12(5) read with the Seventh Schedule is an ineligible arbitrator becomes de jure unable to perform his functions, consequently seeing his mandate terminated. If the parties disagree on this fact that the mandate is terminated, they can apply to a court under Section 14 to receive a judicial decision on this point.

Another important aspect of Ellora Paper Mills[33] is the Court’s decision to appoint a replacement arbitrator itself, instead of remanding the case to the Madhya Pradesh High Court. The Court cites the sheer delay in proceedings as a ground for exercising its powers (presumably under Article 142 of the Indian Constitution) to appoint a replacement arbitrator.[34] This is a welcome move, as it shows the Court’s willingness to exercise its powers as an appellate forum to do justice.

(3) Impact of Ellora Paper Mills on government maintained panels of arbitrators

In Voestalpine Schienen GmbH v. Delhi Metro Rail Corpn. Ltd.[35] (DMRC case) the arbitration clause stipulated that the Delhi Metro Rail Corporation would forward names of five persons from a 31-member panel it maintains to the other party, which would then have to choose its nominee arbitrator from the shortlisted names. The other party challenged this procedure on grounds that the panel comprises of government employees who did not qualify as independent arbitrators.

The Court said the fact that one of the members of the panel was a government employee did not by itself make the person ineligible under Section 12(5), as such persons would possess the necessary technical background to decide the case. The true test was whether such a panel member could be treated as an employee or consultant or advisor of the Delhi Metro Rail Corporation specifically.

As a result, maintaining a panel of arbitrators is not disallowed under the scheme of Section 12(5) of the Act. Nevertheless, the Court in its judgment in the DMRC[36] observed that it is not appropriate for the other party to have been given only five names from a larger pool of 31 names. The Court also said the scope of the panel ought to be expanded, with even retired private sector technical persons as well as persons with a legal background brought under its ambit.

Government contracts today are likely to contain arbitration clauses that fall foul of the prohibition in Section 12(5) read with the Seventh Schedule. As a final takeaway, these clauses should be amended to address the rulings of the series of judgments culminating with Ellora Paper Mills[37] and to address the observations in the DMRC[38]. In particular, clauses that specify designations of government employees as arbitrators can no longer remain, unless those arbitrators are employees of a different government department. Equally, a panel of arbitrators maintained by a government department (or the Government itself) must be diverse, and should allow the opposite party scope to select from a wide pool of people.

Conclusion

The importance of choosing a technically qualified arbitrator can never be overstated. However, the law installs some protections to prevent a party, especially when it is a government entity, from breaching the rule against bias by appointing their own employee, consultant or advisor or anyone with a past business relationship as an arbitrator. While applying this welcome change in Indian law however, care should be taken such that its impact does not unsettle past arbitrations. Of course in this case, the Court was trying to correct a historical long and galvanise a slow moving arbitration – this however should not be read to mean that all pre-amendment arbitrations would now open themselves up to the rigours of the 2015 amendment standards on appointment. A fine balance in this regard has to be maintained to apply these changes even handedly.


† Partner at Cyril Amarchand Mangaldas.

†† Associate at Cyril Amarchand Mangaldas.

[1] 2022 SCC OnLine SC 8.

[2] 2022 SCC OnLine SC 8.

[3] (2018) 6 SCC 287.

[4] (2019) 15 SCC 682.

[5] 2022 SCC OnLine SC 8.

[6] 2022 SCC OnLine SC 8.

[7] 2022 SCC OnLine SC 8, Para 6

[8] (2017) 4 SCC 665.

[9] (2018) 12 SCC 471.

[10] (2017) 8 SCC 377.

[11] (2019) 5 SCC 755.

[12] (2017) 8 SCC 377.

[13] (2017) 8 SCC 377.

[14] (2017) 8 SCC 377.

[15] (2019) 5 SCC 755.

[16] (2019) 5 SCC 755.

[17] 2021 SCC OnLine SC 730.

[18] 2021 SCC OnLine SC 730.

[19] 2022 SCC OnLine SC 8.

[20] (2017) 8 SCC 377.

[21] (2019) 5 SCC 755.

[22] 2021 SCC OnLine SC 730.

[23] (2018) 6 SCC 287.

[24] (2020) 17 SCC 324 : 2019 SCC OnLine SC 1520.

[25] (2018) 6 SCC 287.

[26] 2022 SCC OnLine SC 8.

[27] (2018) 6 SCC 287.

[28] (2018) 6 SCC 287.

[29] 2022 SCC OnLine SC 8.

[30] (2019) 2 SCC 488.

[31] 2022 SCC OnLine SC 8.

[32] 2022 SCC OnLine SC 8.

[33] 2022 SCC OnLine SC 8.

[34] 2022 SCC OnLine SC 8, Para 11.

[35] (2017) 4 SCC 665.

[36] (2017) 4 SCC 665.

[37] 2022 SCC OnLine SC 8.

[38] (2017) 4 SCC 665.

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