Monday, 21 December 2020

Supreme Court: Parameters which the court should follow while referring the dispute to arbitration


Civil Appeal No. 2402 of 2019, 

Decided On: 14.12.2020

Vidya Drolia and Ors. Vs.  Durga Trading Corporation and Ors.

Hon'ble Judges/Coram:

N.V. Ramana, Sanjiv Khanna and Krishna Murari, JJ.

Citation: MANU/SC/0939/2020

Read full judgment here: Click here

 The courts at the referral stage do not perform ministerial functions. They exercise and perform judicial functions when they decide objections in terms of Sections 8 and 11 of the Arbitration Act. Section 8 prescribes the courts to refer the parties to arbitration, if the action brought is the subject of an arbitration agreement, unless it finds that prima facie no valid arbitration agreement exists. 

Prima facie case in the context of Section 8 is not to be confused with the merits of the case put up by the parties which has to be established before the arbitral tribunal. It is restricted to the subject matter of the suit being prima facie arbitrable under a valid arbitration agreement. Prima facie case means that the assertions on these aspects are bona fide. When read with the principles of separation and competence-competence and Section 34 of the Arbitration Act, referral court without getting bogged-down would compel the parties to abide unless there are good and substantial reasons to the contrary.

87. Prima facie examination is not full review but a primary first review to weed out manifestly and ex facie non-existent and invalid arbitration agreements and non-arbitrable disputes. The prima facie review at the reference stage is to cut the deadwood and trim off the side branches in straight forward cases where dismissal is barefaced and pellucid and when on the facts and law the litigation must stop at the first stage. Only when the court is certain that no valid arbitration agreement exists or the disputes/subject matter are not arbitrable, the application Under Section 8 would be rejected. At this stage, the court should not get lost in thickets and decide debatable questions of facts. Referral proceedings are preliminary and summary and not a mini trial. 

 If the challenge requires the production and review of factual evidence, the court should normally refer the case to arbitration, as arbitrators have, for this purpose, the same resources and expertise as courts. Where questions of mixed law and fact are concerned, the court hearing the referral application must refer the case to arbitration unless the questions of fact require only superficial consideration of the documentary evidence in the record.

86. Before departing from the general Rule of referral, the court must be satisfied that the challenge to the arbitrator's jurisdiction is not a delaying tactic and that it will not unduly impair the conduct of the arbitration proceeding. This means that even when considering one of the exceptions, the court might decide that to allow the arbitrator to Rule first on his or her competence would be best for the arbitration process.

92. We now proceed to examine the question, whether the word 'existence' in Section 11 merely refers to contract formation (whether there is an arbitration agreement) and excludes the question of enforcement (validity) and therefore the latter falls outside the jurisdiction of the court at the referral stage. On jurisprudentially and textualism it is possible to differentiate between existence of an arbitration agreement and validity of an arbitration agreement. Such interpretation can draw support from the plain meaning of the word "existence'. However, it is equally possible, jurisprudentially and on contextualism, to hold that an agreement has no existence if it is not enforceable and not binding. Existence of an arbitration agreement presupposes a valid agreement which would be enforced by the court by relegating the parties to arbitration. An agreement evidenced in writing has no meaning unless the parties can be compelled to adhere and abide by the terms. A party cannot sue and claim rights based on an unenforceable document. Thus, there are good reasons to hold that an arbitration agreement exists only when it is valid and legal. A void and unenforceable understanding is no agreement to do anything. Existence of an arbitration agreement means an arbitration agreement that meets and satisfies the statutory requirements of both the Arbitration Act and the Contract Act and when it is enforceable in law.Existence and validity are intertwined, and arbitration agreement does not exist if it is illegal or does not satisfy mandatory legal requirements. Invalid agreement is no agreement.

 The court is not powerless and would not act beyond jurisdiction, if it rejects an application for reference, when the arbitration Clause is admittedly or without doubt is with a minor, lunatic or the only claim seeks a probate of a Will.

(iii) Most scholars and jurists accept and agree that the existence and validity of an arbitration agreement are the same. Even Starvos Brekoulakis accepts that validity, in terms of substantive and formal validity, are questions of contract and hence for the court to examine.

