The Hon’ble Supreme Court (“SC”) has in its judgment dated January 4, 2022 (“Judgment”), in the matter of Ellora Paper Mills Limited v. The State of Madhya Pradesh [Civil Appeal No. 7697 of 2021] held that an arbitral tribunal constituted in violation of the neutrality clause under Section 12(5) of the Arbitration and Conciliation Act, 1996 (“Act”) will lose its mandate and cannot be given effect.

Facts

The State of Madhya Pradesh (“Respondent”) had issued a tender for supply of cream wove paper and duplicating paper for the year 1993 to 1994. Ellora Paper Mills Limited (“Appellant“) participated in the tender process and was awarded the contract by way of a supply order dated September 22, 1993. Thereafter, a dispute arose when the Respondent did not make 90% of the payments as per the terms of the contract for the paper supplied by the Appellant and rejected some consignments without providing any justifications and subsequently by a letter dated November 15, 1993, the Respondent informed the Appellant that the paper supplied did not conform to their specifications.

The Appellant filed a civil suit in the Civil Court, Bhopal, seeking the relief of permanent injunction against the Respondent, restraining it from awarding the contract to a third party. However, the suit had become infructuous since the Respondent had already awarded the contract to a third party. Thereafter, the Appellant filed another suit before the Civil Court to recover Rs. 95,32,103, and in the said suit the Respondent preferred an application under Section 8 of the Act and sought a stay of proceedings on the ground that there existed an arbitration clause in the contract between the Appellant and the Respondent. However, the said application was rejected by the Civil Court. The Respondent filed a revision petition before the Madhya Pradesh High Court (“HC”) and the parties were referred to arbitration by the Stationery Purchase Committee (“Arbitral Tribunal”) comprising officers of the Respondent.

The Appellant filed its objections to the constitution of the Arbitral Tribunal and also challenged its jurisdiction by filing an application under Section 13 of the Act, which was rejected. Thereafter, the Appellant filed another application under Section 14 read with Sections 11 and 15 of the Act before the HC seeking termination of the mandate of originally constituted Arbitral Tribunal and for appointment of a new arbitrator. The Appellant, relying on Section 12 (5) of the Act, submitted that since all the members of the Arbitral Tribunal were employees of the Respondent, a new Arbitral Tribunal had to be constituted.

However, the HC dismissed the application filed by the Appellant and held that since Section 12(5) of the Act was made effective from October 23, 2015 and was introduced through the Arbitration and Conciliation (Amendment) Act, 2015 (“Amendment Act, 2015”), it cannot have retrospective operation in the arbitration proceedings already commenced prior to the Amendment Act, 2015, unless the parties otherwise agree (“Impugned Judgment”). Being aggrieved by the Impugned Judgment, the Appellant filed the present appeal before the SC (“Appeal”).

Issue

• Whether the Arbitral Tribunal consisting of the officers of the Respondent had lost its mandate as per Section 12 (5) read with the Seventh Schedule of the Act.
• Whether a fresh arbitrator had to be appointed as per the Act.

Arguments

Contentions raised by the Appellant:

It was contended that the Impugned Judgment was contrary to the decision of the SC in Jaipur Zila Dugdh Utpadak Sahkari Sangh Limited v. Ajay Sales & Suppliers [AIR 2021 SC 4869] and that the continuation of the Arbitral Tribunal consisting of the officers of the Respondent would frustrate the object and purpose of the Amendment Act, 2015, by which Section 12(5) read with the Seventh Schedule was inserted to keep in check the impartiality and neutrality of the arbitrators. It was further contended that the HC erred in observing that the arbitration proceedings had commenced since there was a stay granted by the HC and the earlier members of the Arbitral Tribunal had already retired. Hence, it could not be claimed that the arbitration proceedings had commenced and that further steps were taken by the Arbitral Tribunal.

In view of the above, it was submitted that the members of the Arbitral Tribunal had lost their mandate as per Section 12(5) of the Act and were ineligible to continue as members of the Arbitral Tribunal and therefore a fresh arbitral tribunal was to be constituted.

Contentions raised by the Respondent:

It was submitted that the Arbitral Tribunal was constituted in the year 2000, and Section 12(5) read with the Seventh Schedule of the Act was inserted into the statute with effect from October 23, 2015. Therefore, it would not be retrospectively applicable in the present factual background, as had been held in the Impugned Judgment.

It was further submitted that the decision of the SC in Jaipur Zila Dugdh Utpadak Sahkari Sangh Limited (supra) was not applicable since in the aforementioned case, the arbitrator was appointed after the Amendment Act, 2015. However, in the present case, the arbitrator was appointed approximately 20 years prior thereto and thereafter the arbitration proceedings commenced and the Appellant had also participated.

Observations of the Supreme Court

The SC observed that the Arbitral Tribunal was constituted in the year 2001 as per the agreement entered into between the parties, however, the arbitration proceedings could not commence due to the proceedings initiated by the Appellant. In the meanwhile, the officers of the originally constituted Arbitral Tribunal had also retired. Hence, the SC was of the view that given the circumstances, technically the arbitration proceedings had not commenced.

The SC by placing reliance on Jaipur Zila Dugdh Utpadak Sahkari Sangh Limited (supra) and Bharat Broadband Network Limited v. United Telecoms Limited [(2019) 5 SCC 755], further observed that Section 12 of the Act was amended by Amendment Act, 2015 based on the recommendations of the Law Commission, which specifically dealt with the issue of neutrality of arbitrators. To achieve the main purpose for amending the provision, Section 12(5) of the Act specifically provides that when an arbitration clause is found to be foul with the amended provision, the appointment of the arbitrator would be outside the scope of the arbitration agreement, empowering the court to appoint such an arbitrator as may be permissible and the other party cannot insist upon the appointment of the arbitrator in terms of the arbitration agreement. When the party appointing an adjudicator is the State, the duty to appoint an impartial and independent adjudicator is that much more onerous and the right to natural justice cannot be said to have been waived only on the basis of a “prior” agreement between the parties at the time of the contract and before arising of the disputes.

Decision of the Supreme Court

In view of the above, the SC held that the Arbitral Tribunal comprising of officers of the Respondent had lost its mandate in view of Section 12(5) read with Seventh Schedule of the Act. Considering that the dispute between the parties was pending since the year 2000, instead of remanding the matter back to the HC, the SC decided to appoint a former Judge of the SC as the new arbitrator.

VA View:
In this Judgment, the SC considered and relied upon its earlier decisions and emphasised that independence and impartiality of an arbitrator are the hallmarks of any arbitration proceedings and the rule against bias is a fundamental principle of natural justice. When an arbitrator is appointed in terms of a contract and by parties to the contract, he is required to be independent of the parties. Thus, where the balance between the principles of natural justice and binding nature of the contract between the parties is considered, party autonomy cannot be stretched beyond the requirement of impartial and independent adjudicators for resolution of disputes.

Hence, the principles of impartiality and independence cannot be abandoned at any stage of the proceedings, more importantly at the stage of constitution of the arbitral tribunal, and it would be implausible to consider that the autonomy of the party can be exercised in disregard of these principles even if the same was agreed prior to the disputes arising between the parties.

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