(iv) Most jurisdictions accept and require prima facie review by the court on non-arbitrability aspects at the referral stage.

(v) Sections 8 and 11 of the Arbitration Act are complementary provisions as was held in Patel Engineering Ltd. The object and purpose behind the two provisions is identical to compel and force parties to abide by their contractual understanding. This being so, the two provisions should be read as laying down similar standard and not as laying down different and separate parameters. Section 11 does not prescribe any standard of judicial review by the court for determining whether an arbitration agreement is in existence. Section 8 states that the judicial review at the stage of reference is prima facie and not final. Prima facie standard equally applies when the power of judicial review is exercised by the court Under Section 11 of the Arbitration Act. Therefore, we can read the mandate of valid arbitration agreement in Section 8 into mandate of Section 11, that is, 'existence of an arbitration agreement'.

(vi) Exercise of power of prima facie judicial review of existence as including validity is justified as a court is the first forum that examines and decides the request for the referral. Absolute "hands off" approach would be counterproductive and harm arbitration, as an alternative dispute resolution mechanism. Limited, yet effective intervention is acceptable as it does not obstruct but effectuates arbitration.

(vii) Exercise of the limited prima facie review does not in any way interfere with the principle of competence- competence and separation as to obstruct arbitration proceedings but ensures that vexatious and frivolous matters get over at the initial stage.

(viii) Exercise of prima facie power of judicial review as to the validity of the arbitration agreement would save costs and check harassment of objecting parties when there is clearly no justification and a good reason not to accept plea of non-arbitrability. 

The interpretation appropriately balances the allocation of the decision-making authority between the court at the referral stage and the arbitrators' primary jurisdiction to decide disputes on merits. The court as the judicial forum of the first instance can exercise prima facie test jurisdiction to screen and knockdown ex facie meritless, frivolous and dishonest litigation. Limited jurisdiction of the courts ensures expeditious, alacritous and efficient disposal when required at the referral stage.

93. Section 43(1) of the Arbitration Act states that the Limitation Act, 1963 shall apply to arbitrations as it applies to court proceedings. Sub-section (2) states that for the purposes of the Arbitration Act and Limitation Act, arbitration shall be deemed to have commenced on the date referred to in Section 21. Limitation law is procedural and normally disputes, being factual, would be for the arbitrator to decide guided by the facts found and the law applicable. The court at the referral stage can interfere only when it is manifest that the claims are ex facie time barred and dead, or there is no subsisting dispute. All other cases should be referred to the arbitral tribunal for decision on merits. 

95. Accordingly, we hold that the expression 'existence of an arbitration agreement' in Section 11 of the Arbitration Act, would include aspect of validity of an arbitration agreement, albeit the court at the referral stage would apply the prima facie test on the basis of principles set out in this judgment. In cases of debatable and disputable facts, and good reasonable arguable case, etc., the court would force the parties to abide by the arbitration agreement as the arbitral tribunal has primary jurisdiction and authority to decide the disputes including the question of jurisdiction and non-arbitrability.

(a) Ratio of the decision in Patel Engineering Ltd. on the scope of judicial review by the court while deciding an application Under Sections 8 or 11 of the Arbitration Act, post the amendments by Act 3 of 2016 (with retrospective effect from 23.10.2015) and even post the amendments vide Act 33 of 2019 (with effect from 09.08.2019), is no longer applicable.

(b) Scope of judicial review and jurisdiction of the court Under Section 8 and 11 of the Arbitration Act is identical but extremely limited and restricted.

(c) The general Rule and principle, in view of the legislative mandate clear from Act 3 of 2016 and Act 33 of 2019, and the principle of severability and competence-competence, is that the arbitral tribunal is the preferred first authority to determine and decide all questions of non-arbitrability. The court has been conferred power of "second look" on aspects of non-arbitrability post the award in terms of Sub-clauses (i), (ii) or (iv) of Section 34(2)(a) or Sub-clause (i) of Section 34(2)(b) of the Arbitration Act.

The court by default would refer the matter when contentions relating to non-arbitrability are plainly arguable; when consideration in summary proceedings would be insufficient and inconclusive; when facts are contested; when the party opposing arbitration adopts delaying tactics or impairs conduct of arbitration proceedings. This is not the stage for the court to enter into a mini trial or elaborate review so as to usurp the jurisdiction of the arbitral tribunal but to affirm and uphold integrity and efficacy of arbitration as an alternative dispute resolution mechanism.

At first blush, the Court seems to have read the existence of the arbitration agreement by limiting the examination to an examination of its factual existence. However, that is not so, as the existence of arbitration agreement does not mean anything unless such agreement is contractually valid. This view is confirmed by the Duro Felguera case (supra), wherein the reference to the contractual aspect of arbitration agreement is ingrained under the Section 7 analysis. A mere agreement is not legally binding, unless it satisfies the core contractual requirements, concerning consent, consideration, legal relationship, etc. In Mayavati Trading Case (supra) and Garware Wall Ropes Ltd. v. Coastal Marine Construction and Engineering Ltd., MANU/SC/0511/2019 : [2019] 9 SCC 209, the aforesaid stand has been confirmed. Therefore, the scope of the Court to examine the prima facie validity of an arbitration agreement includes only the determination of the following:

92. Whether the arbitration agreement was in writing? or

93. Whether the arbitration agreement was contained in exchange of letters, telecommunication, etc?

94. Whether the core contractual ingredients qua the arbitration agreement were fulfilled?

95. On rare occasions, whether the subject-matter of dispute is arbitrable?

N.V. Ramana, J.

99. I have had the advantage of reading in advance the opinion of my learned Brother Justice Sanjiv Khanna. The present matters deal with a very important aspect in the arbitration jurisprudence in this country, which necessitate a separate opinion.

At the cost of repetition, we note that Section 8 of the Act mandates that a matter should not be referred to an arbitration by a court of law unless it finds that prima facie there is no valid arbitration agreement. The negative language used in the Section is required to be taken into consideration, while analyzing the Section. The Court should refer a matter if the validity of the arbitration agreement cannot be determined on a prima facie basis, as laid down above. Therefore, the Rule for the Court is 'when in doubt, do refer'.

168. Moreover, the amendment to Section 8 now rectifies the short-comings pointed out in the Chloro Control Case (supra) with respect to domestic arbitration. Jurisdictional issues concerning whether certain parties are bound by a particular arbitration, under group-company doctrine or good faith, etc., in a multi-party arbitration raises complicated factual questions, which are best left for the tribunal to handle. The amendment to Section 8 on this front also indicates the legislative intention to further reduce the judicial interference at the stage of reference.

169. Courts, while analyzing a case Under Section 8, may choose to identify the issues which require adjudication pertaining to the validity of the arbitration agreement. If the Court cannot Rule on the invalidity of the arbitration agreement on a prima facie basis, then the Court should stop any further analysis and simply refer all the issues to arbitration to be settled.

171. We are cognizant of the fact that the statutory language of Section 8 and 11 are different, however materially they do not vary and both Sections provide for limited judicial interference at reference stage.

173. Before we part, the conclusions reached, with respect to question No. 1, are:

a. Sections 8 and 11 of the Act have the same ambit with respect to judicial interference.

b. Usually, subject matter arbitrability cannot be decided at the stage of Sections 8 or 11 of the Act, unless it's a clear case of deadwood.

c. The Court, Under Sections 8 and 11, has to refer a matter to arbitration or to appoint an arbitrator, as the case may be, unless a party has established a prima facie (summary findings) case of non-existence of valid arbitration agreement, by summarily portraying a strong case that he is entitled to such a finding.

d. The Court should refer a matter if the validity of the arbitration agreement cannot be determined on a prima facie basis, as laid down above, i.e., 'when in doubt, do refer'.

e. The scope of the Court to examine the prima facie validity of an arbitration agreement includes only:

a. Whether the arbitration agreement was in writing? or

b. Whether the arbitration agreement was contained in exchange of letters, telecommunication etc?

c. Whether the core contractual ingredients qua the arbitration agreement were fulfilled?

d. On rare occasions, whether the subject-matter of dispute is arbitrable?

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